Professional Documents
Culture Documents
IntroductiontoManagerialFinance
ChaptersinthisPart
Chapter1
TheRoleofManagerialFinance
Chapter2
TheFinancialMarketEnvironment
Chapter1
TheRoleofManagerialFinance
Instructors Resources
Overview
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance3
Thischapterintroducesthestudenttothefieldoffinanceandexplorescareeropportunitiesinbothfinancial
servicesandmanagerialfinance.Thethreebasiclegalformsofbusinessorganization(soleproprietorship,
partnership,andcorporation)andtheirstrengthsandweaknessesaredescribed,aswellastherelationship
betweenmajorpartiesinacorporation.Themanagerialfinancefunctionisdefinedanddifferentiatedfrom
economicsandaccounting.Thechapterthensummarizesthethreekeyactivitiesofthefinancialmanager:
financialanalysisandplanning,investmentdecisions,andfinancingdecisions.Adiscussionofthefinancial
managersgoalsmaximizingshareholderwealthandpreservingstakeholderwealthandtheroleof
ethicsinmeetingthesegoalsispresented.Thechapterincludesdiscussionoftheagencyproblemthe
conflictthatexistsbetweenmanagersandownersinalargecorporation.
Thischapter,andallthatfollow,emphasizehowthechaptercontentplaysavitalroleinthestudents
professionalandpersonallife.Eachchapterincludesanearlydiscussionoftherelevanceofthetopicto
majorsinaccounting,informationsystems,management,marketing,andoperations.Throughouteach
chapteraredetailedexamplesofhowthechapterstopicrelatestothestudent'sfinanciallife.These
pedagogictoolsshouldmotivatestudentstoquicklygraspanunderstandingofthechaptercontentand
employitinboththeirprofessionalandpersonallives.
2. Financialservicesistheareaoffinanceconcernedwiththedesignanddeliveryofadviceand
financialproductstoindividuals,businesses,andgovernment.
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance5
Managerialfinanceencompassesthefunctionsofbudgeting,financialforecasting,creditadministration,
investmentanalysis,andfundsprocurementforthefirm.Managerialfinanceisthemanagementof
thefirmsfundswithinthefirm.Thisfieldoffersmanycareeropportunities,includingfinancial
analyst,capitalbudgetinganalyst,andcashmanager.(Note:Otheranswerspossible.)
3. Soleproprietorshipsarethemostcommonformofbusinessorganization,whilecorporationsare
responsibleforthemajorityofbusinessreceiptsandprofits.Corporationsaccountforthemajorityof
businessreceiptsandprofitsbecausetheyreceivecertaintaxadvantagesandcanexpandmoreeasily
duetoaccesstocapitalmarkets.
4. Stockholdersarethetrueowners,throughequityincommonandpreferredstock,ofacorporation.
Theyelecttheboardofdirectors,whichhastheultimateauthoritytoguidecorporateaffairsandset
generalpolicy.Theboardisusuallycomposedofkeycorporatepersonnelandoutsidedirectors.The
presidentorchiefexecutiveofficer(CEO)reportstotheboard.Heorsheisresponsiblefordaytoday
operationsandcarryingoutpoliciesestablishedbytheboard.Theownersofthecorporationdonot
haveadirectrelationshipwithmanagementbutgivetheirinputthroughtheelectionofboardmembers
andvotingonmajorcharterissues.Theownersofthefirmarecompensatedthroughthereceiptof
cashdividendspaidbythefirmorbyrealizingcapitalgainsthroughincreasesinthepriceoftheir
commonstockshares.
5. Themostpopularformoflimitedliabilityorganizationsotherthancorporationsare:
LimitedpartnershipsApartnershipwithatleastonegeneralpartnerwithunlimitedliabilityand
oneormorelimitedpartnerswhohavelimitedliability.Inreturnforthelimitedliability,thelimited
partnersareprohibitedfromactivemanagementofthepartnership.
ScorporationIfcertainrequirementsaremet,theScorporationcanbetaxedasapartnership
butreceivemostofthebenefitsofthecorporateformoforganization.
Limitedliabilitycorporation(LLC)ThisformoforganizationislikeanScorporationinthatit
istaxedasapartnershipbutprimarilyfunctionslikeacorporation.TheLLCdiffersfromthe
Scorporationinthatitisallowedtoownothercorporationsandbeownedbyothercorporations,
partnerships,andnonU.S.residents.
