Solution Manual for Foundations of Finance 8th Edition by Keown Complete downloadable file at: https://testbanku.eu/SolutionManualforFoundationsofFinance8thEditionbyKeown
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"n 'ntroduction to the Foundations of Financial Mana(ement C!"#$E% )%'E*$"$')* )%'E*$"$')* This chapter lays a foundation for what will follow. First, it focuses on the goal of the firm, followed by the five principles that form the foundations founda tions of financial financial management and the role of finance in business. The chapter then reviews the legal forms of business organization and discusses the tax implications relating to financial decisions. Finally, the chapter discusses the new role multinational firm and its role in finance.
C!"#$E% )+$,'*E I. The The Goa Goall of the the Fi Firm A. In this boo, we will designate maxim maximizat ization ion of shareholder shareholder wealth, by which which we mean mean maximization of the total maret value of the firm!s common stoc, to be the goal of the firm. To understand this goal and its inclusive nature, it is first necessary to understand the difficulties involved with the fre"uently suggested goal of profit maximization. #. $e have chosen the goal of shareholder shareholder wealth wealth maximi maximization zation because because the effects effects of all financial decisions are included in this goal. %. In order to employ this this goal, goal, we need not consider consider every every price price change change to be a maret maret interpretation of the worth of our decisions. $hat we do focus on is the effect that our decision should decision should have have on the stoc price if everything were held constant. II. Five &rinciples &rinciples That Form the the Foundations of Finance Finance A. #rinciple &: Cash Flow 's -hat Matters. In measuring value we will use cash flows rather than accounting profits because it is only cash flows that the firm receives and is able to reinvest. In addition, in maing business decisions, we will concern ourselves with only what happens as a result of that decision. 1-1
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*-(/eown01artin0&etty Instructor’s Manual with Solutions Solutions #. #rin Almost all financial financial decisions involve involve #rincip ciple le : Money Money !as !as a $ime $ime alue alue.. Almost comparin comparing g money money in differ different ent time time periods, periods, perhaps perhaps invest investing ing today and receivi receiving ng returns later, or borrowing money today and paying it off later. A dollar received today is worth more than a dollar received in the future because of the time value of money. %. #rinciple 0: %isk %e1uires a %eward. There is a ris-return trade-off in finance2we won!t tae additional ris unless we expect to be compensated with additional return. Almost all financial decisions involve some sort of ris-return trade-off. 3. #rinciple 2: Market #rices "re 3enerally %i(ht. In general, the marets are "uic to impound new informat information ion into stoc prices, and the prices tend to be correct. . #rinciple 4: Conflicts of 'nterest Cause "(ency #roblems. As a result of the agency problem, managers will will not wor for the owners! best interest unless unless it is in the managers! best interest as well. The agency problem is a result of the separation of the decision maers and the owners of the firm. As a result, managers may mae decisions that are not in line with the goal of maximization of shareholder wealth. F. $he Current 3lobal Financial Crisis. G. "5oidin( Financial Crisis67ack to the #rinciples. 1any of the financial problems of the past can be traced bac to ignoring the basic principles of finance. 4. $he Essential Elements of Ethics and $rust. thical behavior is doing the right thing, and ethical ethical dilemm dilemmas as are everywhe everywhere re in finance. finance. thical thical behavior behavior is importa important nt in finan financia ciall managem management, ent, 5ust 5ust as it is importa important nt in everyth everything ing we do. 6nfortuna 6nfortunatel tely y, precisely precisely how we define define what is and is not ethical behavior behavior is sometimes sometimes difficu difficult. lt. 7evertheless, 7evertheless, we should not give up the "uest. In addition, businesses businesses cannot interact unless they trust each other. III. The 8ole of Finance in in #usiness #usiness A. $hy $hy 9tudy Financ Finance: e: There There are three basic basic types types of issues issues that that are address addressed ed by the study of finance. *. $hat long-term long-term investme investments nts should the firm firm undertae: undertae: This area of finance finance is generally referred to as capital budgeting. (. 4ow should the firm firm raise raise money to fund these investments: investments: The firm! firm!s funding funding choices are generally referred to as capital structure decisions. ;. 4ow can the firm firm best best manage its cash cash flows flows as they arise in its day-to-day day-to-day operations: This area of finance is generally referred to as woring capital management. #. The 8ole 8ole of the the Financ Financial ial 1anager 1anager I<. I<. The =egal Forms of #usiness #usiness >rganization >rganization A. 9ole 9ole &ropr &ropriet ietors orshi hips ps *. Sole proprietorship: A business owned by a single person and which has a minimum amount of legal structure. (. The predominant predominant form of business business organization organization in the 6nited 9tates in pure numbers numbers is the sole proprietorship.
