Solutions Manual

CHAPTER 1
NATURE, PURPOSE, AND
SCOPE OF FINANCIAL MANAGEMENT
SUGGESTED ANSWERS TO THE REVIEW QUESTIONS
I. Questions
1. The goal of financial management is to make money and add value for
the owner. The kinds of activities that financial management deals with
relate the three financial decisions that finance managers must make
namely, investing, financing and dividend decisions.
2. Refer to page 8 Relationship between inancial !anagement and
"ccounting.
#. The owners$ perspective holds that the only appropriate goal is %to
ma&imi'e shareholder wealth(. The competing viewpoint is from the
stakeholders$ perspective, which emphasi'es social responsibility over
profitability. This view maintains that managers must ma&imi'e the total
satisfaction of all stakeholders in a business. )hile strong arguments
speak in favor of both perspectives, financial practitioners and academics
now tend to believe that the manager$s primary responsibility should be
to ma&imi'e shareholder wealth and give only secondary consideration
to other stakeholders$ welfare. The invisible hand of the market, acting
through compensation and the free price system, would ensure that only
those activities most efficient and beneficial to society as a whole would
survive in the long run. Thus, those same activities would also profit the
individual most. )hen companies try to implement a goal other than
profit ma&imi'ation, their efforts tend to backfire. *onsider the firm that
tries to ma&imi'e employment, the high number of employees raises
costs. +oon the firm will find that its costs are too high to allow it to
compete against more efficient firms, especially in a global business
environment. )hen the firm fails, all employees are let go and
employment ends up being minimi'ed, not ma&imi'ed.
,. inancially stable firms are good for stakeholders, such as employees,
managers, customers and local communities.
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Chapter Nature, Purpose and Scope of Financial Management
-. Theoretically, managers work for shareholders. .n reality, because
shareholders aren$t involved in day/to/day firm activities, managers
control the firm. !anagers might be tempted to operate the firm in such a
way as to benefit themselves more than the shareholders. *orporate
governance is the system of incentives and monitors that tries to
overcome this agency problem. +hareholders can align managers$ interest
with stockholder interests by making managers part owners of the firm.
Then, various monitors follow the firm and report on its activities.
0. *apital budgeting 1deciding whether to e&pand a manufacturing plant2,
capital structure 1deciding whether to issue new e3uity and use the
proceeds to retire outstanding debt2, and working capital management
1modifying the firm$s credit collection policy with its customers2.
4. To ma&imi'e the current market value 1share price2 of the e3uity of the
firm 1whether it$s publicly/traded or not2.
II. Multiple Choice Questions
1. *
2. 5
#. 5
,. *
-. 6
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