Solution Manual For Corporate Finance 12th Edition Stephen Ross Randolph Westerfield Jeffrey Jaffe Bradford Jordan 3
Solution Manual For Corporate Finance 12th Edition Stephen Ross Randolph Westerfield Jeffrey Jaffe Bradford Jordan 3
Solutions Manual
Corporate Finance
03/13/2019
Prepared by:
Brad Jordan
University of Kentucky
Joe Smolira
Belmont University
CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concept Questions
1. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect
the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership from control in the corporate form of organization is what causes agency problems to exist.
Management may act in its own or someone else’s best interests, rather than those of the shareholders.
If such events occur, they may contradict the goal of maximizing the share price of the equity of the
firm.
2. Such organizations frequently pursue social or political missions, so many different goals are
conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and
services are offered at the lowest possible cost to society. A better approach might be to observe that
even a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximize
the value of the equity.
3. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows,
both short-term and long-term. If this is correct, then the statement is false.
4. An argument can be made either way. At the one extreme, we could argue that in a market economy,
all of these things are priced. There is thus an optimal level of, for example, ethical and/or illegal
behavior, and the framework of stock valuation explicitly includes these. At the other extreme, we
could argue that these are non-economic phenomena and are best handled through the political process.
A classic (and highly relevant) thought question that illustrates this debate goes something like this:
“A firm has estimated that the cost of improving the safety of one of its products is $30 million.
However, the firm believes that improving the safety of the product will only save $20 million in
product liability claims. What should the firm do?”
5. The goal will be the same, but the best course of action toward that goal may be different because of
differing social, political, and economic institutions.
6. The goal of management should be to maximize the share price for the current shareholders. If
management believes that it can improve the profitability of the firm so that the share price will exceed
$35, then they should fight the offer from the outside company. If management believes that this
bidder, or other unidentified bidders, will actually pay more than $35 per share to acquire the company,
then they should still fight the offer. However, if the current management cannot increase the value of
the firm beyond the bid price, and no other higher bids come in, then management is not acting in the
interests of the shareholders by fighting the offer. Since current managers often lose their jobs when
the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers
in situations such as this.
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7. We would expect agency problems to be less severe in other countries, primarily due to the relatively
small percentage of individual ownership. Fewer individual owners should reduce the number of
diverse opinions concerning corporate goals. The high percentage of institutional ownership might
lead to a higher degree of agreement between owners and managers on decisions concerning risky
projects. In addition, institutions may be better able to implement effective monitoring mechanisms
on managers than can individual owners, based on the institutions’ deeper resources and experiences
with their own management.
8. The increase in institutional ownership of stock in the United States and the growing activism of these
large shareholder groups may lead to a reduction in agency problems for U.S. corporations and a more
efficient market for corporate control. However, this may not always be the case. If the managers of
the mutual fund or pension plan are not concerned with the interests of the investors, the agency
problem could potentially remain the same, or even increase, since there is the possibility of agency
problems between the fund and its investors.
9. How much is too much? Who is worth more, Larry Ellison or Tiger Woods? The simplest answer is
that there is a market for executives just as there is for all types of labor. Executive compensation is
the price that clears the market. The same is true for athletes and performers. Having said that, one
aspect of executive compensation deserves comment. A primary reason executive compensation has
grown so dramatically is that companies have increasingly moved to stock-based compensation. Such
movement is obviously consistent with the attempt to better align stockholder and management
interests. In recent years, stock prices have soared, so management has cleaned up. It is sometimes
argued that much of this reward is due to rising stock prices in general, not managerial performance.
Perhaps in the future, executive compensation will be designed to reward only differential
performance, i.e., stock price increases in excess of general market increases.
10. Maximizing the current share price is the same as maximizing the future share price at any future
period. The value of a share of stock depends on all of the future cash flows of company. Another way
to look at this is that, barring large cash payments to shareholders, the expected price of the stock must
be higher in the future than it is today. Who would buy a stock for $100 today when the share price in
one year is expected to be $80?
CHAPTER 2
ACCOUNTING STATEMENTS, TAXES,
AND CASH FLOW
Answers to Concepts Review and Critical Thinking Questions
1. True. Every asset can be converted to cash at some price. However, when we are referring to a liquid
asset, the added assumption that the asset can be quickly converted to cash at or near market value is
important.
