Ch 1 Solutions Rev CF2.feb067 - The Scope of Corporate...

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The Scope of Corporate Finance 1 Chapter 1: The Scope of Corporate Finance Answers to Questions 1-1. A financial manager needs to know all five basic finance areas because they all impact his or her job. While the manager’s primary responsibilities may be raising money or choosing investment projects, the manager also needs to know about capital markets and debt/equity optimal levels, be able to manage risks of the business and governance of the corporation. Corporate governance is a function because a manager wants to act in the best interest of its shareholders. New methods of managing risk have been developed in recent years, and a manager must be aware of these in order to maximize shareholder value. 1-2. The core principles are: (1) Time Value of Money; (2) Compensation for Risk; (3) Don’t Put Your Eggs in One Basket (diversification); (4) Markets are Smart; and (5) No Arbitrage. Basic Finance Function: Financing : Raising money can involve external markets suggesting that all five core principles are relevant as investors seek to diversify, value the security using the time value of money, seek sufficient compensation for risk, and the stock’s price will be fairly valued based upon smart markets with no arbitrage. Capital Budgeting : Involves the time value of money, determining whether or not a project is expected to offer adequate compensation for risk, and the firm perhaps seeking to diversify. Financial Management : As the question of the appropriate capital structure for the firm involves the financial markets, again, the principles of no arbitrage and smart markets come into play, as well as that of adequate risk compensation. Corporate Governance : Again, as this can involve the financial markets in the sense that the stockholders ‘grade’ those who govern the corporation, the principle of smart markets comes into play.
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