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Full file at https://testbanku.eu/Foundations of Finance, Finance, ighth dition*-; ;. Advanta ntages a. asily asily establi establishe shed d with with few compl complica icatio tions ns b. 1inimal 1inimal organizational organizational costs c. 3oes not have have to share share profits profits or control control with with others +. 3is 3isadva advant ntag ages es a. 6nlim 6nlimite ited d liab liabil ilit ity y for the the owner b. >wner must absorb absorb all losses c. "uity "uity capital capital limi limited ted to the owner!s owner!s personal personal inves investme tment nt d. #usines #usinesss terminate terminatess immedi immediatel ately y upon owner!s owner!s death #. &art &artne ners rshi hip p *. #artnership: An association of two or more individuals coming together as coowners to operate a business business for profit. profit. (. Two type typess of of partner partnersh ship ipss a. General partnership? 8elationship 8elationship between partners is is dictated by the partnership partnership agreement. @l
Advantages ges @a 1inim 1inimal al organizat organizationa ionall re"uire re"uirement mentss @b 7egligi 7egligibl blee government government regulatio regulations ns
@( @( 3isa 3isadv dvan anta tage gess @a All All partners partners have have unlimi unlimited ted lia liabi bili lity ty @b 3iffi 3ifficul cultt to raise raise large large amounts amounts of capit capital al @c &artnersh &artnership ip disso dissolve lved d by the death or withdrawa withdrawall of general general partner partner b. =imited =imited partnership partnership @l
Advantages ges @a For the limit limited ed partners, liab liabil ility ity limit limited ed to the amount of capital invested in the company @b $ithdrawal or death of a lim limited ited partner does not affect affect continuity continuity of the business @c 9tronger 9tronger induce inducement ment in raisi raising ng capital capital
@( @( 3isa 3isadv dvan anta tage gess @a There must be at least one general partner who has unlimi unlimited ted liabi liabilit lity y in in the partnership @b 7ames of limit limited ed partners may may not appear in the name of the firm firm @c =imited =imited partners may may not participate participate in the management management of the business business
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*-+/eown01artin0&etty Instructor’s Manual with Solutions Solutions @d 1ore expensi expensive ve to organize organize than than general general partners partnership, hip, as as a written written agreement is mandatory %. %orp %orpor orat atio ions ns *. $he corporation: An BimpersonalC legal entity having the power to purchase, sell, and own assets and to incur liabilities while existing separately and apart from its owners. (. >wnersh >wnership ip is is evide evidenced nced by shares shares of stoc. stoc. ;. Advantages ges a. =imite =imited d liab liabil ilit ity y of owners owners b. ase of transferabil transferability ity of ownership @i.e., by the sale sale of one!s one!s shares of stoc stoc c. The death of an an owner does not result result in the discontinuance discontinuance of the firm firm!!s life life d. Ability Ability to raise large amounts of capital is increased increased +. 3isa 3isadv dvan anta tage gess a. 1ost diffic difficult ult and expensive expensive form of busines businesss to establish establish b. %ontrol of corporation not guaranteed g uaranteed by partial partial ownership ownership of stoc c. %orporations %orpo rations also suffer suffer from a double taxation on dividends. dividends. The firm first pays taxes on the income it earnsD after taxes have been paid on this income, it is paid to investors in the form of dividends. The investor then pays personal taxes on that dividend income. 3. 9-Type 9-Type %orporations and =imited =imited =iabil =iability ity %ompanies %ompanies @==% *. The 9-type corporation provides limit limited ed liabi liabilit lity y while while allowing allowing the business business owners owners to be taxed as if they were a partnership2that partnership2that is, distributions distributions bac to the owners are not taxed twice as is the case with dividends dividends in the the corporate corpo rate form. (. The limit limited ed liabi liabilit lity y company company @==% is a cross between a partnership partnership and and a corporation. The ==% retains limited liability for its owners, but is run and taxed lie a partnership. . >rganizational >rganizational Form and Taxes? The 3ouble 3ouble Taxation Taxation on 3ividends 3ividends F. 9-%orporations and =imited =imited =iabilit =iability y %ompanies %ompanies @==%s G. $hich $hich >rganizational >rganizational Form 9hould #e %hosen: <. Finance Finance and the the 1ultinational 1ultinational Firm? Firm? The The 7ew 8ole
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The goal of profit profit maxi maximi mizat zation ion is is too simpl simplis istic tic in that that it assume assumess away away the problem problemss of uncertainty of returns and the timing of returns. 8ather than use this goal, we have chosen maximization of shareholders! wealth2that is, maximization of the maret value of the firm!s common stoc2because the effects of all financial decisions are included. The shareholders react to poor investment or dividend decisions by causing the total value of the firm!s stoc to fall and react to good decisions by pushing the price of the stoc upward. upward. In this this way, way, all all finan financia ciall decisi decisions ons are evaluated evaluated,, and all financ financia iall decisions affect shareholder wealth.
