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Financial Management Theory And Practice, Brigham-11th Ed - Chapter 30

Chapter 30 Financial Management in Not-for-Profit Businesses The major difference in ownership structure is that investor-owned firms have welldefined owners, who own stock in the business and exercise control over the firm through the proxy mechanism. | 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 .