Chapter 1

Question 1

How do corporations pay for assets?

Answer 1

Sell claims on assets and the cash flow they will generate

Question 2

What are claims?

Answer 2

Financial assets or securities

Question 3

What defines a security?

Answer 3

Traded in financial markets

Question 4

What do securities include?

Answer 4

Bonds, shares of stock, other specialized instruments

Question 5

What’s an investment decision?

Answer 5

Purchase of real assets

Question 6

What is a financing decision?

Answer 6

Sale of financial assets

Question 7

What is CAPEX?

Answer 7

capital expenditure or capital budgeting

Question 8

Where can corporation raise money from?

Answer 8

lenders or shareholders

Question 9

What are shareholders?

Answer 9

equity investors who contribute equity financing

Question 10

What is a capital structure decision?

Answer 10

choice between debt and equity financing

Question 11

What is a payout decision?

Answer 11

decision to pay dividends or repurchase shares

Question 12

How do companies create value?

Answer 12

From retaining and reinvesting cash flow, not from sophisticated financing.

Question 13

What are risks a business will face?

Answer 13

recessions, changes in commodity prices, interest rates, exchange rates, adverse political developments

Question 14

What is a corporation?

Answer 14

A legal entity.

Question 15

What does it mean by shareholders having limited liability?

Answer 15

They cannot be held personally responsible for the corporation’s debts.

Question 16

What gives a corporation permanence?

Answer 16

separation of ownership and control

Question 17

What defines a CFO?

Answer 17

Someone who explains earnings results and forecasts to investors and the media.

Question 18

What does the treasurer and controller do?

Answer 18

Treasure: short-term cash management, current trading, financing transactions, and bank relationships. Controller: manage internal accounting systems and oversees preparation of financial statements and tax returns.

Question 19

What are roles of financial managers?

Answer 19

Responsible for investment or financing decisions. Manage money flow between investors and the corporation.

Question 20

How shareholders decide between investment vs. taking cash?

Answer 20

If return of investment higher than what share holders can achieve on their own, they will pursue the project.

Question 21

When will corporations decide on investing in new projects?

Answer 21

When the project earns more than the opportunity cost of capital.

Question 22

What is the opportunity cost?

Answer 22

expected return investors achieve in financial markets at the same level of risk

Question 23

What are stakeholders of the company?

Answer 23

employees, customers, suppliers, communities where the firm’s plants and offices are located.

Question 24

How do shareholders control the managers?

Answer 24

Through the board of directors.

Question 25

When are agency costs incurred?

Answer 25

(1) managers do not attempt to maximize firm value (2) shareholders incur costs to monitor managers and constrain their actions