Solution Manual For Principles of Managerial Finance, 8th Edition

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nCh. 1 Answers to Review Questions1-1.The goal of a firm, and therefore of all financial managers, is maximizing shareholder wealth.The proper metric for this goal is the price of the firm’s stock. Other things equal, anincreasing price per share of common stock relative to the stock market as a whole indicatesachievement of this goal.1-2Actions that maximize the firm’s current profit may not produce the highest stock pricebecause (1) some firm activities that result in slightly lower profit today generate much largerprofits in the future periods (i.e., focusing on current profit overlooks the time value ofmoney); (2) activities that generate higher accounting profits today may not result in highercash flows to stockholders; and (3) activities that lead to high profits today may involve higherrisk, which could result in significant future losses.1-3Risk is the chance actual outcomes may differ from expected outcomes. Financial managersmust consider risk and return because the two factors tend to have an opposite effect on shareprice. That is, other things equal, an increase in the risk of cash flows to shareholders willdepress firm stock price while higher average cash flows to shareholders will increase stockprice.1-4Maximizing shareholder wealth does not mean overlooking or minimizing the welfare of otherfirm stakeholders. Firms with satisfied employees, customers, and suppliers tend to producehigher (or less risky) cash flows for their shareholders compared with companies that neglectnon-owner stakeholders. That said, customers prefer lower prices for firm output, firmemployees prefer higher wages, and firm suppliers prefer higher prices for the input goods andservices they provide. So actions that produce the highest price of the firm’s stock cannotsimultaneously maximize customer, employee, and supplier satisfaction.1-5Broadly speaking, the decisions made by financial managers fall under three headings: (i)investment, (ii) capital budgeting, and (iii) working capital. Investment decisions involve thefirm’s long-term projects while financing decisions concern the funding of those projects.Working-capital decisions, in contrast are related to the firm’s management of short-termfinancial resources.1-6Financial managers must recognize the tradeoff between risk and return because shareholdersprefer higher cash flows but dislike large swings in cash flows. And, as a general rule, actionsthat boost the firm’s average cash flows also result in greater cash-flow greater volatility.Viewed another way, firm actions to reduce the chance cash flows will be low or negative alsotend to reduce average cash flows over time. Understanding this tradeoff is important becauseshareholders are risk averse. That is, they will only accept larger swings in a firm’s cash flowsonly if compensated over time with higher average cash flows.1-7Finance is often considered applied economics. One reason is firms operate within the largereconomy. More importantly, the bedrock concept in economics—marginal benefit-marginalcost analysis—is also central to managerial finance. Marginal benefit-marginal cost analysis isthe notion a firm (or any other economic actor) should take only those actions for which theextra benefits exceed the extra costs. Nearly, all financial decisions ultimately turn on anassessment of their marginal benefits and marginal costs.

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