Foundations of Financial Management Tenth Canadian Edition Solution Manual

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Chapter1Foundations of Fin. Mgt.10CeBlock, Hirt,Danielsen,Short, Perretta1-1Discussion Questions1-1.Capital budgetingwas the first area of studyin which the financial manager waspresented with analytical techniques for allocating resources among the various assets ofthe firm.1-2.The student should beprepared to pay a higher price for the promised $2 from the RoyalBank. The risk is lower.1-3.The goal of shareholder wealth maximization implies that the firm will attempt to achievethe highest possible valuation in the marketplace. It is the one overriding objective of thefirm and should influence every decision. The problem with a profit maximization goal isthat it fails to take account of risk, the timing of the benefits is not considered, and profitmeasurement is a very inexact process.1-4.Agency theory examines the relationship between the owners of the firm and themanagers of the firm. In privately owned firms, management and the owners are usuallythe same people. Management operates the firm to satisfy its own goals, needs, financialrequirements and the like. As a company moves from private to public ownership,management now represents all owners. This places management in the agency positionof making decisions in the best interest of all shareholders.1-5.Because institutional investors such as pension funds(Ontario Teachers’, CPP)andmutual funds own a large percentage of major companies, they are having more to sayabout the way publicly owned companies are managed. As a group, they have the abilityto vote large blocks of shares for the election of a board of directors, which is suppose torun the company in an efficient, competitive manner. The threat of being able to replacepoor performing boards of directors makes institutional investors quite influential. Sincethese institutions, like pension funds and mutual funds, represent individual workers andinvestors, they have a responsibility to see that the firm is managed in an efficient andethical way.1-6.Insider trading occurs when someone has information that is not available to the publicand then uses the information to profit from trading in a company’s common stock. Theprovincial securities commissions are responsible for protecting against insider trading.1-7.Regulations set the “rules of the game” in which the firm operates.Shareholder wealthmaximization can and should still be sought within the rules,for economicefficiency tobe achieved. Society judges deregulationbenefitsagainst the costs of regulation.1-8.Management operateswithin a competitivemarketand they should be paidtheiropportunity cost. If managers do not act to maximize shareholder wealth, share priceswill become depressed. To the extent manager’s compensation is tied to share priceperformance, shareholders can fire managers, and there exists a market for corporatecontrol, management will be compensated based on their economic contribution.

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