Limitedliabilitypartnership(LLP)Apartnershipformauthorizedbymanystatesthatgivesthe
partnerslimitedliabilityfromtheactsofotherpartners,butnotfrompersonalindividualactsof
malpractice.TheLLPistaxedasapartnership.Thisformismostfrequentlyusedbylegaland
accountingprofessionals.
Thesefirmsgenerallydonothavelargenumbersofowners.Mosttypicallytheyhavefewerthan
100owners.
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance7
6. Virtuallyeveryfunctionwithinafirmisinsomewayconnectedwiththereceiptordisbursement
ofcash.Thecashrelationshipmaybeassociatedwiththegenerationofsalesthroughthemarketing
department,theincurringofrawmaterialcoststhroughpurchasing,ortheearningsofproduction
workers.Sincefinancedealsprimarilywithmanagementofcashforoperationofthefirm,every
personwithinthefirmneedstobeknowledgeableoffinancetoeffectivelyworkwithemployees
ofthefinancialdepartments.
Individualsplan,monitor,andassessthefinancialaspectsoftheiractivitiesoveragivenperiod
throughtheconsiderationofcashinflowsandoutflows.
7. Thegoalofthefirm,andthereforeallmanagers,istomaximizeshareholderwealth.Thisgoalis
measuredbyshareprice;anincreasingpricepershareofcommonstockrelativetothestockmarket
asawholeindicatesachievementofthisgoal.
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance9
8. Profitmaximizationisnotconsistentwithwealthmaximizationdueto:(1)thetimingofearningsper
share,(2)earningsthatdonotrepresentcashflowsavailabletostockholders,and(3)afailureto
considerrisk.
9. Riskisthechancethatactualoutcomesmaydifferfromexpectedoutcomes.Financialmanagersmust
considerbothriskandreturnbecauseoftheirinverseeffectonthesharepriceofthefirm.Increased
riskmaydecreasetheshareprice,whileincreasedreturnislikelytoincreasetheshareprice.
10. Inrecentyearsthemagnitudeandseverityofwhitecollarcrimehasincreaseddramatically,with
acorrespondingemphasisonprosecutionbygovernmentauthorities.Asaresult,theactionsofall
corporationsandtheirexecutiveshavebeensubjectedtocloserscrutiny.Thisincreasedscrutinyof
thistypeofcrimehasresultedinmanyfirmsestablishingcorporateethicsguidelinesandpolicies
tocoveremployeeactionsindealingwithallcorporateconstituents.Theadoptionofhighethical
standardsbyacorporationstrengthensitscompetitivepositionbyreducingthepotentialforlitigation,
maintainingapositiveimage,andbuildingshareholderconfidence.Theresultisenhancementof
longtermvalueandapositiveeffectonshareprice.
11. Thetreasurerorfinancialmanagerwithinthematurefirmmustmakedecisionswithrespectto
handlingfinancialplanning,acquisitionoffixedassets,obtainingfundstofinancefixedassets,
managingworkingcapitalneeds,managingthepensionfund,managingforeignexchange,and
distributionofcorporateearningstoowners.
12. Financeisoftenconsideredaformofappliedeconomics.Firmsoperatewithintheeconomyandmust
beawareofeconomicprinciples,changesineconomicactivity,andeconomicpolicy.Principles
developedineconomictheoryareappliedtospecificareasinfinance.Frommacroeconomicscomes
theinstitutionalstructureinwhichmoneyandcreditflowstakeplace.Frommicroeconomics,finance
drawstheprimaryprincipleusedinfinancialmanagement,marginalanalysis.Sincethisanalysisof
marginalbenefitsandcostsisacriticalcomponentofmostfinancialdecisions,thefinancialmanager
needsbasiceconomicknowledge.
13. Accountantsoperateonanaccrualbasis,recognizingrevenuesatthepointofsaleandexpenseswhen
incurred.Thefinancialmanagerfocusesontheactualinflowsandoutflowsofcash,recognizing
revenueswhenactuallyreceivedandexpenseswhenactuallypaid.
Theaccountantprimarilygathersandpresentsfinancialdata;thefinancialmanagerdevotesattention
primarilytodecisionmakingthroughanalysisoffinancialdata.
14. Thetwokeyactivitiesofthefinancialmanagerasrelatedtothefirmsbalancesheetare:
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance11
a.