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The goal goal of share sharehol holder der weal wealth th maxi maximi miza zati tion on must must be looed looed at as a long-r long-run un goal. goal. As such, the public image of the firm may be of concern inasmuch as it may affect sales and legislation. Thus, while these actions may not directly result in increased profits, they may affect consumers! and legislators! attitudes.
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Almos Almostt all finan financia ciall decis decision ionss invol involve ve some some sort of ris-r ris-return eturn trade-of trade-off. f. The The more ris ris the firm is willing to accept, the higher the expected return for the given course of action. For example, in the area of woring capital management, the less inventory held, the higher the expected return, but also the greater the ris of running out of inventory. $hile one manager might accept a given level of ris, another more ris-averse manager may not accept that level of ris. This does not mean that one manager is correct and one is notD rather, it only means that not all managers will view the ris-return trade-off in the same manner.
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The The agen agency cy prob proble lem m is a resu result lt of the separa separati tion on of owners owners and mana manage gers rs,, wher wheree managers do what!s in their own best interests rather than what is in the best interest of the shareholders. =arge firms are typically run by professional managers who own a small fraction of the firms! e"uity. The individual actions of these managers are often motivated by self-interest, which may result in managers not acting in the best interests of the firm!s owners. $hen this happens the firm!s owners will lose value. a. A sol sole prop propri riet etor orsh shiip is is a busi busine nesss own owned ed by by a singl ngle in indivi dividu duaal who who mai maint ntai ains ns complete complete title title to the assets assets and is also personall personally y liable liable for all indebtedn indebtedness ess incurred. b. A partnership is an association association of two or more individua individuals ls coming together as co-owners for the purpose of operating a business for profits. The partnership is e"uivalent to the sole proprietorship, except that the partnership has multiple owners. c. A corpor corporat atio ion n is a lega legall ent entit ity y func functi tion onin ing g sepa separa rate te and and apar apartt from from its its own owner ers. s. It can individually sue and be sued, purchase, sell, or own property, and be sub5ect to criminal punishment for crimes.
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a.
The The sole sole pro propr prie ieto torr mai maintai ntains ns titl titlee to the the fir firm!s ass asset ets, s, has has unl unliimited ted li liabi ability ity, is is entitled to the profits from the business, but must also absorb any losses realized. This form of business is easily initiated. Termination of the business comes by the owner discontinuing the business or upon his death.
b.
In a partnership, all general partners have unlimit unlimited ed liabil liability ity.. ach partner is liable for the actions of the other partners. The partnership agreement dictates
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b. c.
the basic relationships among the partners within the firm. As with the sole proprietorship, the partnership is terminated terminated upon the desires of any partner within the organization, or upon a partner!s death. 6nder certain conditions a partner!s liabil liability ity may be restricted to the amount of capital invested invested in the partnership. 4owever, 4owever, at least one general partner must remain remain in the association for whom the privilege of limited liability does not apply. The corpo orporrati ation is legally separ parate from its owners. >wnership of the corporation is determined by the number of shares of common stoc owned by an individual. 9ince the shares are transferable, the ownership in a corporation may be easily transferred. Investors! liability is limited to the amount of their investment. The life of the corporation is not dependent upon the status of the investors. The death or withdrawal of an investor does not disrupt the corporate life life.. 4oweve 4oweverr, the cost of formi forming ng a corporat corporation ion is more expen expensi sive ve than than a proprietorship or partnership. >rga >rgani niza zattiona ionall re"u re"uir irem emen ents ts and and cos costs ts favor avor the the sol solee pro propr prie ieto tors rsh hip or pos posssibl ibly the general general partnership partnership depending depending upon the approach approach taen in formin forming g the partnership. 6nder corporation, owners have minimu minimum m liabi liabilit lities. ies. The The corp corpor orat atio ion n is def definitel tely the the most most favo favora rabl blee form form of busi busine ness ss beca becaus usee it provides the continuity of the business business regardless of an owner!s withdrawal or o r death.
d.
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If ease ease of owners ownershi hip p tran transf sfer erab abil ilit ity y is desire desired, d, the the corpor corporati ation on is is best best.. 4oweve 4oweverr, because of certain circumstances, circumstances, the owners may prefer that ownership not be easily transferred, in which case the partnership would be the most desirable. e. The The sol sole prop proprrietor etor is abl able to mainta ntain com complet pletee and ult ultimate ate cont contro roll and and minimize minimize regulations. regula tions. f. The The corpo corpora rati tion on is is the the stro strong nges estt form form of leg legaal ent entit ity y in in ter terms ms of of the the ease ease of of raising capital from external investors. g. In rega regard rd to inco income me tax taxes es,, it is dif difficu ficult lt to to dete determ rmiine whi which ch for form m of bus busiiness ness is is the the most most adva advant ntage ageous ous.. 9uch 9uch a sele select ctio ion n is depe depend nden entt upon upon indi indivi vidu dual al circumstances. Thi This is an Inte Intern rnet et "ue "uest stio ion. n. Thi This is an Inte Intern rnet et "ue "uest stio ion. n.
