Chapter 1

Question 1

Why is corporate finance important to managers

Answer 1

1.) add value to the firm

2.) Devise strategies to acquire funds

Question 2

What is a proprietorship

Answer 2

business owned by one individual

Question 3

what are the advantages of a proprietorship

Answer 3

• ease of formation
• fewer regulations
• no corporate income tax

Question 4

what are the disadvantages of a proprietorship

Answer 4

• difficult to raise capital (grow company)
• unlimited liability
• limited life

Question 5

What is a Partnership

Answer 5

two or more people conducting the business

Question 6

What is the difference between a general partnership and a limited partnership

Answer 6

general: unlimited liability
limited partners: limited liability

Question 7

What is a corporation

Answer 7

legal entity separate from its owners and managers

Question 8

How to become a corporation

Answer 8

File papers to get a charter and create bylaws

Question 9

what does a Charter include

Answer 9

Name, type of activities, amount of capital stock, # of directors and names and addresses of directors

Question 10

what doe Bylaws include:

Answer 10

A set of rules drawn by founders of the corporation

Question 11

What are the advantages of a corporation

Answer 11

-unlimited life
-easy transfer of ownership
-limited liability

Question 12

what are the disadvantages of a corporation

Answer 12

• double taxation (earnings and dividends)
  -cost of set-up

Question 13

As a corporation grows what happens?

Answer 13

Initial Public Offerings (IPO’s) of Stock help raise proceeds

Question 14

Which of the following represents a significant disadvantage to the corporate form of organization (class reflection question)

Answer 14

Exposure to taxation of corporate earnings and stockholder dividend income

Question 15

What should be a mangers primary objective

Answer 15

Shareholder wealth maximization and maximizing the fundamental stock price

Question 16

Do the same actions that maximize intrinsic stock value usually benefit society (yes/no)

Answer 16

Yes

Question 17

What determines a firms intrinsic value?

Answer 17

The companies ability to generate cash flow now and in the future

Question 18

What does a firms value depend on?

Answer 18

• The size of the firms free cash flow
• The timing of those flows
• The risk of the cash flow

Question 19

What is Free Cash Flows

Answer 19

All cash flows that are available for distribution to all investors (stockholders and creditors) after expenses and taxes

Question 20

What is WAAC

Answer 20

weighted average cost of capital is the average rate of return required by all of the companies investors

Question 21

What is the definition of intrinsic value (fundamental value)

Answer 21

Value or price that incorporates all relevant information regarding expected FCF and risk

Question 22

Who are the providers and users of capital?

Answer 22

• Individuals: net savers
• Non-financial corporation: net users (borrowers)
  -Governments
  -Financial corporations
  -Financial Markets

Question 23

What are the two ways to classify financial securities

Answer 23

1.) Time until maturity (capital and money market security)
2.) Types of claimes

Question 24

What are the different types of claims for financial securities

Answer 24

1. Debt: specified payments and maturity
2. Equity: a claim upon residual value
3. Derivatives: values depend on the values of some other traded assets
4. Hybrid: mix of debt, equity and derivatives
5. Securitized Financial Assets: created from packages of other financial assets

Question 25

Money markets are markets for

Answer 25

Short term debt securities

Question 26

What 4 factors affect the cost of Money

Answer 26

1. Production opportunities (ability to turn capital into benefits) 2. Time preference for consumption 3. Risk 4. Inflation

Question 27

What is capital allocated through

Answer 27

the price system "price" of money is a cost for the user but a return for provider

Question 28

when does a financial instruments rate of return generally increase when...

Answer 28

maturity and risk increase - if u are riskier with money their is higher risk

Question 29

What are Economic conditions that affect the cost of money

Answer 29

1.) Federal Reserve policy - stimulate/slow down the economy 2.) The level of the federal budget deficit 3.)The level of business activity 4.) International factors: foreign trade balance, the international country risk, and the exchange rate

Question 30

what does the federal reserve policy do

Answer 30

stimulate the economy: purchase treasury securities (lower interest rates) Slow down the economy: issue treasury securities (higher interest rates)

Question 31

For economic condition #2 what does level of federal budget deficit mean?

Answer 31

a budget deficit is when federal government spend more than it takes from tax revenues

Question 32

What does economic condition #3 mean when it says level of business activity

Answer 32

interest and inflation typically rise prior to a recession and fall afterwards

Question 33

What does economic condition #4 International factors

Answer 33

what does a foreign trade deficit mean... we import more than we export increase borrowing drives up interest rates

Question 34

What do investment banks do

Answer 34

help raise capital

Question 35

what do commercial banks do

Answer 35

raise funds from depositors and from issuing stock and bonds

Question 36

what are credit unions

Answer 36

member savings are only lent to other members

Question 37

what are mutual funds

Answer 37

-pool funds and invest -very regulated

Question 38

what are hedge funds

Answer 38

limited to institutional investors and high-net-worth individuals

Question 39

what are private equity funds

Answer 39

limited to a relative small number of large investors - turn companies private and later sell them for a profit

Question 40

What are life insurance companies

Answer 40

take premiums, invest, and make payments to beneficiaries

Question 41

What is the process of securization

Answer 41

happened after housing crisis - S& L's now put their mortgages into pools and sell to other organizations like Fanny May (risk shifts to Fanny May) Fanny Mae doesn't keep mortgages and puts them in a pool and sells shares to investors (risk shifts to investors)

Question 42

what is securitization def

Answer 42

new securities are created based on original securities

Question 43

What is CollateralizedDebt Obligations

Answer 43

It is a part of the securities is and is bundled debt resold to investors