Makinginvestmentdecisions:Determiningboththemostefficientlevelandthebestmixof
assets;and
b. Makingfinancingdecisions:Establishingandmaintainingthepropermixofshortandlongterm
financingandraisingneededfinancinginthemosteconomicalfashion.
Investmentdecisionsconcernthelefthandsideofthebalancesheet(currentandfixedassets).
Financingdecisionsdealwiththerighthandsideofthebalancesheet(currentliabilities,longterm
debt,andstockholdersequity).
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance13
15. Corporategovernancereferstoasystemoforganizationalcontrolthatisusedtodefineandestablish
linesofresponsibilityandaccountabilityamongmajorparticipantsinthecorporation.Theseparticipants
includetheshareholders,boardofdirectors,officers,andmanagersofthecorporationsandother
stakeholders.Acompanysorganizationalchartisanexampleofabroadarrangementofcorporate
governance.Moredetailedresponsibilitieswouldbeestablishedwithineachbranchofthe
organizationalchart.
TheSarbanesOxleyActof2002isdirectedtowardreducingtheapparentconflictsofinterestthat
existinmanycorporatestructures.Theacthasmanyprovisions,butthemajorthrustoftheactisto
reducethenumberofsituationsinwhichaconflictofinterestcanariseandtoholdmanagementmore
accountableforthefinancialandoperatinginformationtheycommunicatedtothepublic.
16. Firmsincuragencycoststopreventorminimizeagencyproblems.Itisunclearwhethertheyare
effectiveinpractice.Thefourcategoriesofagencycostaremonitoringexpendituresincurredby
theownersforauditandcontrolprocedures,bondingexpenditurestoprotectagainstthepotential
consequencesofdishonestactsbymanagers,structuringexpendituresthatusemanagerialcompensation
planstoprovidefinancialincentivesformanagerialactionsconsistentwithsharepricemaximization,
andopportunitycostsresultingfromthedifficultiestypicallyencounteredbylargeorganizationsin
respondingtonewopportunities.
Theagencyproblemandtheassociatedagencycostscanbereducedbyaproperlyconstructedand
followedcorporategovernancestructure.Thestructureofthegovernancesystemshouldbedesigned
toinstituteasystemofchecksandbalancestoreducetheabilityandincentivesofmanagementto
deviatefromthegoalofshareholderwealthmaximization.
17. Structuringexpendituresarecurrentlythemostpopularwaytodealwiththeagencyproblemand
alsothemostpowerfulandexpensive.Compensationplanscanbeeitherincentiveorperformance
plans.Incentiveplanstiemanagementperformancetoshareprice.Managersmayreceivestock
optionsgivingthemtherighttopurchasestockatasetprice.Thisprovidestheincentivetotake
actionsthatmaximizestockpricesothatthepricewillriseabovetheoptionspricelevel.Thisform
ofcompensationplanhasfallenfromfavorrecentlybecausemarketbehavior,whichhasasignificant
effectonshareprice,isnotundermanagementscontrol.Asaresult,performanceplansaremore
populartoday.Withthese,compensationisbasedonperformancemeasures,suchasearningsper
share(EPS),EPSgrowth,orotherreturnratios.Managersmayreceiveperformancesharesand/or
cashbonuseswhenstatedperformancegoalsarereached.
Inpractice,recentstudieshavebeenunabletodocumentanysignificantcorrelationbetweenCEO
compensationandshareprice.
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance15
18. Marketforcesforexample,shareholderactivismfromlargeinstitutionalinvestorscanreduceor
avoidtheagencyproblembecausethesegroupscanusetheirvotingpowertoelectnewdirectorswho
supporttheirobjectivesandwillacttoreplacepoorlyperformingmanagers.Inthisway,thesegroups
placepressureonmanagementtotakeactionsthatmaximizeshareholderwealth.
Thethreatofhostiletakeoversalsoactsasadeterrenttotheagencyproblem.Hostiletakeovers
occurwhenacompanyorgroupnotsupportedbyexistingmanagementattemptstoacquirethe
firm.Becausetheacquirerlooksforcompaniesthatarepoorlymanagedandundervalued,this
threatmotivatesmanagerstoactinthebestinterestsofthefirmsowners.
