FREE Download Chapter 1 Solution Manual Financial Management by Brigham

Chapter 1

An Overview of Corporate Finance and

The Financial Environment

FREE Download Chapter 1 Solution Manual Financial Management by Brigham

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QUESTIONS

(1.1) Define each of the following terms:

a. Sole proprietorship; partnership; corporation

b. Limited partnership; limited liability partnership; professional corporation

c. Stockholder wealth maximization

d. Money market; capital market; primary market; secondary market

e. Private markets; public markets; derivatives

f. Investment banker; financial sevice corporation; financial intermediatory

g. Mutual fund; Money market fund

h. Physical location exxcahnge; Computer/Telephone Network

i. Open outcry auction; dealer market; Electronic Ciommunicatiopn Network (ECN)

J. Production opportunities; Time preference for Consumption

k. Foreign Trade deficit

(1. 2) What are the three principal forms of business organization? What are the advantages and disadvantages of each?

(1.3) What is the firm's fundamental, or intrinsic, value? What might cause a firm's intrinsic value to be different than it's actual market value?

(1.4) The president of Eastern Semiconductor Corporation (ESC) made this statement inthe company’s annual report: “ESC’s primary goal is to increase the value of the com-mon stockholders’ equity over time.” Later on in the report, the following announce-ments were made:

a. The company contributed $1.5 million to the symphony orchestra in Bridgeport, Connecticut, its headquarters city.

b. The company is spending $500 million to open a new plant and expand operations in China. No profits will be produced by the Chinese operations for 4 years, so earnings will be depressed during this period versus what they would have been had the decision not been made to expand in that market. Discuss how each of these actions would be reacted to by ESC’s stockholders and customers, and how the each action might affect ESC’s stock price.

(1.5) Edmund Enterprises recently made a large investment in upgrading its technology. While the technology improvements will not have much of an impact on performance in the short run, they are expected to produce significant cost savings over the next several years. What impact will this investment have on Edmund Enterprises’ earnings per share this year? What impact might this investment have on the company’s stock price?

(1.6) Describe the different ways  in which capital can be transferred from suppliers of capital to those who are demanding capital.

(1.7) What are financial intermediaries, and what economic function do they perform?

(1.8) Suppose the population of Area Y is relatively young while that of Area O is relatively
old, but everything else about the two areas is equal.
a. Would interest rates likely be the same or different in the two areas? Explain.
b. Would a trend toward nationwide branching by banks and savings and loans, and the development of nationwide diversified financial corporations, affect your answer to part a?

(1.9) Suppose a new and much more liberal Congress and administration were elected, and their
first order of business was to take away the independence of the Federal Reserve System,
and to force the Fed to greatly expand the money supply. What effect would this have on the level and slope of the yield curve immediately after the announcement?

(1.10) Is an initial public offering an example of primary or secondary market transaction?

(1.11) Differentiate between dealer markets and stock markets that have a physical location.

(1.12) Identify and briefly compare two leading stock exchanges in the United States today?

MINI CASE

Assume that you recently graduated with a degree in finance and have just reported to work as an investment advisor at the brokerage firm of Balik and Kiefer Inc.  One of the firm’s clients is Michelle Dellatorre, a professional tennis player who has just come to the United States from Chile.  Dellatorre is a highly ranked tennis player who would like to start a company to produce and market apparel that she designs.  She also expects to invest substantial amounts of money through Balik and Kiefer.  Dellatorre is also very bright, and, therefore, she would like to understand, in general terms, what will happen to her money.  Your boss has developed the following set of questions which you must ask and answer to explain the U.S. financial system to Dellatorre.

a.      Why is corporate finance important to all managers?

b.      Describe the organizational forms a company might have as it evolves from a start-up to a major corporation. List the advantages and disadvantages of each form.

c.               How do corporations “go public” and continue to grow? What are agency problems?

d.               What should be the primary objective of managers?

d.         1.   Do firms have any responsibilities to society at large?

d.         2.   Is stock price maximization good or bad for society?

d.         3.   Should firms behave ethically?

e.               What three aspects of cash flows affect the value of any investment?

f.                What are free cash flows? What are the three determinants of free cash flows?

g.               What is the weighted average cost of capital? What affects it?

h.               How do free cash flows and the weighted average cost of capital interact to determine a firm’s value?

i.                What are financial assets?  Describe some financial instruments.

j.                Who are the providers (savers) and users (borrowers) of capital?  How is capital transferred between savers and borrowers?

k.               List some financial intermediaries.

l.                What are some different types of markets?

m.              How are secondary markets organized?

m.        1.   List some physical location markets and some computer/telephone networks.

m.        2.   Explain the differences between open outcry auctions, dealer markets, and electronic communications networks (ECNS).

n.               What do we call the price that a borrower must pay for debt capital? What is the price of equity capital?  What are the four most fundamental factors that affect the cost of money, or the general level of interest rates, in the economy?

o.               What is the real risk-free rate of interest  (r*) and the nominal risk-free rate (r_RF)?  How are these two rates measured?

p.               Define the terms inflation premium (IP), default risk premium (DRP), liquidity premium (LP), and maturity risk premium (MRP).  Which of these premiums is included when determining the interest rate on (1) short-term U.S. treasury securities, (2) long-term U.S. treasury securities, (3) short-term corporate securities, and (4) long-term corporate securities?  Explain how the premiums would vary over time and among the different securities listed above.

q.               What is the term structure of interest rates?  What is a yield curve?

r.               Suppose most investors expect the inflation rate to be 5 percent next year,  6 percent the following year, and 8 percent thereafter.  The real risk-free rate is 3 percent.  The maturity risk premium is zero for securities that mature in 1 year or less, 0.1 percent for 2-year securities, and then the MRP increases by 0.1 percent per year thereafter for 20 years, after which it is stable.  What is the interest rate on 1-year, 10-year, and 20-year treasury securities?  Draw a yield curve with these data.  What factors can explain why this constructed yield curve is upward sloping?

s.                At any given time, how would the yield curve facing an AAA-rated company compare with the yield curve for U. S. Treasury securities?  At any given time, how would the yield curve facing a BB-rated company compare with the yield curve for U. S. Treasury securities?  Draw a graph to illustrate your answer.

t.                What is the pure expectations theory?  What does the pure expectations theory imply about the term structure of interest rates?

u.               Finally, Dellatorre is also interested in investing in countries other than the United States.  Describe the various types of risks that arise when investing overseas.