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1SolutionsManualCorporateFinanceRoss,Westerfield,andJaffe9theditionCHAPTER1INTRODUCTIONTOCORPORATEFINANCEAnswerstoConceptQuestions1.Inthecorporateformofownership,theshareholdersaretheownersofthefirm.Theshareholderselectthedirectorsofthecorporation,whointurnappointthefirm‘smanagement.Thisseparationofownershipfromcontrolinthecorporateformoforganizationiswhatcausesagencyproblemstoexist.Managementmayactinitsownorsomeoneelse‘sbestinterests,ratherthanthoseoftheshareholders.Ifsucheventsoccur,theymaycontradictthegoalofmaximizingthesharepriceoftheequityofthefirm.22.Suchorganizationsfrequentlypursuesocialorpoliticalmissions,somanydifferentgoalsareconceivable.Onegoalthatisoftencitedisrevenueminimization;i.e.,providewhatevergoodsandservicesareofferedatthelowestpossiblecosttosociety.Abetterapproachmightbetoobservethatevenanot-for-profitbusinesshasequity.Thus,oneansweristhattheappropriategoalistomaximizethevalueoftheequity.3.Presumably,thecurrentstockvaluereflectstherisk,timing,andmagnitudeofallfuturecashflows,bothshort-termandlong-term.Ifthisiscorrect,thenthestatementisfalse.4.Anargumentcanbemadeeitherway.Attheoneextreme,wecouldarguethatinamarketeconomy,allofthesethingsarepriced.Thereisthusanoptimallevelof,forexample,ethicaland/orillegalbehavior,andtheframeworkofstockvaluationexplicitlyincludesthese.Attheotherextreme,wecouldarguethatthesearenon-economicphenomenaandarebesthandledthroughthepoliticalprocess.Aclassic(andhighlyrelevant)thoughtquestionthatillustratesthisdebategoessomethinglikethis:―Afirmhasestimatedthatthecostofimprovingthesafetyofoneofitsproductsis$30million.However,thefirmbelievesthatimprovingthesafetyoftheproductwillonlysave$20millioninproductliabilityclaims.Whatshouldthefirmdo?‖5.Thegoalwillbethesame,butthebestcourseofactiontowardthatgoalmaybedifferentbecauseofdifferingsocial,political,andeconomicinstitutions.6.Thegoalofmanagementshouldbetomaximizethesharepriceforthecurrentshareholders.Ifmanagementbelievesthatitcanimprovetheprofitabilityofthefirmsothatthesharepricewillexceed$35,thentheyshouldfighttheofferfromtheoutsidecompany.Ifmanagementbelievesthatthisbidderorotherunidentifiedbidderswillactuallypaymorethan$35persharetoacquirethecompany,thentheyshouldstillfighttheoffer.However,ifthecurrentmanagementcannotincreasethevalueofthefirmbeyondthebidprice,andnootherhigherbidscomein,thenmanagementisnotactingintheinterestsoftheshareholdersbyfightingtheoffer.Sincecurrentmanagersoftenlosetheirjobswhenthecorporationisacquired,poorlymonitoredmanagershaveanincentivetofightcorporatetakeoversinsituationssuchasthis.37.Wewouldexpectagencyproblemstobelesssevereinothercountries,primarilyduetotherelativelysmallpercentageofindividualownership.Fewerindividualownersshouldreducethenumberofdiverseopinionsconcerningcorporategoals.Thehighpercentageofinstitutionalownershipmightleadtoahigherdegreeofagreementbetweenownersandmanagersondecisionsconcerningriskyprojects.Inaddition,institutionsmaybebetterabletoimplementeffectivemonitoringmechanismsonmanagersthancanindividualowners,basedontheinstitutions‘deeperresourcesandexperienceswiththeirownmanagement.8.TheincreaseininstitutionalownershipofstockintheUnitedStatesandthegrowingactivismoftheselargeshareholdergroupsmayleadtoareductioninagencyproblemsforU.S.corporationsandamoreefficientmarketforcorporatecontrol.However,thismaynotalwaysbethecase.Ifthemanagersofthemutualfundorpensionplanarenotconcernedwiththeinterestsoftheinvestors,theagencyproblemcouldpotentiallyremainthesame,orevenincreasesincethereisthepossibilityofagencyproblemsbetweenthefundanditsinvestors.9.Howmuchistoomuch?Whoisworthmore,RayIraniorTigerWoods?Thesimplestansweristhatthereisamarketforexecutivesjustasthereisforalltypesoflabor.Executivecompensationisthepricethatclearsthemarket.Thesameistrueforathletesandperformers.Havingsaidthat,oneaspectofexecutivecompensationdeservescomment.Aprimaryreasonexecutivecompensationhasgrownsodramaticallyisthatcompanieshaveincreasinglymovedtostock-basedcompensation.Suchmovementisobviouslyconsistentwiththeattempttobetteralignstockholderandmanagementinterests.Inrecentyears,stockpriceshavesoared,somanagementhascleanedup.Itissometimesarguedthatmuchofthisrewardissimplyduetorisingstockpricesingeneral,notmanagerialperformance.Perhapsinthefuture,executivecompensationwillbedesignedtorewardonlydifferentialperformance,i.e.,stockpriceincreasesinexcessofgeneralmarketincreases.10.Maximizingthecurrentsharepriceisthesameasmaximizingthefuturesharepriceatanyfutureperiod.Thevalueofashareofstockdependsonallofthefuturecashflowsofcompany.Anotherwaytolookatthisisthat,barringlargecashpaymentstoshareholders,theexpectedpriceofthestockmustbehigherinthefuturethanitistoday.Whowouldbuyastockfor$100todaywhenthesharepriceinoneyearisexpectedtobe$80?4CHAPTER2FINANCIALSTATEMENTSANDCASHFLOWAnswerstoConceptsReviewandCriticalThinkingQuestions1.True.Everyassetcanbeconvertedtocashatsomeprice.However,whenwearereferringtoaliquidasset,theaddedassumptionthattheassetcanbequicklyconvertedtocashatornearmarketvalueisimportant.2.Therecognitionandma