2. The recognition and matching principles in financial accounting call for revenues, and the costs
associated with producing those revenues, to be “booked” when the revenue process is essentially
complete, not necessarily when the cash is collected or bills are paid. Note that this way is not
necessarily correct; it’s the way accountants have chosen to do it.
3. The bottom line number shows the change in the cash balance on the balance sheet. As such, it is not
a useful number for analyzing a company.
4. The major difference is the treatment of interest expense. The accounting statement of cash flows
treats interest as an operating cash flow, while the financial cash flows treat interest as a financing
cash flow. The logic of the accounting statement of cash flows is that since interest appears on the
income statement, which shows the operations for the period, it is an operating cash flow. In reality,
interest is a financing expense, which results from the company’s choice of debt and equity. We will
have more to say about this in a later chapter. When comparing the two cash flow statements, the
financial statement of cash flows is a more appropriate measure of the company’s performance because
of its treatment of interest.
5. Market values can never be negative. Imagine a share of stock selling for –$20. This would mean that
if you placed an order for 100 shares, you would get the stock along with a check for $2,000. How
many shares do you want to buy? More generally, because of corporate and individual bankruptcy
laws, net worth for a person or a corporation cannot be negative, implying that liabilities cannot exceed
assets in market value.
6. For a successful company that is rapidly expanding, for example, capital outlays will be large, possibly
leading to negative cash flow from assets. In general, what matters is whether the money is spent
wisely, not whether cash flow from assets is positive or negative.
7. It’s probably not a good sign for an established company to have negative cash flow from operations,
but it would be fairly ordinary for a start-up, so it depends.
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8. For example, if a company were to become more efficient in inventory management, the amount of
inventory needed would decline. The same might be true if the company becomes better at collecting
its receivables. In general, anything that leads to a decline in ending NWC relative to beginning would
have this effect. Negative net capital spending would mean more long-lived assets were liquidated
than purchased.
9. If a company raises more money from selling stock than it pays in dividends in a particular period, its
cash flow to stockholders will be negative. If a company borrows more than it pays in interest and
principal, its cash flow to creditors will be negative.
10. The adjustments discussed were purely accounting changes; they had no cash flow or market value
consequences unless the new accounting information caused stockholders to revalue the assets.
NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
Balance Sheet
CA $ 4,300 CL $ 2,900
NFA 24,000 LTD 10,700
OE ??
TA $28,300 TL & OE $28,300
We know that total liabilities and owners’ equity (TL & OE) must equal total assets of $28,300. We
also know that TL & OE is equal to current liabilities plus long-term debt plus owners’ equity, so
owners’ equity is:
And net working capital is current assets minus current liabilities, so:
In the autumn and winter of the year 1704, Madam Sarah Knight,
a resident of Boston, made a journey on horseback from Boston to
New York, and returned in the same manner. It was a journey difficult
and perilous, “full of buggbears to a fearfull female travailler,” and
which “startled a masculine courage,” but which was performed by
this woman with the company and protection only of hired guides,
the “Western Post,” or whatever chance traveller she might find
journeying her way, at a time when brave men feared to travel
through New England, and asked for public prayers in church before
starting on a journey of twenty miles. She was probably the first
woman who made such a journey, in such a manner, in this country.
Madam Knight was the daughter of Captain Kemble, of Boston,
who was in 1656 set two hours in the public stocks as a punishment
for his “lewd and unseemly behavior,” which consisted in his kissing
his wife “publicquely” on the Sabbath Day, upon the doorstep of his
house, when he had just returned from a voyage and absence of
three years.
The diary which Madam kept on this eventful trip contains the
names of no persons of great historical interest, though many of
historical mention; but it is such a vivacious and sprightly picture of
the customs of the time, and such a valuable description of localities
as they then appeared, that it has an historical interest of its own,
and is a welcome addition to the few diaries and records of the times
which we possess.
Everything was not all serene and pleasant in the years 1704 and
1705 in New England. Events had occurred which could not have
been cheerful for Madam Knight to think of when riding through the
lonely Narragansett woods and along the shores of the Sound. News
of the frightful Indian massacre at Deerfield had chilled the very
hearts of the colonists. At Northampton shocking and most
unexpected cruelties had been perpetrated by the red men. At
Lancaster, not any too far from Boston, the Indians had been most
obstreperous. We can imagine Madam Knight had no very pleasant
thoughts of these horrors when she wrote her description of the red
men whom she saw in such numbers in Connecticut. Bears and
wolves, too, abounded in the lonely woods of Massachusetts and
Connecticut. The howls of wolves were heard every night, and
rewards were paid by New England towns for the heads of wolves
that were killed, provided the heads were brought into town and
nailed to the side of the meeting-house. Twenty-one years later than
Madam Knight’s journey, in 1725, twenty bears were killed in one
week in September, within two miles of Boston, so says the History
of Roxbury; and all through the eighteenth century bears were
hunted and killed in upper Narragansett. Hence “buggbears” were
not the only bears to be dreaded on the lonely journey.
