Managerial Finance

Solutions to Chapter 1

Goals and Governance of the Firm

13. The responsibilities of the treasurer include the following: supervising cash management, raising capital, and banking relationships. The controller’s responsibilities include supervision of accounting, preparation of financial statements, and tax matters. The CFO of a large corporation supervises both the treasurer and the controller. The CFO is responsible for large-scale corporate planning and financial policy.

14. A corporation might cut its labor force dramatically, which could reduce immediate expenses and increase profits in the short term. Over the long term, however, the firm might not be able to serve its customers properly, or it might alienate its remaining workers; if so, future profits will decrease, and the stock price, and the market value of the firm, will decrease in anticipation of these problems.

Similarly, a corporation can boost profits over the short term by using less costly materials even if this reduces the quality of the product. Once customers catch on, sales will decrease and profits will fall in the future. The stock price will fall.

The moral of these examples is that, because stock prices reflect present and future profitability, the corporation should not necessarily sacrifice future prospects for short-term gains.

15. Financial managers refer to the opportunity cost of capital because corporations increase value for their shareholders only by accepting all investment projects that earn more than this rate. If the company earns below this rate, the market value of the company’s stock falls and stockholders look for other places to invest.

To find the opportunity cost of capital for a safe investment, managers and investors look at current interest rates on safe debt securities, such as U.S. Treasury debt.

Solutions to Chapter 2

Financial Markets and Institutions

17. Financial markets provide extensive data that can be useful to financial managers. Examples include:

· Prices for agricultural commodities, metals, and fuels.

· Interest rates for a wide array of loans and securities, including money market instruments, corporate and U.S. government bonds, and interest rates for loans and investments in foreign countries.

· Foreign exchange rates.

· Stock prices and overall market values for publicly listed corporations, as determined by trading on the New York Stock Exchange, NASDAQ, or stock markets in London, Frankfurt, Tokyo, and so on.

18.

a. 386.65 × $90 = $34.799 billion

b. 4.28 %

c. The farmer sells since the farmer owns cattle and the meat packer needs to buy cattle for processing.

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19.

a. False. The financial crisis had its roots in an easy monetary policy that provided funds for banks to expand the supply of subprime mortgages to low-income borrowers.

b. False. Subprime mortgages are for residential properties.

c. False. While subprime mortgages were packaged into mortgage-backed securities that could be resold, most were held by banks on their own books or sold to other banks.

d. False. The government arranged for Bank of America to take over Merrill but did nothing to rescue Lehman Brothers, which filed for bankruptcy protection.

e. False. Though the massive bailout of Greece calmed the markets somewhat, concerns over Greece and other weak eurozone countries, such as Portugal, Italy, Spain, and even Ireland, remain today.

20. Answers will vary. Causes of financial crisis included in the text are the easy monetary policy of the Federal Reserve, incorrect credit ratings of mortgage bonds, and agency problems with bank managers.

Solutions to Chapter 5

The Time Value of Money

1. $1,000 1.04 = $1,040.00 interest = $40

$1,040 1.04 = $1,081.60 interest = $1,081.60 $1,040 = $41.60

After 10 years, your account has grown to $1,000 (1.04)10 = $1,480.24.

Interest earned in 10th year = $1,480.24 $1,423.31 = $56.93.

2. If you earned simple interest (without compounding), then the total growth in your account after 25 years would be 4% per year x 25 years = 100%. Therefore, your money would double. With compound interest, your money would grow faster than it would with simple interest and therefore would require less than 25 years to double.

3. Since we are assuming that it is currently 2013, 113 years have passed since 1900.

$1,000 (1.05)113 = $247,965.23

PV (1.05)113 = $1,000,000 PV = $4,032.82

4.

1. $100 (1.08)10 = $215.89

1. $100 (1.08)20 = $466.10

1. $100 (1.04)10 = $148.02

1. $100 (1.04)20 = $219.11

5.

1. With simple interest, you earn 4% of $1,000, or $40 each year. There is no interest on interest. After 10 years, you earn total interest of $400, and your account accumulates to $1,400.

1. With compound interest, your account grows to $1,000 x (1.04)10 = $1,480.24 Therefore $80.24 is interest on interest.

6. Solve the following for t: 1.08t = 2 t = 11.9 years

On a financial calculator, enter PV = ()1, FV = 2, PMT = 0, i = 6; then compute n.

The financial calculator generates an answer of 12 years.

7. a. $100 (1.04)113 = $8,409.45

b. $100 (1.08)113 = $598,252.29

8. Using a financial calculator for each question.

1. Enter PV = −400, FV = 1000, PMT = 0, i = 4; then compute n.

The financial calculator generates an answer of 23.36 years (which some financial calculators will round up to 24 years).

1. Enter PV = −400, FV = 1000, PMT = 0, i = 8; then compute n.

The financial calculator generates an answer of 11.90 years (again, some calculators round up 12 years).

1. Enter PV = −400, FV = 1000, PMT = 0, i = 16; then compute n.

The financial calculator generates an answer of 6.17 years (again, some calculators will round up to 7 years).

9.

1. The present value of the future payoff is $2,000/(1.06)10 = $1,116.79.

This is a good deal: Present value exceeds the initial investment.

1. The present value is now equal to $2,000/(1.10)10 = $771.09.

This is now less than the initial investment. Therefore, this is a bad deal.

10.

a. The present value of the ultimate sales price is $4 million/(1.08)5 = $2.722 million.

b. The present value of the sales price is less than the cost of the property, so this would not be an attractive opportunity.

c. The present value of the total cash flows from the property is now:

PV = [$0.2 million annuity factor (8%, 5 years)] + $4 million/(1.08)5