Type:
Solution Manual
Resource:
Corporate Finance
Edition:
3rd Edition
Author(s):
Jonathan Berk Peter DeMarzo Jarrad Harford
Contents Chapter 1
The Corporation
1
Chapter 2
Introduction to Financial Statement Analysis
4
Chapter 3
Financial Decision Making and the Law of One Price
20
Chapter 4
The Time Value of Money
30
Chapter 5
Interest Rates
58
Chapter 6
Valuing Bonds
77
Chapter 7
Investment Decision Rules
94
Chapter 8
Fundamentals of Capital Budgeting
114
Chapter 9
Valuing Stocks
131
Chapter 10
Capital Markets and the Pricing of Risk
143
Chapter 11
Optimal Portfolio Choice and the Capital Asset Pricing Model
158
Chapter 12
Estimating the Cost of Capital
177
Chapter 13
Investor Behavior and Capital Market Efficiency
187
Chapter 14
Capital Structure in a Perfect Market
196
Chapter 15
Debt and Taxes
205
Chapter 16
Financial Distress, Managerial Incentives, and Information
214
Chapter 17
Payout Policy
231
Chapter 18
Capital Budgeting and Valuation with Leverage
242
Chapter 19
Valuation and Financial Modeling: A Case Study
261
Chapter 20
Financial Options
269
Chapter 21
Option Valuation
280
Chapter 22
Real Options
291
Chapter 23
Raising Equity Capital
319
Chapter 24
Debt Financing
325
Chapter 25
Leasing
329
Chapter 26
Working Capital Management
337
Chapter 27
Short-Term Financial Planning
344
Chapter 28
Mergers and Acquisitions
350
Chapter 29
Corporate Governance
355
Chapter 30
Risk Management
358
Chapter 31
International Corporate Finance
370
iii
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Chapter 1
The Corporation 1-1.
What is the most important difference between a corporation and all other organizational forms? A corporation is a legal entity separate from its owners.
1-2.
What does the phrase limited liability mean in a corporate context? Owners’ liability is limited to the amount they invested in the firm. Stockholders are not responsible for any encumbrances of the firm; in particular, they cannot be required to pay back any debts incurred by the firm.
1-3.
Which organizational forms give their owners limited liability? Corporations and limited liability companies give owners limited liability. Limited partnerships provide limited liability for the limited partners, but not for the general partners.
1-4.
What are the main advantages and disadvantages of organizing a firm as a corporation? Advantages: Limited liability, liquidity, infinite life Disadvantages: Double taxation, separation of ownership and control
1-5.
Explain the difference between an S corporation and a C corporation. C corporations must pay corporate income taxes; S corporations do not pay corporate taxes, but must pass through the income to shareholders to whom it is taxable. S corporations are also limited to 75 shareholders and cannot have corporate or foreign stockholders.
1-6.
You are a shareholder in a C corporation. The corporation earns $2 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. The corporate tax rate is 40% and the personal tax rate on (both dividend and non-dividend) income is 30%. How much is left for you after all taxes are paid? First, the corporation pays the taxes. After taxes, $2 ´ (1 - 0.4) = $1.20 is left to pay dividends. Once the dividend is paid, personal tax must be paid, which leaves $1.20 ´ (1 - 0.3) = $0.84 . So, after all the taxes are paid, you are left with 84¢.
1-7.
Repeat Problem 6 assuming the corporation is an S corporation. An S corporation does not pay corporate income tax. So it distributes $2 to its stockholders. These stockholders must then pay personal income tax on the distribution. So they are left with $2 ´ (1 - 0.3) = $1.40 .
1
.
2
Berk/DeMarzo, Corporate Finance, Third Edition
1-8.