Institutionalinvestorsareapowerfulsourceofshareholderinvolvementinthemonitoringof
managerstoreducetheagencyproblem.Institutionsholdlargequantitiesofsharesinmanyofthe
corporationsintheirportfolio.Managersoftheseinstitutionsshouldbeactiveinthemonitoringof
managementandvotetheirsharesforthebenefitoftheshareholders.Thepowerofinstitutional
investorsfarexceedsthevotingpowerofindividualinvestors.
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance17
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance19
Whydoemployersvaluehavingemployeeswithprofessionalcertifications?
Studyingtopasscertificationexamsallowsemployeestocontinuetheireducationbeyondtheir
undergraduatedegree.Thestudywillbefocusedononeareaoffinance,whichislikelytobethatneeded
toperformtheirjobwell.Furthermore,itwillallowtheemployertoadvertisetheadditionaltrainingof
theemployees,andtherebyattractadditionalbusiness.
Comparisonofadvantagesanddisadvantagesofapartnershipversusincorporation.
Answer: WhileJackandAnndisagreeoverwhetherornottheirfirmshouldincorporateorremainasa
partnership,eachformofbusinessorganizationhasitsadvantagesanddisadvantages.One
advantageofapartnershipisthatincomeistaxedateachpartnersindividualtaxratethat
includes10%,15%,25%,andhigherratesuptoatoprateof35%whilecorporateratesare
15%,25%,and34%withatoprateof39%.Thecorporationisallowedtoretainaccumulated
taxableincome,butforapersonalservicecorporationsuchasJackandAnnstaxpreparation
service,thereisanadditionaltax,calledanaccumulatedearningstax,of15%foraccumulated
taxableincomeinexcessof$150,000.Ifcorporateearningsarepaidoutassalary,Jackand
Annwillpaytheirindividualratesastheydoontheirpartnershipearnings.Ifsomeofthe
incomeispaidoutintheformofdividendsitwillbetaxedtwice,firstascorporateincomeand
thenasdividendincome(generally5%or15%dependingupontheindividualstaxbracket).
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance21
Whiletaxationofincomeisakeyfactorindecidingwhichformofbusinessorganizationto
select,twootherfactorsarealsoimportant.Inapartnership,eachpartnerhasunlimited
liabilityandmayhavetocoverdebtsofotherpartners,whilecorporateownershavelimited
liabilitythatguaranteesthattheycannotlosemorethantheyhaveinvestedinthecorporation.
Thethirdmajorconsiderationiseaseoftransferofthebusiness.Partnershipsareharderto
transferandaretechnicallydissolvedwhenapartnerdies,whileacorporationcanhaveavery
longlifewithownershipreadilytransferredthroughthesaleofstock.
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance23
IfathirdpartywasaskedtodecidewhichlegalformofbusinessA&JTaxPreparationshould
take,itwouldbeusefultohavethefollowinginformation:
Maritalstatusandtaxsituationofeachpartner
Expectationofthelongevityofthefirm
Ageofthecurrentowners
Currentplanofsuccession
Risktoleranceoftheowners
Expectationoffuturetaxlawchanges
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance25
E12.
Capitalneedsofthefirm
Growthprospectsofthefirm
Reasonsforeachpartnersviewofthepreferredformofownership
Cashflowvs.accruedprofits
Answer: Itisnotunusualforafirmtobeprofitableyetexperienceacashcrunch.Themostcommoncause
iswhenexpenseshaveashorterduedatethanexpectedrevenue.Insuchcasesthefirmmust
arrangeshorttermfinancingtomeetitsdebtobligationsbeforetherevenuearrives.Ifthe
forthcomingcashcrunchisnotanewsituationforthisfirm,managementshouldprobably
considergoingaheadwiththeyearendpartyifitisimportanttoemployeemoraleandthe
futuresuccessofthefirm,aslongasadequateshorttermfundingcanbearranged.Ontheother
hand,ifthefirmhasnotexperiencedsuchacashcrunchbefore,theremaybelargerproblems
loomingaheadanditwouldbeunseemlytospendcashonapartythatwouldbebetterspent
meetingthedebtobligationsofthefirm.
E13.
Sunkcosts
Answer: Marginalcostbenefitanalysisignoressunkcosts,sothe$2.5milliondollarsisirrelevantto
thecurrentdecisionthatmustbemade.Atthispointtherearetwoquestionsthatmustbeanswered.
