Solutions Manual For l l
Fundamentals of Corporate
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Finance with Islamic Finance
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(Custom Edition for MEA) 1e
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Stephen Ross l l
Custom Edition Chapters Extracted from 13th USA Edition
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th
Fundamentals of Corporate Finance 13 edition
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Ross, Westerfield, and Jordan
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Prepared by l
BradJordan
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Joe Smolira l
All Chapters Solutions Manual Supplement files download
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link at the end of this file.
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,CHAPTER 1 l
INTRODUCTION TO CORPORATE l l
FINANCE
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Answers to Concepts Review and Critical Thinking Questions
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1. Capital budgeting (deciding whether to expand a manufacturing plant), capital structure (deciding
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whether to issue new equity and use the proceeds to retire outstanding debt), and working capital
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management (modifying the firm’s credit collection policy with its customers).
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2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, difficulty in raising l l l l l l l l l l l
capital funds. Some advantages: simpler, less regulation, the owners are also the managers, sometimes
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personal tax rates are better than corporate tax rates.
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3. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed
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earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to
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raise capital, and unlimited life.
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4. In response to Sarbanes-Oxley, small firms have elected to go dark because of the costs of compliance.The
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costs to comply with Sarbox can be several million dollars, which can be a large percentage of a small
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firm’s profits. A major cost of going dark is less access to capital. Since the firm is no longer publicly
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traded, it can no longer raise money in the public market. Although the company will still have access to
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bank loans and the private equity market, the costs associated with raising funds in these markets are
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usually higher than the costs of raising funds in the public market.
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5. The treasurer’s office and the controller’s office are the two primary organizational groups that report
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directly to the chief financial officer. The controller’s office handles cost and financial accounting, tax
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management, and management information systems, while the treasurer’s office is responsible for cashand
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credit management, capital budgeting, and financial planning. Therefore, the study of corporate finance
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is concentrated within the treasury group’s functions.
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6. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly traded
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or not).
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7. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders electthe
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directors of the corporation, who in turn appoint the firm’s management. This separation of ownership
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from control in the corporate form of organization is what causes agency problems to exist.Management
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may act in its own or someone else’s best interests, rather than those of the shareholders. If such events
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occur, they may contradict the goal of maximizing the share price of the equity of the firm.
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8. A primary market transaction.
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,2 SOLUTIONS MANUAL
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9. In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to match
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buyers and sellers of assets. Dealer markets like NASDAQ consist of dealers operating at dispersed
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locales who buy and sell assets themselves, communicating with other dealers either electronically or
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literally over-the-counter.
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10. Such organizations frequently pursue social or political missions, so many different goals are
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conceivable. One goal that is often cited is revenue minimization; that is, provide whatever goods and
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services are offered at the lowest possible cost to society. A better approach might be to observe that even
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a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximizethe value
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of the equity.
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11. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, both l l l l l l l l l l l l l l l l
short-term and long-term. If this is correct, then the statement is false.
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12. An argument can be made either way. At the one extreme, we could argue that in a market economy,all of
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these things are priced. There is thus an optimal level of, for example, ethical and/or illegal behavior, and
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the framework of stock valuation explicitly includes these. At the other extreme, we could argue that
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these are noneconomic phenomena and are best handled through the political process.A classic (and highly
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relevant) thought question that illustrates this debate goes something like this: “A firm has estimated that
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the cost of improving the safety of one of its products is $30 million. However, the firm believes that
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improving the safety of the product will only save $20 million in product liability claims. What should
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the firm do?”
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13. The goal will be the same, but the best course of action toward that goal may be different because of
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differing social, political, and economic institutions.
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14. The goal of management should be to maximize the share price for the current shareholders. If
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management believes that itcan improve the profitability of thefirmso that the share price will exceed
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$35, then they should fight the offer from the outside company. If management believes that this bidder or
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other unidentified bidders will actually pay more than $35 per share to acquire the company, then they
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should still fight the offer. However, if the current management cannot increase the value of the firm
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beyond the bid price, and no other higher bids come in, then management is not acting in the interests of
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the shareholders by fighting the offer. Since current managers often lose their jobs when the corporation
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is acquired, poorly monitored managers have an incentive to fight corporate takeoversin situations such as
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15. We would expect agency problems to be less severe in countries with a relatively small percentage of
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individual ownership. Fewer individual owners should reduce the number of diverse opinions
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concerning corporate goals. The high percentage of institutional ownership might lead to a higher degree
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of agreement between owners and managers on decisions concerning risky projects. In addition,institutions
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may be better able to implement effective monitoring mechanisms on managers than can individual
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owners, based on the institutions’ deeper resources and experiences with their own management. The
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increase in institutional ownership of stock in the United States and the growing activism of these large
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shareholder groups may lead to a reduction in agency problems for U.S. corporations and a more
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efficient market for corporate control.
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16. How much is too much? Who is worth more, Mark Parker or LeBron James? The simplest answer is that
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there is a market for executives just as there is for all types of labor. Executive compensation is the price
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that clears the market. The same is true for athletes and performers. Having said that, one aspect of
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executive compensation deserves comment. A primary reason executive compensation has grown so
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dramatically is that companies have increasingly moved to stock-based compensation. Suchmovement is
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obviously consistent with the attempt to better align stockholder and management interests. In recent
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years, stock prices have soared, so management has cleaned up. It is sometimes argued that much of this
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reward is due to rising stock prices in general, not managerial performance. Perhaps in the future,
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executive compensation will be designed to reward only differential performance, that is, stock price
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increases in excess of general market increases.
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