Part1

IntroductiontoManagerialFinance
ChaptersinthisPart
Chapter1

TheRoleofManagerialFinance

Chapter2

TheFinancialMarketEnvironment

Integrative Case 1: Merit Enterprise Corp.

Chapter1
TheRoleofManagerialFinance
Instructors Resources

Overview

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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.

Suggested Answer to Opener in Review Question

IfZuckerbergisexpectedtoremaintheCEOofFacebookaftertheIPO,whywouldhebeworried
aboutgoingpublic?
Beyondthechallengesarisingfromtheinfluencesofoutsideinvestorsandgovernmentregulations,as
mentionedinthecase,thereisalsothefactthathisactionsandthefirmsfinancialstatementswouldbe
moreaccessibletothegeneralpublic.Whilethepublicmightrewardhimwithahighersalaryingood
years,thereisapotentialthathecouldberemovedfromofficeinbadyears.Also,Facebookwouldbea
tantalizingcompanytomanyotherfirms,makingitatakeovertarget.

Answers to Review Questions

1. Financeistheartandscienceofmanagingmoney.Financeaffectsallindividuals,businesses,and
governmentsintheprocessofthetransferofmoneythroughinstitutions,markets,andinstruments.
Atthepersonallevel,financeisconcernedwithanindividualsdecisionsregardingthespendingand
investingofincome.Businessesalsohavetodeterminehowtospendandinvestrevenues.

2. Financialservicesistheareaoffinanceconcernedwiththedesignanddeliveryofadviceand
financialproductstoindividuals,businesses,andgovernment.

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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.

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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.

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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:

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Chapter1TheRoleofManagerialFinance11

a.

Makinginvestmentdecisions:Determiningboththemostefficientlevelandthebestmixof
assets;and

b. Makingfinancingdecisions:Establishingandmaintainingthepropermixofshortandlongterm
financingandraisingneededfinancinginthemosteconomicalfashion.
Investmentdecisionsconcernthelefthandsideofthebalancesheet(currentandfixedassets).
Financingdecisionsdealwiththerighthandsideofthebalancesheet(currentliabilities,longterm
debt,andstockholdersequity).

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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.

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Chapter1TheRoleofManagerialFinance15

18. Marketforcesforexample,shareholderactivismfromlargeinstitutionalinvestorscanreduceor
avoidtheagencyproblembecausethesegroupscanusetheirvotingpowertoelectnewdirectorswho
supporttheirobjectivesandwillacttoreplacepoorlyperformingmanagers.Inthisway,thesegroups
placepressureonmanagementtotakeactionsthatmaximizeshareholderwealth.
Thethreatofhostiletakeoversalsoactsasadeterrenttotheagencyproblem.Hostiletakeovers
occurwhenacompanyorgroupnotsupportedbyexistingmanagementattemptstoacquirethe
firm.Becausetheacquirerlooksforcompaniesthatarepoorlymanagedandundervalued,this
threatmotivatesmanagerstoactinthebestinterestsofthefirmsowners.
Institutionalinvestorsareapowerfulsourceofshareholderinvolvementinthemonitoringof
managerstoreducetheagencyproblem.Institutionsholdlargequantitiesofsharesinmanyofthe
corporationsintheirportfolio.Managersoftheseinstitutionsshouldbeactiveinthemonitoringof
managementandvotetheirsharesforthebenefitoftheshareholders.Thepowerofinstitutional
investorsfarexceedsthevotingpowerofindividualinvestors.

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Chapter1TheRoleofManagerialFinance17

Suggested Answer to Focus on Practice Box: Professional

Certifications in Finance

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Chapter1TheRoleofManagerialFinance19

Whydoemployersvaluehavingemployeeswithprofessionalcertifications?
Studyingtopasscertificationexamsallowsemployeestocontinuetheireducationbeyondtheir
undergraduatedegree.Thestudywillbefocusedononeareaoffinance,whichislikelytobethatneeded
toperformtheirjobwell.Furthermore,itwillallowtheemployertoadvertisetheadditionaltrainingof
theemployees,andtherebyattractadditionalbusiness.

Suggested Answer to Focus on Ethics Box: Will Google Live Up

to Its Motto?
Isthegoalofmaximizationofshareholderwealthnecessarilyethicalorunethical?
Itisnotthegoalthatmakesmaximizationofshareholderwealthethicalorunethical,itisactionsofthe
financialmanagerinpursuitofthisgoal.
HowcanGooglejustifyitsactionsintheshortruntoitslongruninvestors?
Googlemuststressthelongrunbenefitsofitsdecisiontoinvestors.Forexample,Googlemightmakethe
casethatthecompanysstanceinChinawillopenupbusinessopportunitieselsewhere.Theymightalso
showthatthecompanysbusinessmodelismorevaluablewhensearchresultsareuncensored.

