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Solutions Manual
Chapter 1
Basic
4. Auction versus Dealer Markets [LO3]What does it mean when
we say that
Euronext is an auction market? How are auction
markets different from dealer markets? What kind of market is the
London Stock Exchange?
Answer: In auction markets like Euronext, brokers and agents meet
at a physical location (the exchange) to match buyers and sellers of
assets. Dealer markets like the foreign exchange market consist of
dealers operating at dispersed locales who buy and sell assets
themselves, communicating with other dealers either electronically
or literally over-the-counter. The London Stock Exchange is a hybrid
market where the largest securities are traded in an auction market
and the other securities are traded in a dealer market.
5. Goal of the Firm [LO2]Evaluate the following statement:
Managers should not focus on the current equity value because
doing so will lead to an overemphasis on short-term profits at the
expense of long-term profits.
Answer: Presumably, the current equity 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.
6. Corporate Finance [LO1]Your grandmother sees you reading a
fantastic book called Fundamentals of Corporate Finance. She asks
you, What does corporate finance mean? Explain to her in a way
that doesnt put her to sleep.
Answer: Finance relates to the decision-making and strategies of
corporations. It is composed of three main elements.
a. The investment decision.
b. The financing decision.
c. Short-term capital management.
Each decision is framed within the general objective of maximizing
firm value while ensuring that risk is appropriately managed.
Think of a family, with one parent earning the monthly salary and
the other looking after the children. Every month, money comes
into the house and there will be times when the family needs to
spend money on items like furniture. This will usually come from
savings. However, sometimes, the family will want to buy a car or a
house and will need to take out a loan for the investment. At all
times, the family must have enough cash and this applies every
single day. This example concerns a family, but if you change the
object to a corporation, the same decisions need to be made. When
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10 per cent on these funds. The company pays a 23 per cent tax on
earnings and has a 75 per cent pay-out ratio. How much money did
it pay in taxes and dividends? How much did it retain for future
operations? Note: taxes are always paid before dividends.
Answer: We create a summary Income Statement for Strang plc.
Earnings Before Taxes (2,000,000 x 10%)
200,000
Tax (23% x 200,000)
46,000
Net Income
154,000
Dividends (75% x 154,000)
115,500
Retained Earnings
38,500
11.
Not-for-Profit Firm Goals [LO2]Suppose you were the
financial manager of a not-for-profit business (a not-for-profit
hospital, perhaps). What kinds of goals do you think would be
appropriate?
Answer: 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.
12.
International Firm Goal [LO2]Would our goal of
maximizing equity value be different if we were thinking about
financial management in a foreign country? Why or why not?
Answer: 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.
13.
Financial Management Goals [LO2]If you are in charge
of a private firm and it doesnt have a share price, what should be
your goal as a financial manager? Explain.
Answer: The objective of the firm will remain the same, which is to
maximize the market value of existing owners equity. Principally,
the goal does not change whether the company is private or public
since good financial decisions increase the market value of the
owners equity and poor financial decisions decrease it.
Challenge
14.
Corporate Case Study [LO1, LO2, LO3] Google is special in
many ways because of the firms meteoric success and now
dominant position in the world. Extend the case study on Google by
looking at the title of each chapter and then identifying a similar
event or news story about the firm that captures the material
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17.
Financial Market Regulators [LO3]The UKs Financial
Services Authority states that its objectives are to promote efficient,
orderly and fair markets, help retail consumers achieve a fair deal,
and improve the countrys business capacity and effectiveness. The
German financial markets regulator, BaFin, states that The objective
of securities supervision is to ensure the transparency and integrity
of the financial market and the protection of investors. Are the
British and German objectives consistent with each other? Explain.
Answer: Yes. The main theme of UK and Germany regulation is
similar which is on addressing investor protection and protection of
quality of the information that market participants receive. The
latter will ensure that investors are informed before making
decisions and enhance confidence which is crucial element for any
well-functioning financial market.