Ch. 1 - Introduction to Corporate Finance

Question 1

What is the primary goal of a financial manager?

Answer 1

Maximize the shareholders’ wealth

Question 2

Sole Proprietor

Answer 2

A business owned by one person

Question 3

What are the advantages of a sole proprietorship compared to corporate firms?

Answer 3

• Simpler to start up
• Less regulation (more autonomy for owners)

Question 4

What are the disadvantages of a sole proprietorship compared to corporate firms?

Answer 4

• Low liquidity
• Tough to borrow money
• Unlimited liability
• Limited life (owners will eventually die)

Question 5

Partnership

Answer 5

A business that has two or more owners

Question 6

Corporation

Answer 6

A legal entity that is separate and distinct from its owners. Its owners have limited liability (i.e. they are not liable for mistakes they were not involved with)

Question 7

Why is limited liability desirable?

Answer 7

Limited liability gives protection to shareholders and directors if they are behaving correctly

Question 8

The Agency Problem

Answer 8

There is a separation of goals (or interests). “Agents” (managers, directors, employees) have their own goals/interests that may not align with the goals/interests of “principals” (shareholders, owners, members)

Question 9

How can corporations reduce agency issues?

Answer 9

• Monitoring
• Compensation
• Competition

Question 10

Monitoring

Answer 10

Using KPIs (key performance indicators) that are related to company value

Question 11

Compensation

Answer 11

Pay in part with shares and options so the managers become owners too

Question 12

Competition

Answer 12

Give control of larger divisions or geographical areas to managers who are performing the best

Question 13

What are the types of financial decisions?

Answer 13

• Investing Decisions
• Financing Decisions
• Cash management decisions

Question 14

Investing Decisions

Answer 14

What to spend money on

Question 15

Financing Decisions

Answer 15

How to pay for investments

Question 16

Cash Management Decisions

Answer 16

Managing the treasury in the short-term

Question 17

Direct Finance

Answer 17

Investors directly lending money to borrowers

Question 18

Indirect Finance

Answer 18

Investors lending money to a financial intermediary (e.g. bank) who lend money to borrowers

Question 19

Money Markets

Answer 19

Deal with short term cash (less than 1 year)

Question 20

Capital Markets

Answer 20

Deal with long term investments. This includes stock markets and bond markets

Question 21

Primary Markets

Answer 21

A company sells shares or bonds to investors

Question 22

Secondary Markets

Answer 22

One investor sells to another investor

Question 23

Initial Public Offerings (IPOs)

Answer 23

When a company “floats” (become listed for the first time on a stock exchange)

Question 24

Seasoned Equity Offerings (SEOs)

Answer 24

When an existing listed company issues more shares (raises more capital)

Question 25

Investment Bank

Answer 25

Brings 2 parties together without being part of the transaction (set up direct finance for 2 parties)

Question 26

Commercial Bank

Answer 26

Owes money to lenders and lends money to borrowers. Acts as a financial intermediary for lenders and borrowers