First,willthe$10,000additionalinvestmentgenerateaPVofexpectedrevenuethatwillexceed
the$10,000investment?Inotherwords,willtheprojectgenerateapositivenetPV?Ifitdoes,
theprojectmustbeconsideredfurthertoseeifitisthebestuseofcapital.Ifthefirmhasaneed
torationcapital,theprojectmustthenbecomparedtootherprojectscompetingforthelimited
capitaltoseeifitisviable.Thefactthattheprojectstechnologyhasbeensurpassedbynew
technologydoesnotimmediatelydisqualifytheprojectsincenewtechnologydoesnotensure
apositivecostbenefitresult.Inthiscase,asmall$10,000investmentmightavoidaheavy
expenditureinnewtechnology.Dependingupontheindustry,however,failuretokeepupwith
competitorscanbedevastating.Thekeymaywelllieinthedescriptiontheprojecthaslittle
chancetobeviable,whichindicatesthatapprovingthe$10,000islikelytobethrowinggood
moneyafterbad.
E14.
Agencycosts
Answer: Agencycostsarethecostsbornebystockholderstomaintainagovernancestructurethat
ensuresagainstdishonestactsofmanagement,andgivesmanagersthefinancialincentiveto
maximizeshareprice.Oneexampleofagencycostsisstockoptions,whichareusedtoprovide
anincentiveformanagerstoworkdiligentlyforthebenefitofthefirm.Tipsaresimilarto
stockoptionsinthattheyareofferedasrewardsforgoodservicemuchasstockoptionsare
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance27
usedtorewardmanagers,presumablybasedontheirgoodperformancewhichsubsequently
leadstoahigherstockprice.TheDonutShop,Inc.exampledoesnotrepresentaclearcaseof
agencycostsbecauseitisthemanagementitselfthathasinstitutedtheNotipspolicyandthe
employeeshaverespondedwithreducedperformance.Bybanningtips,themanagementhas
createdasituationwhereanagencycostmaybenecessarytoprovideanincentiveforemployees
toresumetheirformerlevelofperformance.
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance29
OnesolutionthatmayworkforDonutShop,Inc.istoinstituteaprofitsharingplanthatreaches
downtotheemployeelevelwheretheslowdownandinefficiencyareoccurring.Aprofitsharing
planisdesignedtomotivatetheemployeesandcouldalleviatetheaggravationcausedbythe
notippolicy,butmustbeclearlyidentifiedasthereplacementtotippinginordertobeeffective.
Aprofitsharingplanisusuallyviewedbytheemployeesasarewardforgoodperformance,but
doesnothavetheimmediacyofthepositiveeffectthatanemployeegetsfromatip.
Itisunclearfromthecasewhetherthenewnotippolicyisacompanywidepolicyorsimply
theactionsofafewbranchmanagers.However,therealsolutionhereistorecognizethatthe
notippolicyhascreatedanunnecessarybacklashthatcanbealleviatedbyreversingmanagements
positionwithoutincurringtheadditionalcostsofrevisingthecurrentemployeebenefitplan
andpayingoutaportionofcorporateprofits.
Solutions to Problems
P11.
Liabilitycomparisons
LG2;Basic
a. Ms.Harperhasunlimitedliability.
b. Ms.Harperhasunlimitedliability.
c.
P12.
Ms.Harperhaslimitedliability,whichguaranteesthatshecannotlosemorethansheinvested.
Accrualincomevs.cashflowforaperiod
LG4;Basic
a.
Sales
$760,000
Costofgoodssold
300,000
Netprofit
$460,000
b. Cashreceipts
$690,000
c.
Costofgoodssold
300,000
Netcashflow
$390,000
Thecashflowstatementismoreusefultothefinancialmanager.Theaccountingnetincome
includesamountsthatwillnotbecollectedand,asaresult,donotcontributetothewealthof
theowners.
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance31
P13.
Cashflowstatement
LG4;Intermediate
a.
Totalcashinflow:$450$4,500$4,950
Totalcashoutflow:$1,000$500$800$355$280$1,200$222$4,357
b. Netcashflow:$4,950$4,357$593
c.
