Ch 1 - Intro to Corporate Finance

Question 1

3 types of financial management decisions

Answer 1

1. Capital budgeting decisions
2. Capital structure decisions
3. Working capital management decisions

Question 2

Capital budgeting decisions

Answer 2

• choosing long-term investments to grow the firm
• ex: Apple investing in podcasts to turn into TV shows (takes a long time to develop benefits for the investor)

Question 3

Capital structure decisions

Answer 3

• how long-term investments are paid for
• usually an investor or borrowing capital from a financial institution
• ex: Royal Caribbean refinances debt, promises to pay back 11% interest to investors

Question 4

Working capital management decisions

Answer 4

• what to do with revenues
• managing cash or liquid component of the corporation

Question 5

3 forms of business organization

Answer 5

1. Sole proprietorship
2. Partnership (general and limited)
3. Corporation

Question 6

Sole proprietorship definition

Answer 6

A business owned by a single individual

Question 7

Sole proprietorship advantages (4)

Answer 7

• easiest to start
• least regulated
• single owner keeps all the profits
• taxed once as personal income

Question 8

Sole proprietorship disadvantages (4)

Answer 8

• unlimited liability
• limited to life of owner
• equity capital limited to owner’s personal wealth
• difficult to sell ownership interest

Question 9

Partnership definition (general)

Answer 9

A business formed by two or more co-owners

Question 10

General vs Limited partnership

Answer 10

General - partners have equal share, corresponding unlimited liability

Limited - usually for a newcomer to the partnership
- portion of the ownership, limited or no liability
- attracts individuals fearful of liability

Question 11

Partnership advantages (4)

Answer 11

• two or more owners, sharing responsibilities
• more human and financial capital available
• relatively easy to start
• income taxed once as personal income

Question 12

Partnership disadvantages (4)

Answer 12

• unlimited liability
• partnership dissolves when one partner dies or wants to sell (agreements must be rewritten)
• difficult to transfer ownership
• possible disagreements between partners

Question 13

Corporation definition

Answer 13

A business created as a distinct legal entity owned by one or more individuals or entities

Question 14

Corporation advantages (5)

Answer 14

• limited liability
• unlimited life
• separation of ownership and management
• transfer of ownership is easy
• easier to raise capital

Question 15

Corporation disadvantages (2)

Answer 15

• separation of ownership and management
• double taxation (income is taxed at the corporate rate and then dividends are taxed at the personal rate

Question 16

2 groups report to CFO

Answer 16

• treasurer
• controller

Question 17

Treasurer definition

Answer 17

Oversees cash management, capital expenditures, financial planning
(focus of financial management)

Question 18

Controller definition

Answer 18

Oversees taxes, cost accounting, financial accounting, data processing

Question 19

3 goals of financial management

Answer 19

1. Maximize shareholder wealth
2. Maximize share price
3. Maximize firm value

Question 20

Goals of a corporation

Answer 20

• maximize profit
• minimize costs
• ma

Question 21

Goal of the financial manager

Answer 21

To maximize the current value per share of the existing stock

Question 22

Agency relationship

Answer 22

Principal (stockholders) hire agents (managers) to represent their interests (run the company)

Question 23

Agency problem

Answer 23

Conflicts of interest can exist between the principal and the agent

Question 24

Direct agency costs

Answer 24

Misusage of firm’s assets, monitoring costs to prevent this

Question 25

Indirect agency costs

Answer 25

Forgone opportunity costs

Question 26

3 methods of managing managers

Answer 26

• Managerial compensation: Carefully structured incentives to align management to stockholder interests
• Corporate control: Threat of a takeover to result in better management
• Conflicts with other stakeholders: Several types of stakeholders may not always agree

Question 27

Social responsibility and ethical investing

Answer 27

How a corporation treats the community in which it operates, their customers, corporate governance, their employees, the environment, and human rights

Question 28

Cash flows between the firm and the financial market (6)

Answer 28

1. Firm issues securities to raise cash
2. Firm invests in assets
3. Firm’s operations generate cash flow
4. Cah is paid to government as taxes, other stakeholders may receive cash
5. Reinvested cash flows are plowed back into the firm
6. Cash is paid out to investors in the form of interest and dividends

Question 29

Money vs Capital markets

Answer 29

Money market: short-term debts (<= 1yr) and liquid securities
Capital market: long-term debts and shares of a firm

Question 30

Primary vs Secondary markets

Answer 30

Primary market: Original sale by the user
Secondary market: Where securities are sold and bought after the original sale

Question 31

Financial institutions definition

Answer 31

Financial institutions act as intermediaries between suppliers and users of funds

Question 32

Institutions earn income on service provided in 2 ways

Answer 32

Indirect finance: Earn interest on the spread between loans and deposits
Direct finance: Service fees (bankers acceptance and stamping fees)