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S),+$')* $) M'*' C"SE a.
The goal goal of prof profit it max maxim imiz izat ation ion is too simp simpli list stic ic in that that it assum assumes es awa away y the the probl problem emss of of uncertainty of returns and the timing of returns. 8ather than use this goal, we have chosen maximization of shareholders! wealth2that is, maximization of the maret value of the firm!s common stoc2because the effects of all financial decisions are included. The shareholders react to poor investment or dividend decisions by causing the total value of the firm!s stoc to fall and react to good decisions by pushing the price of the stoc upward. upward. In this this way, way, all all finan financia ciall decisi decisions ons are evaluated evaluated,, and all financ financia iall decisions affect shareholder wealth.
b.
9imply 9imply put, investors investors will will not put their money in risy investments investments unless unless they are compensated for taing on that additional ris. In effect, the return investors expect is composed of two parts. First, they receive a return for delaying consumption, which must be greater than the anticipated rate of inflation. 9econd, they receive a return for taing on added ris. >therwise, both risy and safe investments would have the same expected return associated with them, and no one would tae on the risy invest investments. ments.
c.
The The firm firm rece receiv ives es cas cash h flow flowss and and is abl ablee to rein reinve vest st them them,, whic which h cann cannot ot be done done with with accounting profits. In effect, accounting profits are shown when they are earned rather than when the money is actually in hand. 6nfortunately, a firm!s accounting profits and cash flows may not be timed to occur together. For example, capital expenses, such as the purchase of a new plant or piece of e"uipment, are depreciated over several years, with the annual depreciation subtracted from profits. 4owever, the cash flow associated with these expenses generally occurs immediately. It is the cash inflows that can be reinve reinvested sted and cash outflows that invol involve ve paying paying out money money. Therefore Therefore,, cash flows correctly reflect the true timing of the benefits and costs.
d.
In an effi efficcient ient mar mare et, t, info inform rmat atio ion n is impo impoun unde ded d into into secu securi rity ty pric prices es with with such such spee speed d that that ther theree are are no opport opportun unit itie iess for for inve invest stor orss to prof profit it from from publ public iclly avai availa labl blee information. Actually, what types of information are immediately reflected in security prices and how "uicly "uicly that information information is reflected reflected determine determine how effici efficient ent the maret actually is. The implications for us are that stoc prices reflect all publicly available information regarding the value of the company. This means we can implement our goal of maximization of shareholder wealth by focusing on the effect each decision should have on the stoc price, all else held constant. It also means that earnings manipulations throu through gh accou account ntin ing g chan change gess shou should ld not not resu result lt in pric pricee chan change ges. s. In effe effect ct,, our preoccupation with cash flows flows is validated. validated.
e.
The agenc agency y prob proble lem m is the result result of the separat separation ion of mana managem gement ent and the owners ownershi hip p of of the firm. As a result, managers may mae decisions that are not in line with the goal of maximization of shareholder wealth. To control this problem, we monitor managers and try to align the interests of shareholders and managers. The interests of shareholders and managers can be aligned by setting up stoc options, bonuses, and per"uisites that are tied tied direc directl tly y to how close closely ly manag managem emen entt decis decisio ions ns coinc coincid idee with with the inter interest est of shareholders.
f.
thica thicall erro errors rs are are not not for forgi give ven n in in the the bus busin ines esss worl world. d. #us #usin ines esss inte interac racti tion on is is based based upon upon trust, and there is no way that trust can be eliminated "uicer than through an ethical violation. The fall of Ivan #oesy and 3rexel, #urnham, =anbert and the near collapse
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*-H/eown01artin0&etty Instructor’s Manual with Solutions Solutions of 9alomon #rothers illustrates this fact. As a result, acting in an ethical manner is not only morally correct, but it is congruent with our goal of maximization of shareholder wealth. g.
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A sol sole prop proprrietor etorsship hip is is a bus busiiness own owned ed by by a si single in individual who who ma maintai tains complete title to the assets, but who is also personally liable for all indebtedness incurred.
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A part partne ners rshi hip p is an asso associ ciat atio ion n of two or more more indiv indiviidual dualss comin coming g togeth together er as co-owners for the purpose of operating a business for profit. The partnership is e"uivalent to the sole proprietorship, except that the partnership has multiple owners.
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A corpora corporatio tion n is a lega legall enti entity ty func functi tion onin ing g separ separate ate and and apart apart from from its its owners owners.. It can individually sue and be sued, purchase, sell, or own property, and be sub5ect to criminal punishment for crimes.
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