Principles of Corporate Finance: Goals and Governance of the Firm

Topics: Investment, Stock, Finance Pages: 3 (800 words) Published: September 13, 2015
Goals and Governance of the Firm

Answers to Problem Sets

1. a. real

b. executive airplanes

c. brand names

d. financial

e. bonds

f. investment

g. capital budgeting

h. financing

2. c, d, e, and g are real assets. Others are financial.

3. a. Financial assets, such as stocks or bank loans, are claims held by investors. Corporations sell financial assets to raise the cash to invest in real assets such as plant and equipment. Some real assets are intangible.

b. Capital budgeting means investment in real assets. Financing means raising the cash for this investment.

c. The shares of public corporations are traded on stock exchanges and can be purchased by a wide range of investors. The shares of closely held corporations are not traded and are not generally available to investors.

d. Unlimited liability: investors are responsible for all the firm’s debts. A sole proprietor has unlimited liability. Investors in corporations have limited liability. They can lose their investment, but no more.

e. A corporation is a separate legal “person” with unlimited life. Its owners hold shares in the business. A partnership is a limited-life agreement to establish and run a business.

4.c, d.

5.b, c.

6.Separation of ownership and management typically leads to agency problems, where managers prefer to consume private perks or make other decisions for their private benefit -- rather than maximize shareholder wealth.

7. a. Assuming that the encabulator market is risky, an 8% expected return on
the F&H encabulator investments may be inferior to a 4% return on U.S.
government securities.

b. Unless their financial assets are as safe as U.S. government securities, their cost of capital would be higher. The CFO could consider what the expected return is on assets with similar risk.

8.Shareholders will only vote for (a)...
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