If you bought a share of stock, what would you expect to receive, when would you
expect to receive it, and would you be certain that your expectations would be met?
1-2 Are the stocks of different companies equally risky? If not, what are some factors that would cause a company’s stock to be viewed as being relatively risky?
1-3 If most investors expect the same cash flows from Companies A and B but are more confident that A’s cash flows will be close to their expected value, which should have the higher stock price? Explain.
1-4 Are all corporate projects equally risky, and if not, how do a firm’s investment decisions affect the riskiness of its stock?
1-5 What is a firm’s intrinsic value? Its current stock price? Is the stock’s “true long-run value” more closely related to its intrinsic value or its current price?
1-6 When is a stock said to be in equilibrium? At any given time, would you guess that most stocks are in equilibrium as you defined it? Explain. 20 Part 1 Introduction to Financial Management
1-7 Suppose three completely honest individuals gave you their estimates of Stock X’s intrinsic value. One is your current girlfriend or boyfriend, the second is a professional security analyst with an excellent reputation on Wall Street, and the third is Company X’s CFO. If the three estimates differed, which one would you have the most confidence in? Why?
1-8 Is it better for a firm’s actual stock price in the market to be under, over, or equal to its intrinsic value? Would your answer be the same from the standpoints of both stockholders in general and a CEO who is about to exercise a million dollars in options and then retire? Explain.
1-9 If a company’s board of directors wants management to maximize shareholder wealth, should the CEO’s compensation be set as a fixed dollar amount, or should it depend on how well the firm performs? If it is to be based on performance, how should performance be measured? Would it be easier to measure performance by the growth rate in reported profits or the growth rate in the stock’s intrinsic value? Which would be the better performance measure? Why?
1-10 What are the three principal forms of business organization? What are the advantages and disadvantages of each?
1-11 Should stockholder wealth maximization be thought of as a long-term or a short-term goal—for example, if one action would probably increase the firm’s stock price from a current level of $20 to $25 in 6 months and then to $30 in 5 years but another action would probably keep the stock at $20 for several years but then increase it to $40 in 5 years, which action would be better? Can you think of some specific corporate actions that might have these general tendencies?
1-12 What are some actions stockholders can take to ensure that management’s and stock holders’ interests are aligned?
1-13 The president of Southern Semiconductor Corporation (SSC) made this statement in the company’s annual report: “SSC’s primary goal is to increase the value of our common stockholders’ equity.” Later in the report, the following announcements were made:
a. The company contributed $1.5 million to the symphony orchestra in Birmingham,
Alabama, its headquarters city.
b. The company is spending $500 million to open a new plant and expand operations
in China. No profits will be produced by the Chinese operation for 4 years, so earnings will be depressed during this period versus what they would have been had
the decision not been made to expand in that market.
c. The company holds about half of its assets in the form of U.S. Treasury bonds, and it keeps these funds available for use in emergencies. In the future, though, SSC plans to shift its emergency funds from Treasury bonds to common stocks.
Discuss how SSC’s stockholders might view each of these actions, and how they might affect the stock price.
1-14 Investors generally can make one vote for each share of stock they hold. Teacher’s Insurance and Annuity Association–College Retirement Equity Fund (TIAA–CREF) is the largest institutional shareholder in the United States, hence it holds many shares and has more votes than any other organization. Traditionally, this fund has acted as a passive investor, just going along with management. However, back in 1993 it mailed a notice to all 1,500 companies whose stocks it held that henceforth it planned to actively intervene if, in its opinion, management was not performing well. Its goal was to improve corporate performance so as to boost the prices of the stocks it held. It also wanted to encourage corporate boards to appoint a majority of independent (outside) directors, and it stated that it would vote against any directors of firms that “don’t have an effective, independent board that can challenge the CEO.” In the past, TIAA–CREF responded to poor performance by “voting with its feet,”which means selling stocks that were not doing well. However, by 1993 that position had become difficult for two reasons. First, the fund invested a large part of its assets in “index funds,” which hold stocks in accordance with their percentage value in the broad stock market. Furthermore, TIAA–CREF owns such large blocks of stocks in many companies that if it tried to sell out, this would severely depress the prices of those stocks. Thus, TIAA–CREF is locked in to a large extent, and that led to its decision to become a more active investor.
b. Due to its asset size, TIAA–CREF owns many shares in a number of companies. The fund’s management plans to vote those shares. However, TIAA–CREF is itself
owned by many thousands of investors. Should the fund’s managers vote its shares,
or should it pass those votes, on a pro rata basis, back to its own shareholders?
Explain.
1-15 Edmund Enterprises recently made a large investment to upgrade its technology. While these improvements won’t have much of an effect on performance in the short run, they are expected to reduce future costs significantly. What effect will this investment have on Edmund Enterprises’ earnings per share this year? What effect might this investment have on the company’s intrinsic value and stock price?
1-16 Suppose you were a member of Company X’s board of directors and chairman of the company’s compensation committee. What factors should your committee consider when setting the CEO’s compensation? Should the compensation consist of a dollar salary, stock options that depend on the firm’s performance, or a mix of the two? If “performance” is to be considered, how should it be measured? Think of both theoretical and practical (that is, measurement) considerations. If you were also a vice president of Company X, might your actions be different than if you were the CEO of some other company?
1-17 Suppose you are a director of an energy company that has three divisions—natural gas, oil, and retail (gas stations). These divisions operate independently from one another, but the division managers all report to the firm’s CEO. If you were on the compensation committee as discussed in question 1-16 and your committee was asked to set the compensation for the three division managers, would you use the same criteria as you would use for the firm’s CEO? Explain your reasoning.
