Free Download Chapter 30 Solution Manual Financial Management by Brigham

Chapter 30

Financial Management in Not-for-Profit BusinessesANSWERS TO END-OF-CHAPTER QUESTIONS

 

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 Summary
This chapter focuses on financial management within not-for-profit businesses.
The key concepts covered are listed below:
• Although most finance graduates will go to work for investor-owned firms,
many financial management professionals work for or closely with not-for-profit organizations, which range from government agencies such as school districts and colleges to charities such as the United Way and the American Heart
Association.
• If an organization meets a set of stringent requirements, it can qualify for tax-exempt status. Such organizations, which must be incorporated, are called not-for-profit corporations. One type of not-for-profit organization is the not-for-profit business,which sells goods and/or services to the public but which has
not-for-profit status.
• The goal of a not-for-profit business is typically stated in terms of some mission
rather than shareholder wealth maximization.
• Not-for-profit businesses raise the equivalent of equity capital, which is called
fund capital,in three ways: (1) by earning profits, which by law are retained
within the business, (2) by receiving grants from governmental entities, and
(3) by receiving contributions from individuals and companies.
• In not-for-profit businesses, the weighted average cost of capital is developed in the same way as in investor-owned firms. Although there is no direct tax benefit to the issuer associated with debt financing, there is a benefit to investors because interest received is often tax exempt; thus, the net cost of debt is similar for investor-owned and not-for-profit businesses.
• For cost of capital purposes, fund capital has an opportunity cost that is roughly equal to the cost of equity of similar investor owned firms.
• The trade-off theory of capital structure generally applies to not-for-profit firms, but such firms do not have as much financial flexibility as investor-owned firms because not for profit firms cannot issue new common stock.
• The social value version of the net present value model recognizes that not-for-profit businesses should value social contributions as well as cash flows.

30-20 Chapter 30 Financial Management in Not-for-Profit Businesses

Self-Test Questions
• In general, the relevant capital budgeting risk for not-for-profit businesses is
corporate risk rather than market risk. Corporate risk is measured by a proect’s corporate beta.
• Many not-for-profit organizations can raise funds in the municipal bond market.
• Credit enhancement upgrades the rating of a municipal bond issue to that of the insurer. However, issuers must pay a fee to obtain credit enhancement.
• With minor exceptions, the financial statement formats of investor-owned and
not-for-profit businesses are the same.
• Short-term financial management is generally unaffected by the ownership type.
Questions
(30-1) What is the major difference in ownership structure between investor-owned and
not-for-profit businesses?
(30-2) Does the asymmetric information theory of capital structure apply to not-for-profit businesses? Explain.
(30-3) Does a not-for-profit firm’s marginal cost of capital (MCC) schedule have a
retained earnings break point? Explain.
(30-4) Assume that a not-for-profit firm does not have access to tax-exempt (municipal)
debt and thus gains no benefits from the use of debt financing.
a. What would be the firm’s optimal capital structure according to the cost-benefit trade-off theory?
b. Is it likely that the firm would be able to operate at its theoretically optimal
structure?
(30-5) Describe how social value can be incorporated into the NPV decision model. Do
you think not-for-profit firms would normally try to quantify net present social
value, or would they merely treat it as a qualitative factor?
(30-6) Why is corporate risk the most relevant project risk measure for not-for-profit
businesses?
(30-7) If all markets were informationally efficient, meaning that buyers and sellers
would have easy access to the same information, would firms gain any cost advantage by purchasing bond insurance (credit enhancement)?
Mini Case 30-21
Mini Case
Sandra McCloud, a finance major in her last term of college, is currently scheduling her placement inter-views through the university’s career resource center. Her list of companies is typical of most finance
majors: several commercial banks, a few industrial firms, and one brokerage house. However, she
noticed that a representative of a not-for-profit hospital is scheduling interviews next week, and the
position—that of financial analyst—appears to be exactly what Sandra has in mind. Sandra wants to
sign up for an interview, but she is concerned that she knows nothing about not-for-profit organizations
and how they differ from the investor-owned firms that she has learned about in her finance classes. In
spite of her worries, Sandra scheduled an appointment with the hospital representative, and she now
wants to learn more about not-for-profit businesses before the interview.
To begin the learning process, Sandra drew up the following set of questions. See if you can help her
answer them.
a. First, consider some basic background information concerning the differences between not-for-profit organizations and investor-owned firms.
(1) What are the key features of investor-owned firms? How do a firm’s owners exercise control?
30-22 Chapter 30 Financial Management in Not-for-Profit Businesses
Selected Additional References
(2) What is a not-for-profit corporation? What are the major control differences between
investor-owned and not-for-profit businesses?
(3) How do goals differ between investor-owned and not-for-profit businesses?
b. Now consider the cost of capital estimation process.
(1) Is the weighted average cost of capital (WACC) relevant to not-for-profit businesses?
(2) Is there any difference between the WACC formula for investor-owned firms and that for not-for-profit businesses?
(3) What is fund capital? How is the cost of fund capital estimated?
c. Just as in investor-owned firms, not-for-profit businesses use a mix of debt and equity (fund) financing.
(1) Is the trade-off theory of capital structure applicable to not-for-profit businesses? What about the asymmetric information theory?
(2) What problems do not-for-profit businesses encounter when they attempt to implement the trade-off theory?
d. Consider the following questions relating to capital budgeting decisions.
(1) Why is capital budgeting important to not-for-profit businesses?
(2) What is social value? How can the net present value method be modified to include the social value of proposed projects?
(3) Which of the three project risk measures—stand-alone, corporate, and market—is relevant to not-for-profit businesses?
(4) What is a corporate beta? How does it differ from a market beta?
(5) In general, how is project risk actually measured within not-for-profit businesses? How is project risk incorporated into the decision process?
e. Not-for-profit businesses have access to many of the same long-term financing sources as do investor-owned firms.
(1) What are municipal bonds? How do not-for-profit health care businesses access the municipal bond market?
(2) What is credit enhancement, and what effect does it have on debt costs?
(3) What are a not-for-profit business’s sources of fund capital?
(4) What effect does the inability to issue common stock have on a not-for-profit business’s cap-ital structure and capital budgeting decisions?
f. What unique problems do not-for-profit businesses encounter in financial analysis and planning?
What about short-term financial management?