You have decided to form a new start-up company developing applications for the iPhone. Give examples of the three distinct types of financial decisions you will need to make. As the manager of an iPhone applications developer, you will make three types of financial decisions. i. You will make investment decisions such as determining which type of iPhone application projects will offer your company a positive NPV and that your company, therefore, should develop. ii. You will make the decision on how to fund your iPhone application investments and what mix of debt and equity your company will have. iii. You will be responsible for the cash management of your company, ensuring that your company has the necessary funds to make investments, pay interest on loans, and pay your employees.
1-9.
When a pharmaceutical company develops a new drug, it often receives patent protection for that medication, allowing it to charge a higher price. Explain how this public policy of providing patent protection might help align the corporation’s interests with society’s interests. Without patent protection, the developer of the drug would be forced to lower prices to compete with generic manufacturers. Because this price competition would lower expected future profits, the developer would be willing to spend much less in R&D to develop the drug initially, and drug innovation would be curtailed. Alternatively, by allowing the drug’s developer to earn higher profits that are commensurate with the value of the drug to society, drug developers will find it in their best interests to spend more on R&D, and drug innovation is enhanced. Thus, patent protection can align the corporation’s and society’s interests and provide for more efficient spending on drug R&D.
1-10.
Corporate managers work for the owners of the corporation. Consequently, they should make decisions that are in the interests of the owners, rather than their own. What strategies are available to shareholders to help ensure that managers are motivated to act this way? Shareholders can do the following. i. Ensure that employees are paid with company stock and/or stock options. ii. Ensure that underperforming managers are fired. iii. Write contracts that ensure that the interests of the managers and shareholders are closely aligned. iv. Mount hostile takeovers.
1-11.
Suppose you are considering renting an apartment. You, the renter, can be viewed as an agent while the company that owns the apartment can be viewed as the principal. What principalagent conflicts do you anticipate? Suppose instead that you work for the apartment company. What features would you put into the lease agreement that would give the renter incentives to take good care of the apartment? The agent (renter) will not take the same care of the apartment as the principal (owner), because the renter does not share in the costs of repairing damage to the apartment. To mitigate this problem, having the renter pay a deposit should motivate the renter to keep damages to a minimum. The deposit forces the renter to share in the costs of repairing any problems that they cause.
1-12.
You are the CEO of a company and you are considering entering into an agreement to have your company buy another company. You think the price might be too high, but you will be the CEO of the combined, much larger, company. You know that when the company gets bigger, your pay and prestige will increase. What is the nature of the agency conflict here and how is it related to ethical considerations? There is an ethical dilemma when the CEO of a firm has the opposite incentives to those of the shareholders. In this case, you (as the CEO) have an incentive to potentially overpay for another company (which would be damaging to your shareholders) because your pay and prestige will improve.
1-13.
Are hostile takeovers necessarily bad for firms or their investors? Explain. No. They are a way to discipline managers who are not working in the interests of shareholders.
.
Chapter 1/The Corporation
3
1-14.
What is the difference between a public and private corporation? The shares of a public corporation are traded on an exchange (or “over the counter” in an electronic trading system) while the shares of a private corporation are not traded on a public exchange.
1-15.
Explain why the bid-ask spread is a transaction cost. Investors always buy at the ask and sell at the bid. Since ask prices always exceed bid prices, investors “lose” this difference. It is one of the costs of transacting. Since the market makers take the other side of the trade, they make this difference.
1-16.
The following quote on Yahoo! Stock appeared on July 9, 2012, on Yahoo! Finance:
If you wanted to buy Yahoo!, what price would you pay? How much would you receive if you wanted to sell Yahoo!? You would buy at $15.78 and sell for $15.77.
.
Chapter 2
Introduction to Financial Statement Analysis 2-1.
What four financial statements can be found in a firm’s 10-K filing? What checks are there on the accuracy of these statements? In a firm’s 10-K filing, four financial statements can be found: the balance sheet, income statement, statement of cash flows, and statement of stockholders’ equity. Financial statements in form 10-K are required to be audited by a neutral third party, who checks and ensures that the financial statements are prepared according to GAAP and that the information contained is reliable.
