Solutions of Financial Management

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Chapter 1
An Overview of Financial Management

Learning Objectives

After reading this chapter, students should be able to:

◆ Identify the three main forms of business organization and describe the advantages and disadvantages of each one.

◆ Identify the primary goal of the management of a publicly held corporation, and understand the relationship between stock prices and shareholder value.

◆ Differentiate between what is meant by a stock’s intrinsic value and its market value and understand the concept of equilibrium in the market.

◆ Briefly explain three important trends that have been occurring in business that have implications for managers.

◆ Define business ethics and briefly explain what companies are doing in response to a renewed interest in ethics, the consequences of unethical behavior, and how employees should deal with unethical behavior.

◆ Briefly explain the conflicts between managers and stockholders, and explain useful motivational tools that can help to prevent these conflicts.

◆ Identify the key officers in the organization and briefly explain their responsibilities.

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 mid-term 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 immediately as time value of money concepts are covered in Chapter 2. 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 2 for more on calculators.

DAYS ON CHAPTER: 1 OF 58 DAYS (50-minute periods)

Answers to End-of-Chapter Questions

1-1When you purchase a stock, you expect to receive dividends plus capital gains. Not all stocks pay dividends immediately, but those corporations that do, typically pay dividends quarterly. Capital gains (losses) are received when the stock is sold. Stocks are risky, so you would not be certain that your expectations would be met—as you would if you had purchased a U.S. Treasury security, which offers a guaranteed payment every 6 months plus repayment of the purchase price when the security matures.

1-2No, the stocks of different companies are not equally risky. A company might operate in an industry that is viewed as relatively risky, such as biotechnology—where millions of dollars are spent on R&D that may never result in profit. A company might also be heavily regulated and this could be perceived as increasing its risk. Other...
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