hw 1 - BUAD 306: Business Finance, Spring 2010 Solutions to...

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BUAD 306: Business Finance, Spring 2010 Solutions to HW1 Chapter 1 Concepts Review 7. In a corporation, the shareholders are the owners of the firm. The shareholders elect the directors of the corporation, who in turn appoint the firm’s management. This separation of ownership from control in the corporation is what causes agency problems to exist. Management may act in its own or so meone else’s best interests, rather than those of the shareholders. If such events occur, they may contradict the goal of maximizing the share price of the equity of the firm. 11. If financial markets are efficient, then the current stock value reflects the risk, timing, and magnitude of all future cash flows, both short-term and long-term. So, if markets are efficient, then the statement is false. Chapter 2 Concepts Review 5. Market values can never be negative. To understand why, recall that corporations (which are the firms that can issues shares) have limited liability: if you own shares in a company, you can only lose the money you have put in the company, but no more. Remember that market value equals stock price times the number of shares, so the market value is negative only when the stock price is negative. Now, imagine that the stock price is negative, let's say -$20. Then, for every share you buy, you would also receive a check for $20. Since, under limited liability, nobody can be forced to give more money to the company no matter what happens, you could pocket the $20 and forget about any problems with the company. If you can make money from buying one share, why not buy millions of shares? If stock prices could be negative, all of us would become billionaires! Of course this doesn't happen: in reality, stock prices cannot fall below zero. That is the result of
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This note was uploaded on 09/06/2010 for the course BUAD 306 taught by Professor Selvili during the Spring '07 term at USC.

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hw 1 - BUAD 306: Business Finance, Spring 2010 Solutions to...

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