Fundamentals of Corporate Finance
ROSS
Thirteenth Edition
About this book
When the three of us decided to write a book, we were united by one strongly held principle: Corporate finance should be developed in terms of a few integrated, powerful ideas. We believed that the subject was all too often presented as a collection of loosely related topics, unified primarily by virtue of being bound together in one book, and we thought there must be a better way.
One thing we knew for certain was that we didn’t want to write a “me-too” book. So, with a lot of help, we took a hard look at what was truly important and useful. In doing so, we were led to eliminate topics of dubious relevance, downplay purely theoretical issues, and minimize the use of extensive and elaborate calculations to illustrate points that are either intuitively obvious or of limited practical use.
Questions & Answers from this book
Questions and answers are connected to the referenced book and its available source material.
Chapter 1: Introduction to Corporate Finance
What roles do the treasurer and controller play in the financial management of a corporation as described in the chapter?
The treasurer is responsible for managing the firm's cash, credit, financial planning, and capital expenditures. The controller oversees cost and financial accounting, tax payments, and management information systems. Both roles are essential for effective financial management within a corporation.
What are the three key questions that corporate finance seeks to answer according to the chapter?
Corporate finance seeks to answer three key questions: 1. What long-term investments should a firm undertake? 2. Where will the firm obtain the long-term financing for these investments? 3. How will the firm manage its everyday financial activities?
Chapter 2: Financial Statements, Taxes, and Cash Flow
What are the key differences between accounting value and market value as discussed in the chapter?
The key differences between accounting value and market value are that accounting value, or book value, is based on the historical cost of assets minus liabilities, while market value reflects the current price at which an asset could be bought or sold in the market. Accounting value is often less relevant for decision-making compared to market value, which is influenced by investor perceptions and market conditions.
How can a firm determine its cash flow from financial statements according to the chapter?
A firm can determine its cash flow from its financial statements by analyzing the differences between accounting income and cash flow, as well as understanding the relevant features of financial statements. This involves recognizing that cash flow is distinct from accounting value and market value.
Chapter 3: Working with Financial Statements
What is the difference between book value and market value as explained in the chapter?
Book value refers to the value of a company's assets as recorded on its balance sheet, which is based on historical cost. In contrast, market value represents the current worth of those assets in the marketplace, which can differ significantly from book value due to factors like depreciation and changes in market conditions.
What is the balance sheet identity as described in the chapter?
The balance sheet identity states that a firm's total assets equal the sum of its liabilities and shareholders' equity. This can be expressed with the equation: Assets = Liabilities + Shareholders' equity.
Chapter 4: Long-Term Financial Planning and Growth
What are the three components that return on equity (ROE) can be expressed as, according to the expanded DuPont analysis?
Return on equity (ROE) can be expressed as three components according to the expanded DuPont analysis: profit margin, total asset turnover, and financial leverage (equity multiplier).
What were the major sources and uses of cash for Prufrock Corporation in 2021 as detailed in the chapter?
In 2021, Prufrock Corporation's major sources of cash included an increase in accounts payable ($32 million), an increase in common stock ($50 million), and an increase in retained earnings ($290 million), totaling $372 million. The major uses of cash were an increase in accounts receivable ($23 million), an increase in inventory ($29 million), a decrease in notes payable ($35 million), a decrease in long-term debt ($74 million), and fixed asset acquisitions ($425 million), totaling $731 million.
How do increases in asset accounts affect cash flow, according to the chapter?
Increases in asset accounts generally indicate that a firm has purchased assets, which is considered a use of cash. Therefore, when asset accounts increase, it typically results in a decrease in cash flow.
Chapter 5: Introduction to Valuation: The Time Value of Money
How does compounding differ from simple interest according to the chapter?
Compounding differs from simple interest in that compounding involves earning interest on both the original principal and any previously earned interest, while simple interest is calculated only on the original principal amount.
What is the future value of a $100 investment after one year at an interest rate of 10 percent?
The future value of a $100 investment after one year at an interest rate of 10 percent is $110.
Chapter 9: Net Present Value and Other Investment Criteria
What is the primary reason the net present value criterion is considered the best way to evaluate proposed investments according to the chapter?
The primary reason the net present value (NPV) criterion is considered the best way to evaluate proposed investments is that it directly measures the increase in value to the firm. NPV accounts for the time value of money, ensuring that cash flows are discounted appropriately, which helps in making informed investment decisions.
How is the total payment calculated for an amortized loan, and how does it change over time according to the example provided in the chapter?
The total payment for an amortized loan is calculated by determining a fixed payment amount that includes both principal and interest, which remains constant throughout the loan term. Over time, as the loan balance decreases, the interest portion of each payment declines while the principal portion increases, resulting in a fixed total payment that covers both components.
In the context of the two-stage dividend growth model, what happens if the assumption that dividends drop immediately from a high growth rate to a perpetual growth rate is violated?
If the assumption that dividends drop immediately from a high growth rate to a perpetual growth rate is violated, it can lead to inaccuracies in stock valuation. The model may not accurately reflect the true growth trajectory of dividends, potentially resulting in an incorrect stock price. Analysts may need to use alternative methods, such as linear interpolation, to better estimate dividend growth over time.
