Chapter 1 CFIN6
Chapter 1 Solutions
1-1 Finance deals with decisions about money. Finance decisions deal with how money is raised and used
by businesses, governments, and individuals. In business, decisions about cash inflows include for what
price products should be sold, how funds should be raised when the firms has good investment
opportunities, and so forth; decisions about cash outflows include what expenses must be incurred, which
investments should be purchased, and so forth.
1-3 The value of a firm can be measured by the market value of its stock. Thus, the firm maximizes
value/wealth by maximizing the value of its stock.
1-4 Value is measured as the present value of the cash flows that an investment is expected to generate
during its life. The three factors that determine value are: (1) the amount of the future cash flows, (2) the
timing of the future cash flows, and (3) investors’ required rate of return. If the amount of the cash flows
increases, the cash flows are received sooner, investors’ required rate of return decreases, or any
combination of these events occur, the value of an investment will increase.
1-6 Such factors as a compensation system that is based on management performance (bonuses tied to
profits, stock option plans) as well as the possibility of being removed from office (voted out of office, an
unfriendly tender offer by another firm) serve to keep management’s focus on stockholders’ interests. If a
firm is taken over, or acquired, by another firm, generally top management is let go. To help ensure that
they are not in this position, management should take steps to make the firm is operated as efficient as
possible. Efficient firms generally are priced correctly in the financial markets, thus are not takeover
targets.
Chapter 1 CFIN6
increases the chances of going bankrupt. The effects of the use of debt, called “financial leverage,” are
spelled out in detail in Chapter 16.
1-10 Firms “go international” for many reason, including to seek new markets, to get access to raw materials,
to avoid political hurdles, to name a few. Taking into account differential labor costs abroad, transportation,
tax advantages, and so forth, U.S. corporations can maximize long-run profits. There are also nonprofit
behavioral and strategic considerations, such as maximizing market share and enhancing the prestige of
corporate officers.
1-12 The general areas of study in finance include: (1) financial markets and institutions, which includes the
study of the roles of banks, credit unions, and other financial organizations in the financial markets; (2)
investments, which focuses on how investments are valued and selected to be included in portfolios; (3)
financial services, which refers to the area of study that deals with the management of money, primarily
for individuals; and (4) managerial finance, which deals with how firms make decisions about their cash
flows, both inflows and outflows.
Simply stated, finance deals with how firms generate and use funds. To do a good job, people must
understand how all four of the areas of finance are related. For example, publicly-traded firms raise money
in the financial markets, which means financial managers must understand the financial markets.
Likewise, persons who work in the financial markets must understand the needs of publicly-traded firms
and of investors to ensure they are offering the right financial products.
Chapter 1 CFIN6
1-14 Hybrid forms of business have been created over the years as the result of the needs of businesspeople
and investors. The hybrid forms of business generally include the advantages of partnerships and
corporations in one business. As business operations change in the future, so too will the structure of
business organizations.
1-15 Ethics refers to the attitude and behavior that a firm applies when dealing with stakeholders. A firm must
consider all of its stakeholders—that is, investors, customers, employees, local community, environment,
and so forth—when conducting business; otherwise it will not stay in business for very long. For example,
1-16 A firm must consider all of its stakeholders—that is, investors, customers, employees, local community,
environment, and so forth—when conducting business; otherwise it will not stay in business for very long.
1-17 The corporate structure of foreign firms generally is characterized by greater concentration in ownership,
which often means more involvement in ownership and operations by large lenders, such as banks and
other financial institutions, and by large groups or families. In many instances, this means that banks,
other financial institutions, and ownership groups can meet most or all of the financing needs of a firm. In
the United States, on the other hand, banks and financial institutions are restricted in the amounts of
Chapter 1 CFIN6
1-18 Stockholder wealth maximization is a long-run goal. Companies, and consequently the stockholders,
prosper when management makes decisions that will produce long-term increases in earnings. Actions
1-19 (a) Agency problems should not exist in a proprietorship, because there is only one owner, who
generally is the sole decision maker. The owner operates the business in a fashion that will improve
his or her own welfare. Thus, the owner can do whatever makes him or her happy, even if such
actions are harmful to the business.
1-20 The statement is not valid in every instance. Clearly, there are cases in which a firm’s stock price has
declined as the result of managerial decisions that were not in the best interest of shareholders. However,
the stock prices of firms are also based on external factors, including economic conditions. In a poor
economy, the stock prices of most companies decline even when management is making decisions that
are considered in the best interests of their shareholders.