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FM12 Ch 30 Solutions Manual - Chapter 30 Financial...

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Chapter 30 Financial Management in Not-for-Profit Businesses ANSWERS TO END-OF-CHAPTER QUESTIONS 30-1 The major difference in ownership structure is that investor-owned firms have well- defined owners, who own stock in the business and exercise control over the firm through the proxy mechanism. Conversely, not-for-profit firms do not have stockholders. Control rests in a board of trustees comprised mostly of community leaders who have no direct economic interest in the firm. Because of this ownership structure difference, the goals of investor-owned and not-for-profit firms are quite different as well. 30-2 No. The asymmetric information theory refers to a preferred "pecking order" of financing by corporate managers, with new common stock being the least preferred because of the negative signals that new stock issues typically send to investors. Since not-for-profit firms have no common stock, this theory is not applicable. 30-3 No. The break in an investor-owned firm's MCC schedule is due to the higher cost involved with issuing new common stock once the firm's retained earnings has been exhausted. Since not-for-profit firms do not have common stock, there are no such breaks in their MCC schedules. In fact, all of a not-for-profit firm's fund capital, which includes retained earnings, grants from government entities, and private contributions, have a common opportunity cost to the firm, which is the return that could be expected from investing in the stock of a similar type investor-owned company. 30-4 a. Without access to tax-exempt debt, all of the benefits to using debt for a not-for-profit firm would disappear. Thus, in accordance with MM capital structure theory, and considering financial distress and agency costs related to debt, the firm's optimal capital structure would be zero debt. b. No. Managers of not-for-profit firms do not have the same degree of flexibility as investor-owned firms in raising equity capital. Thus, it is often necessary for not-for- profit firms to use more than the theoretically optimal amount of debt when new fund capital cannot be obtained for needed services. Answers and Solutions: 30 - 1
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30-5 Since not-for-profit businesses are expected to provide a social value in addition to an economic benefit, project analysis must consider social value along with expected cash flows. The summation of a project's net present social and cash flow values is its total net present value (TNPV). If the TNPV is 0, then the project is deemed acceptable. To perform this analysis, the social value of a project must be quantified in some manner for each year of the project's life, and then discounted back to Year 0. This requires the not-for-profit firm to quantify the social value of the services provided by the project in each year, and to determine the discount rate that is to be applied to those services.
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