IfJaneisfacingashortage,shecouldcutbackonsomeofherdiscretionaryitems,including
clothing,diningout,andgas(i.e.,travelless).
d. IfJanehasasurplusinAugust,sheshouldcomparethesecashflowstothoseofothermonths
andverifythatAugustscashflowsaretypical.Shemay,forinstance,observetheexistence
oflargeautomobileinsurancebillsortendencytospendmoreduringtheChristmasholiday
season.Ifshehassuchneeds,Janewillwanttosavethe$593inamoneymarketsecurity,
wheresheisunlikelytofaceadeclineininvestment.IfherAugustnetcashflowisnotneeded
topayanticipatedbills,sheshouldinvestinadiversifiedportfolio.
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance33
P14.
Marginalcostbenefitanalysisandthegoalofthefirm
PG3,5;Challenge
a. MarginalbenefitsofnewroboticsMarginalbenefitsoforiginalroboticsMarginalbenefits
ofproposedrobotics
$560,000$400,000$160,000
b. MarginalcostofnewroboticsSalespriceofcurrentrobotics=Marginalcostofproposed
robotics
$220,000$70,000$150,000
c. NetbenefitsofnewroboticsMarginalbenefitsofproposedroboticsMarginalcostof
proposedrobotics
$160,000$150,000
d. KenAllenshouldrecommendthenewroboticsbeusedontheheavytruckgearline.
Themarginalbenefitsexceedthemarginalcosts
e. KenAllenshoulddeterminewhethertherewillbeadditionaltrainingnecessarywiththenew
robotics,whetherevenbetterroboticsmaybeavailableinashortwhile,andwhatwillbethe
energyconsumptionofthenewrobotics.
P15.
Identifyingagencyproblems,costs,andresolutions
LG4;Intermediate
a. Inthiscasetheemployeeisbeingcompensatedforunproductivetime.Thecompanymust
paysomeonetotakeherplaceduringherabsence.Installationofatimeclockthatmustbe
punchedbythereceptionisteverytimesheleavesworkandreturnswouldresultineither:
(1)herreturningontimeor(2)reducingthecosttothefirmbyreducingherpayforthe
lostwork.
b. Thecoststothefirmareintheformofopportunitycosts.Moneybudgetedtocoverthe
inflatedcostsofthisprojectproposalisnotavailabletofundotherprojectsthatmayhelp
toincreaseshareholderwealth.Makethemanagementrewardsystembasedonhowclosethe
managersestimatescometotheactualcostratherthanhavingthemcomeinbelowcost.
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Chapter1TheRoleofManagerialFinance35
c.
Themanagermaynegotiateadealwiththemergingcompetitorthatisextremelybeneficialto
theexecutiveandthensellthefirmforlessthanitsfairmarketvalue.Agoodwaytoreduce
thelossofshareholderwealthwouldbetoopenthefirmupforpurchasebidsfromother
firmsoncethemanagermakesitknownthatthefirmiswillingtomerge.Ifthepriceoffered
bythecompetitoristoolow,otherfirmswillraisethepriceclosertoitsfairmarketvalue.
d. Generallyparttimeortemporaryworkersarenotasproductiveasfulltimeemployees.These
workershavenotbeenonthejobaslongtoincreasetheirworkefficiency.Also,thebetter
employeesgenerallyneedtobehighlycompensatedfortheirskills.Thismanagerisgetting
ridofthehighestcostemployeestoincreaseprofits.Oneapproachtoreducingtheproblem
wouldbetogivethemanagerperformancesharesifheorshemeetscertainstatedgoals.
Implementingastockincentiveplantyingmanagementcompensationtosharepricewould
alsoencouragethemanagertoretainqualityemployees.
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Chapter1TheRoleofManagerialFinance37
P16.
EthicsProblem
LG3;Intermediate
Thephraseethicalconstraintsisquitebroad.Thecompanymaybereferringtolegalissues,and
thefactthatitwillcomplywithlaws.Forinstance,itmaybeimplyingthatitwillnotbeusingillegal
immigrantsandpayingthemareducedsalary.Itmayrefertotheuseofsubstandardmaterials,which
arelesslikelytoholdupoveranextendedperiodoftime.Sometimestheuseofsubstandard
manufacturingfacilitieswillincreasethechanceofharmtoemployeesorworse,aswitnessedby
theBPGulfoilspillinApril2010.
