Essentials of Financial

Essentials of Financial Management 4th Asia- Pacific Edition, Brigham, Joel Houston, Jun-Ming Hsu, Yoon Kee Kong, Bany-Ariffin

(Solution Manual all Chapters)

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Chapter 1: An Overview of Financial Management Learning Objectives 1

© 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Chapter 1 An Overview of Financial Management

Learning Objectives

After reading this chapter, students should be able to:

◆ Explain the role of finance and the different types of jobs in finance.◆ Identify the advantages and disadvantages of different forms of business organization.◆ Explain the links between stock price, intrinsic value, and executive compensation.◆ Identify the potential conflicts that arise within the firm between stockholders and managers and between stockholders and bondholders, and discuss the techniques that firms can use to mitigate these potential conflicts.◆ Discuss the importance of business ethics and the consequences of unethical behavior.

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2 Lecture Suggestions Chapter 1: An Overview of Financial Management

© 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Lecture Suggestions

Chapter 1 covers some important concepts, and discussing them in class can be interesting. However, students can read the chapter on their own, so it can be assigned but not covered in class.We spend the first day going over the syllabus and discussing grading and other mechanics relating to the course. To the extent that time permits, we talk about the topics that will be covered in the course and the structure of the book. We also discuss briefly the fact that it is assumed that managers try to maximize stock prices, but that they may have other goals, hence that it is useful to tie executive compensation to stockholder-oriented performance measures. If time permits, we think it’s worthwhile to spend at least a full day on the chapter. If not, we ask students to read it on their own, and to keep them honest, we ask one or two questions about the material on the first exam.One point we emphasize in the first class is that students should print a copy of the PowerPoint slides for each chapter covered and purchase a financial calculator immediately, and bring both to class regularly. We also put copies of the various versions of our “Brief Calculator Manual,” which in about 12 pages explains how to use the most popular calculators, in the copy center. Students will need to learn how to use their calculators before time value of money concepts are covered in Chapter 5. It is important for students to grasp these concepts early as many of the remaining chapters build on the TVM concepts.We are often asked what calculator students should buy. If they already have a financial calculator that can find IRRs, we tell them that it will do, but if they do not have one, we recommend either the HP-10BII+ or 17BII+. Please see the “Lecture Suggestions” for Chapter 5 for more on calculators.

DAYS ON CHAPTER: 1 OF 56 DAYS (50-minute periods)

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Chapter 1: An Overview of Financial Management Answers and Solutions 3

© 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Answers to End-of-Chapter Questions

1-1 A firm’s intrinsic value is estimated by security analysis and its market value is perceived by the marginal investor. The goal of management is to take actions designed to maximize a firm’s intrinsic value, not its market value.

1-2 When a stock’s actual market price is equal to its intrinsic value, the stock is in equilibrium. Some possible reasons for stock not being in equilibrium include managerial actions, the economic environment, taxes, and the political climate. In addition, a stock might not be in equilibrium when there exists information asymmetry between insiders and outside investors.

1-3 If the three intrinsic value estimates for Stock X were different, you would have the most confidence in Company X’s CFO’s estimate. Intrinsic values are strictly estimates, and different analysts with different data and different views of the future will form different estimates of the intrinsic value for any given stock. However, a firm’s managers have the best information about the company’s future prospects, so managers’ estimates of intrinsic value are generally better than the estimates of outside investors.

1-4 Investors prefer undervalued stocks because the stock prices would rise in the future when the market prices approach their intrinsic value. The investors will have capital gain in this situation. For the CEO near retirement, overvalued stock is preferred because they can realize the exercise value in the near future when they retire.

1-5 The board of directors should set CEO compensation dependent on how well the firm performs.The compensation package should be sufficient to attract and retain the CEO but not go beyond what is needed. Compensation should be structured so that the CEO is rewarded on the basis of the stock’s performance over the long run, not the stock’s price on an option exercise date. This means that options (or direct stock awards) should be phased in over a number of years so the CEO will have an incentive to keep the stock price high over time. If the intrinsic value could be measured in an objective and verifiable manner, then performance pay could be based on changes in intrinsic value. However, it is easier to measure the growth rate in reported profits than the intrinsic value, although reported profits can be manipulated through aggressive accounting procedures and intrinsic value cannot be manipulated. Since intrinsic value is not observable, compensation must be based on the stock’s market price—but the price used should be an average over time rather than on a specific date.

1-6 The different forms of business organization are proprietorships, partnerships, corporations, and limited liability corporations and partnerships. The advantages of the first two include the ease and low cost of formation. The advantages of corporations include limited liability, indefinite life, ease of ownership transfer, and access to capital markets. Limited liability companies and partnerships have limited liability like corporations.The disadvantages of a proprietorship are (1) difficulty in obtaining large sums of capital; (2) unlimited personal liability for business debts; and (3) limited life. The disadvantages of a partnership are (1) unlimited liability, (2) limited life, (3) difficulty of transferring ownership, and (4) difficulty of raising large amounts of capital. The disadvantages of a corporation are (1) double taxation of earnings and (2) setting up a corporation and filing required state and federal reports, which are complex and time-consuming. Among the disadvantages of limited liability corporations and partnerships are difficulty in raising capital and the complexity of setting them up.

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