Answers to Warm-Up Exercises

E11.

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).

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Chapter1TheRoleofManagerialFinance21

Whiletaxationofincomeisakeyfactorindecidingwhichformofbusinessorganizationto
select,twootherfactorsarealsoimportant.Inapartnership,eachpartnerhasunlimited
liabilityandmayhavetocoverdebtsofotherpartners,whilecorporateownershavelimited
liabilitythatguaranteesthattheycannotlosemorethantheyhaveinvestedinthecorporation.
Thethirdmajorconsiderationiseaseoftransferofthebusiness.Partnershipsareharderto
transferandaretechnicallydissolvedwhenapartnerdies,whileacorporationcanhaveavery
longlifewithownershipreadilytransferredthroughthesaleofstock.

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Chapter1TheRoleofManagerialFinance23

IfathirdpartywasaskedtodecidewhichlegalformofbusinessA&JTaxPreparationshould
take,itwouldbeusefultohavethefollowinginformation:

Maritalstatusandtaxsituationofeachpartner

Expectationofthelongevityofthefirm

Ageofthecurrentowners

Currentplanofsuccession

Risktoleranceoftheowners

Expectationoffuturetaxlawchanges

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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
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Chapter1TheRoleofManagerialFinance27

usedtorewardmanagers,presumablybasedontheirgoodperformancewhichsubsequently
leadstoahigherstockprice.TheDonutShop,Inc.exampledoesnotrepresentaclearcaseof
agencycostsbecauseitisthemanagementitselfthathasinstitutedtheNotipspolicyandthe
employeeshaverespondedwithreducedperformance.Bybanningtips,themanagementhas
createdasituationwhereanagencycostmaybenecessarytoprovideanincentiveforemployees
toresumetheirformerlevelofperformance.

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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.

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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.

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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.

Assessing the Goal of Sports Products, Inc.

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.
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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.

Notes for Adopters

Themotivationforthesegroupexercisesistoplacethelearninggoalsofeachchapterwithinthecontext
ofafictitiousfirmwhilegivingstudentsavaluablesetofteamworkskills.Creativityisencouraged,while
thestronglinksofeachassignmenttoarealworld,shadowfirmshouldgroundeachgroupsworkin
reality.Anyoftheseassignmentsandtheirdeliverablescanbemodifiedtobetterfitwithinanadopters
coursegoalsastheyweredesignedwithaneyetowardflexibilityofuse.Thelearningthroughthese
exercisesshouldbesomethingstudentsenjoy,beingbothapplicabletotherealworldandlessconfining
thantraditionalhomework.
Thefirstissueforadopterstoaddressisgroupcompositionandsize.Shouldstudentsselfseparateor
bedividedbytheirinstructor?Howbigshouldthegroupsbe?Thisisasemesterlongassignmentand
studentswillneedtogetalongwiththeirfellowgroupmembers.Ifstudentschoosetheirowngroupsit
may,thoughnotalways,reducetheincidenceofintragroupsquabbles.Diversitywithinthegroupsmight
thenbesacrificed,however.Onestrategyistoaskstudentstofirstpairoff.Theinstructorcanthenjoin
thepairsintogroupsof4.Thispairingofthepairscouldbedonerandomlythroughanumberinthehat
selectionprocess,ascouldtheentiregroupsetup.
Groupsizedoesmatterandtheseexercisesweredesignedforaworkloadspreadacrossaminimumof
3students.Largergroupswouldlessenthehomeworkload;however,theissueoffreeridingisoftenmore
prevalentinlargergroups,whereslackerscanhide.Managementoflargergroupsisalsomorechallenging
fortheparticipants.Thesuggestedgroupsizeisbetween35students.
Groupleadershipisanotherissue.ThebestsituationmightberotatingtheCEO/leader,whereeachgroup
memberhasseveralopportunitiestobeincharge.Lastly,theseexercisesweredesignedtoallowstudents
freedombutwiththeresponsibilityofworkingsomewhatindependentlyoftheirinstructor.Inthisveinthe
instructionsforeachassignmenthavebeenwrittentoberelativelyselfexplanatory.

Chapter 1

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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