Chapter 10: Making Capital Investment Decisions
Chapter 12: Some Lessons from Capital Market History
What is the significance of using a zero NPV as a benchmark when setting a bid price according to the chapter?
Using a zero NPV as a benchmark when setting a bid price is significant because it helps determine the lowest price that can be charged while still earning the required return on investment. This approach minimizes the risk of the winner's curse, where a bidder might underbid and incur losses. By ensuring the bid results in a zero NPV, the company can confidently compete for contracts without jeopardizing profitability.
What are the three different approaches to calculating operating cash flow (OCF) discussed in the chapter?
The three different approaches to calculating operating cash flow (OCF) are the bottom-up approach, the top-down approach, and the tax shield approach.
Chapter 13: Return, Risk, and the Security Market Line
Chapter 14: Cost of Capital
According to the chapter, what is the historical risk premium for large-company stocks and how does it affect the required return on an investment with similar risk?
The historical risk premium for large-company stocks is 8.7%. This risk premium affects the required return on an investment with similar risk by indicating that the investment should offer a return equal to the risk-free rate plus this premium.
Why can’t systematic risk be eliminated through diversification according to the chapter on Cost of Capital?
Systematic risk cannot be eliminated through diversification because it affects nearly all assets to some degree, regardless of the number of assets in a portfolio. Unlike unsystematic risk, which is unique to individual assets and can be diversified away, systematic risk remains present in any investment portfolio.
How does the reward-to-risk ratio of Asset A compare to that of Asset B based on their expected returns and betas?
Asset A has a reward-to-risk ratio of 7.5 percent, while Asset B has a reward-to-risk ratio of 6.67 percent. This indicates that Asset A offers a higher return per unit of systematic risk compared to Asset B.
Chapter 16: Financial Leverage and Capital Structure Policy
What is the formula for calculating the value of a levered firm (VL) according to the text?
The formula for calculating the value of a levered firm (VL) is VL = VU + TC × D, where VU is the value of the firm if it has no debt, TC is the corporate tax rate, and D is the amount of debt.
How does the tax deductibility of interest affect the value of a levered firm compared to an unlevered firm according to M&M Proposition I with corporate taxes?
The tax deductibility of interest increases the value of a levered firm compared to an unlevered firm. According to M&M Proposition I with corporate taxes, the value of a levered firm equals the value of an unlevered firm plus the present value of the interest tax shield, represented as VL = VU + TC × D.
In the context of Marker, Inc., how does issuing new equity to finance an investment affect the book value per share and the stock price, assuming a constant price-earnings ratio?
Issuing new equity to finance an investment typically leads to a decrease in book value per share and a decline in stock price, assuming a constant price-earnings ratio. This occurs because the total book value increases with the new investment, but the number of shares outstanding also increases, resulting in lower book value per share. Additionally, the stock price may drop due to market perceptions of dilution and the potential negative signal about the firm's financial health.
Chapter 18: Short-Term Finance and Planning
Chapter 20: Credit and Inventory Management
What are the key differences between the flexible and restrictive financing policies as described in the chapter?
The key differences between flexible and restrictive financing policies lie in their investment in current assets and their financing methods. A flexible policy maintains a high ratio of current assets to sales and uses less short-term debt, resulting in higher liquidity. In contrast, a restrictive policy has a low ratio of current assets to sales and relies more on short-term debt, leading to lower liquidity and potentially higher risks of shortages.
How is the NPV of a credit policy switch calculated according to the chapter's content?
The NPV of a credit policy switch is calculated by determining the incremental cash inflow from increased sales, subtracting the costs associated with the switch, and then calculating the present value of the future cash flows. Specifically, the formula is: NPV = -[PQ + v(Q′ - Q)] + [(P - v)(Q′)]/R, where PQ is the sales revenue under the old policy, v(Q′ - Q) is the additional production cost, and (P - v)(Q′) is the incremental cash inflow from increased sales.
Chapter 22: Behavioral Finance: Implications for Financial Management
Chapter 23: Enterprise Risk Management
How do strategic options in capital budgeting differ from conventional DCF methods according to the chapter on Enterprise Risk Management?
Strategic options in capital budgeting differ from conventional DCF methods by focusing on the flexibility and future business opportunities that a project may create, rather than just the immediate cash flows. While DCF methods typically evaluate projects based on their expected cash flows and discount rates, strategic options account for the value of potential future decisions and adaptations that can arise from a project, making them more complex to assess.
What are the four factors that determine the value of a call option according to the chapter on Enterprise Risk Management?
The four factors that determine the value of a call option are: the stock price, the exercise price, the time to expiration, and the risk-free rate.
What are the four types of risks identified in enterprise risk management (ERM)?
The four types of risks identified in enterprise risk management (ERM) are hazard risks, financial risks, operational risks, and strategic risks.
You may also be interested in
Financial Management: Principles and Applications
Sheridan Titman
38 questions
AI-Driven Finance in the VUCA World
Ashutosh Yadav, Mansaf Alam etc.
37 questions
International Financial Statement Analysis Workbook (CFA Institute ...
Thomas R. Robinson;
37 questions
Fundamentals of Financial Management, Concise Edition
Eugene F. Brigham, Joel F. Houston
35 questions