Solutions Manual - nd edition Prepared By P.V. Viswanath and Aswat...

Solutions Manual

to

Aswath Damodaran’s

Corporate Finance: Theory and Practice, 2

nd

edition

Prepared

By

P.V. Viswanath and Aswath Damodaran

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2 Table of Contents Chapter 2: The Objective Function in Corporate Finance ...................................4 Chapter 3: The Time Value of Money .................................................................7 Chapter 4: Understanding Financial Statements ..................................................11 Chapter 5: Value and Price: An Introduction ......................................................16 Chapter 6: The Basics of Risk .............................................................................19 Chapter 7: Estimating Hurdle Rates for Firms ....................................................23 Chapter 8: Estimating Hurdle Rates for Projects .................................................29 Chapter 9: Estimating Earnings and Cash Flows on Projects ..............................33 Chapter 10: Investment Decision Rules ...............................................................39

Chapter 11: Investment Decision Rules with Inflation and Exchange Rate

Risk ......................................................................................................................47 Chapter 12: Project Interactions, Side Benefits and Side Costs ..........................54 Chapter 13: Investments in Non-Cash Working Capital .....................................61 Chapter 14: Investments in Cash and Marketable Securities...............................67 Chapter 15: Investment Returns and Corporate Strategy ....................................70 Chapter 16: An Overview of Financing Choices .................................................77 Chapter 17: The Financing Process .....................................................................79 2 / 4

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Chapter 18: The Financing Mix: Trade-Offs and Theory ....................................81 Chapter 19: The Optimal Financing Mix .............................................................86 Chapter 20: Financing Mix and Choices .............................................................98 Chapter 21: Dividend Policy ................................................................................108 Chapter 22: Analyzing Cash Returned to Stockholders ......................................110 Chapter 23: Beyond Cash Dividends: Buybacks, Spinoffs and Divestitures ......117 Chapter 24: Valuation: Principles and Practice ...................................................120 Chapter 25: Value Enhancement: Tools and Techniques ....................................127 Chapter 26: Acquisitions and Takeovers .............................................................132 Chapter 27: Option Applications in Corporate Finance ......................................137

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Chapter 2: The Objective Function in Corporate Finance

1.Annual Meeting: Stockholders may not show up at annual meetings or be provided with enough information to have effective oversight over incumbent management. In addition, the corporate charter is often tilted to provide incumbent managers with the advantage, if there is a contest at the annual meeting.Board of Directors: Directors are often chosen by the incumbent managers (rather than by stockholders), own few shares and lack the expertise/information to ask tough questions of incumbent managers.

2.

(a) An increase in dividends: Make existing debt riskier and reduce its value.

Bondholders can protect themselves by constraining dividend policy.(b) A leveraged buyout: If the existing debt is not refinanced at the “new” interest rate, existing bondholders will find the value of their holdings are lower after the LBO.Bondholders can protect themselves by inserting protective puts into their debt, allowing them to put the bonds back to the firm and receive face value.(c) Acquiring a risky business: If a risky business is acquired, existing bondholders may find themselves worse off since the underlying debt is now riskier. Bondholders can protect themselves by restricting investment policy.

3.The fact that markets are volatile, by itself, does not imply that they are not efficient. If the underlying value of the investments traded in the market is changing a lot from period to period, prices should be volatile. Even if the underlying value is not moving as much as prices are, the fact that markets make mistakes (which is what the noise is) does not imply that the prices are not unbiased estimates of value.

4.The empirical evidence does not support the notion that all investors focus on short term results. In particular, the evidence that high growth stocks are able to command high price-earnings multiples, and that stock prices go up, on average, on the announcement of R&D and major investments can be viewed as consistent with a market where some investors at least focus on the long term.

5.This strategy is likely to work if higher market share leads to higher profits and cash flows in the long term. If, on the other hand, the higher market share is obtained by cutting prices and sacrificing long-term profitability, the strategy is unlikely to work.

6.If the incumbent management is efficient and runs the firm for the benefit of existing stockholders, anti-takeover amendments will help in two ways – (1) it may relieve them of the distraction of unwanted takeover attempts and allow them to focus on maximizing cash flows and value, and

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