The year 1704 was memorable also because it gave birth to the
first newspaper in the colonies, the Boston News-Letter. Only a few
copies were printed each week, and each copy contained but four or
five square feet of print, and the first number contained but one
advertisement—that of the man who printed it.
When Madam Knight’s journal was published in New York by Mr.
Theodore Dwight, in 1825, the editor knew nothing of the diarist, not
even her family name; hence it was confidently believed by many
that the journal was merely a clever and entertaining fiction. In 1852,
however, Miss Caulkins published her history of the town of New
London, and contradicted that belief, for she gave an account of the
last days of Madam Knight, which were spent in Norwich and New
London. Madam Knight’s daughter married the Colonel Livingston
who is mentioned in the journal, and left no children. From a
descendant of Mrs. Livingston’s administratrix, Mrs. Christopher, the
manuscript of the journal was obtained for publication in 1825, it
having been carefully preserved all those years. In Blackwood’s
Magazine for the same year an article appeared, entitled Travelling
in America, which reprinted nearly all of Madam Knight’s journal, and
which showed a high appreciation of its literary and historical merits.
In 1858 it was again printed by request in Littell’s Living Age, with
some notes of Madam Knight’s life, chiefly compiled from Miss
Caulkins’ History of New London, and again provoked much inquiry
and discussion. Recently a large portion of the journal has been
reprinted in the Library of American Literature, with many alterations,
however, in the spelling, use of capitals, and punctuation, thus
detracting much from the interest and quaintness of the work; and
most unnecessarily, since it is perfectly easy to read and understand
it as first printed, when, as the editor said, “the original orthography
was carefully preserved for fear of introducing any unwarrantable
modernism.”
The first edition is now seldom seen for sale, and being rare is
consequently high-priced. The little shabby, salmon-colored copy of
the book which I saw was made interesting by two manuscript
accounts of Sarah Knight, which were inserted at the end of the
book, and which are very valuable, since they give positive proof of
the reality of the fair traveller, as well as additional facts of her life.
The first account was in a fine old-fashioned, unpunctuated
handwriting, on yellow, time-stained paper, and read thus:—
Madam Knight was born in Boston She was the daughter of
Capt. Kemble who was a rich merchant of Boston he was a
native of Great Britain settled in Boston built him a large
house for that day near New North Square in the year 1676
this daughter Sarah Kemble was married to a son of a
London trader by the name of Knight he died abroad and left
her a smart young widow in October 1703 she made a
journey to New York to claim some property of his there. She
returned on horse-backe March 1705 Soon after her return
she opened a school for children Dr. Frankelin and Dr Saml
Mather secured their first rudiments of Education from her her
parents both died and as She was the only child they left she
continued to keep school in the Mansion house till the year
1714. She then sold the estate to Peter Papillion he died not
long after in the year 1736 Thomas Hutchinson Esqr
purchased the estate of John Wolcott, who was administrator
of the Papillion estate Mr Hutchinson gave the estate to his
daughter Hannah who was the wife of Dr Saml Mather. The
force of Madam Knight’s Diamond Ring was displayed on
several panes of glass in the old house in the year 1763 Dr
Mather had the house new glazed and one pane of glass was
preserved as a curiosity for years till 1775 it was lost at the
conflagration when Charlestown was burnt by the British June
17th. The lines on the pane of glass were committed to
memory by the present writer. She was an original genius our
ideas of Madam are formed from hearing Dr Frankelin and Dr
Mather converse about their old school misstress
And I know not but my wishes took effect for the dispute
soon ended with tother Dram.
To one who, unused to venturing abroad in boats on stormy
waters, has trusted her bodily safety to one of those ticklish Indian
vehicles, a canoe, this vivid account of the sensations of an early
female colonist in a similar situation may prove of interest; nor do I
think, after the lapse of centuries, could the description be improved
by the added words of our newer and more profuse vocabulary:—