2-2.
Who reads financial statements? List at least three different categories of people. For each category, provide an example of the type of information they might be interested in and discuss why. Users of financial statements include present and potential investors, financial analysts, and other interested outside parties (such as lenders, suppliers and other trade creditors, and customers). Financial managers within the firm also use the financial statements when making financial decisions. Investors. Investors are concerned with the risk inherent in, and return provided by, their investments. Bondholders use the firm’s financial statements to assess the ability of the company to make its debt payments. Stockholders use the statements to assess the firm’s profitability and ability to make future dividend payments. Financial analysts. Financial analysts gather financial information, analyze it, and make recommendations. They read financial statements to determine a firm’s value and project future earnings, so that they can provide guidance to businesses and individuals to help them with their investment decisions. Managers. Managers use financial statements to look at trends in their own business, and to compare their own results with that of competitors.
2-3.
Find the most recent financial statements for Starbucks’ corporation (SBUX) using the following sources: a.
From the company’s Web site www.starbucks.com (Hint: Search for “investor relations.”)
b.
From the SEC Web site www.sec.gov. (Hint: Search for company filings in the EDGAR database.)
c.
From the Yahoo! Finance Web site http://finance.yahoo.com.
d.
From at least one other source. (Hint: Enter “SBUX 10K” at www.google.com.)
Each method will help find the same SEC filings. Yahoo! Finance also provides some analysis such as charts and key statistics.
4
.
Chapter 2/Introduction to Financial Statement Analysis
2-4.
2-5.
5
Consider the following potential events that might have taken place at Global Conglomerate on December 30, 2012. For each one, indicate which line items in Global’s balance sheet would be affected and by how much. Also indicate the change to Global’s book value of equity. (In all cases, ignore any tax consequences for simplicity.) a.
Global used $20 million of its available cash to repay $20 million of its long-term debt.
b.
A warehouse fire destroyed $5 million worth of uninsured inventory.
c.
Global used $5 million in cash and $5 million in new long-term debt to purchase a $10 million building.
d.
A large customer owing $3 million for products it already received declared bankruptcy, leaving no possibility that Global would ever receive payment.
e.
Global’s engineers discover a new manufacturing process that will cut the cost of its flagship product by over 50%.
f.
A key competitor announces a radical new pricing policy that will drastically undercut Global’s prices.
a.
Long-term liabilities would decrease by $20 million, and cash would decrease by the same amount. The book value of equity would be unchanged.
b.
Inventory would decrease by $5 million, as would the book value of equity.
c.
Long-term assets would increase by $10 million, cash would decrease by $5 million, and longterm liabilities would increase by $5 million. There would be no change to the book value of equity.
d.
Accounts receivable would decrease by $3 million, as would the book value of equity.
e.
This event would not affect the balance sheet.
f.
This event would not affect the balance sheet.
What was the change in Global Conglomerate’s book value of equity from 2011 to 2012 according to Table 2.1? Does this imply that the market price of Global’s shares increased in 2012? Explain. Global Conglomerate’s book value of equity increased by $1 million from 2011 to 2012. An increase in book value does not necessarily indicate an increase in Global’s share price. The market value of a stock does not depend on the historical cost of the firm’s assets, but on investors’ expectation of the firm’s future performance. There are many events that may affect Global’s future profitability, and hence its share price, that do not show up on the balance sheet.
2-6.
Use EDGAR to find Qualcomm’s 10-K filing for 2011. From the balance sheet, answer the following questions: a.
How much did Qualcomm have in cash and short-term investments?
b.
What were Qualcomm’s total accounts receivable?
c.
What were Qualcomm’s total assets?
d.
What were Qualcomm’s total liabilities? How much of this was long-term debt?
e.
What was the book value of Qualcomm’s equity?
a.
$5,462 million (cash) and $6,190 million (short-term investments/marketable securities) for a total of $11,652 million
b.
$993 million
c.
$36,422 million
.