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Chapter1TheRoleofManagerialFinance39
Case
Casestudiesareavailableonwww.myfinancelab.com.
a. Maximizationofshareholderwealth,whichmeansmaximizationofshareprice,shouldbetheprimary
goalofthefirm.Unlikeprofitmaximization,thisgoalconsiderstiming,cashflows,andrisk.Italso
reflectstheworthoftheownersinvestmentinthefirmatanytime.Itisthevaluetheycanrealize
shouldtheydecidetoselltheirshares.
b. Yes,thereappearstobeanagencyproblem.Althoughcompensationformanagementistiedtoprofits,
itisnotdirectlylinkedtoshareprice.Inaddition,managementsactionswithregardtopollution
controlssuggestaprofitmaximizationfocus,whichwouldmaximizetheirearnings,ratherthanan
attempttomaximizeshareprice.
c. Thefirmsapproachtopollutioncontrolseemstobequestionableethically.Whileitisunclearwhether
theiractswereintentionaloraccidental,itisclearthattheyareviolatingthelawanillegalactpotentially
leadingtolitigationcostsandasaresultaredamagingtheenvironment,animmoralandunfairact
thathaspotentialnegativeconsequencesforsocietyingeneral.Clearly,SportsProductshasnotonly
brokenthelawbutalsoestablishedpoorstandardsofconductandmoraljudgment.
d. Fromtheinformationgiventhereappearstobeaweakcorporategovernancesystem.Thefact
thatmanagementisabletomeasureandrewardtheirperformanceonprofitsindicatesthatnoone
iswatchingoutfortheshareholders.LorenandDalesconcernsindicatethatemployeesapparently
haveaninterestinthelongrunsuccessofthefirm.Allowingthecontinuationofpollutionviolations
isalsoapparentlyescapingtheinterestandcontrolabilityofotherswhoshouldbemonitoringthefirm.
e. Somespecificrecommendationsforthefirminclude:
Tiemanagement,andpossiblyemployee,compensationtosharepriceoraperformancebased
measureandmakesurethatallinvolvedownstockandhaveastakeinthefirm.Beingcompensated
partiallyonthebasisofsharepriceoranotherperformancemeasure,andowningstockinthefirm
willmorecloselylinkthewealthofmanagersandemployeestothefirmsperformance.
Complywithallfederalandstatelawsaswellasacceptedstandardsofconductormoraljudgment.
2012PearsonEducation,Inc.PublishingasPrenticeHall
Chapter1TheRoleofManagerialFinance41
Establishacorporateethicspolicy,tobereadandsignedbyallemployees.
Setupacorporategovernancesystemthathasasitsbasistheoversightandwelfareofallthe
stakeholdersinthefirm.
(Otheranswersare,ofcourse,possible.)
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Chapter1TheRoleofManagerialFinance43
Spreadsheet Exercise
TheanswertoChapter1sMonsantospreadsheetproblemislocatedontheInstructorsResourceCenter
atwww.pearsonhighered.com/ircundertheInstructorsManual.
Group Exercise
Groupexercisesareavailableonwww.myfinancelab.com.
Chapter 1
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Chapter1TheRoleofManagerialFinance45
Thisfirstchapterasksstudentstonametheirfictitiousfirmanddescribeitsbusiness.Asthisfirmisgoing
publicstudentsareaskedtoexplainwhyitisappropriateforthemtogopublic,andalsodiscussdifferent
managerialroleswithinthecorporation.Thegroupmustchooseashadowfirmtofollowthatispublicly
held,allowingthemtogatherasubstantialamountofinformationaboutitontheInternet.Thispublicly
tradedfirmshouldbeinanindustryrelatedtotheirfictitiousfirm.
Themostimportantcounselstudentscouldgetattheoutsetistospendtimemakingtheseinitialdecisions.
Laterworkisgoingtobuildonthesechoicesandcarefulchoosingisparamount.Forexample,inchoosing
theshadowfirm,studentsshouldpickawellestablishedfirmwhoseinformation,includingfinancials,will
beeasilyfound.Thisalsoimpactstheirdecisionsregardingtheirownfictitiousfirm.Throughoutmanyof
thesubsequentchaptersstudentswillbetakingrealworldinformationfromtheirshadowfirmandapplying
ittotheirfictitiousfirm;dressingtheirownfirmwiththeclothesoftheshadowfirm.Studentsshouldfeel
comfortableintheseclothes,soencouragingthemtochooseindustriestheyrefamiliarwith,orinterested
in,ishelpful.
2012PearsonEducation,Inc.PublishingasPrenticeHall