Chapter 1: Introduction to Corporate Finance

Question 1

What must a company do before it can invest in assets?

Answer 1

It must raise money to pay for the investments.

Question 2

How are the forms of finance shown on a balance sheet?

Answer 2

They are show as debts and equity shares.

Question 3

What questions does finance answer?

Answer 3

1. In what long-lived assets should the firm invest?
2. How can the firm rasie cash for required capital expenditures?
3. How should short-term operating cashflows be managed?

Question 4

Capital budgeting definition

Answer 4

Describes the process of making and managing expenditures on long-lived assets

Question 5

Capital Structure definition

Answer 5

represents the porportions of the firm’s financing from current liabilities, long-term debt, and equity

Question 6

Define: Net working capital

Answer 6

Current assets - Current liabilities.

Short-term management of cash flow is associated with a firm’s net working capital

Question 7

Define: Sole Proprietorship

Answer 7

A business owned by one person.

Question 8

5 important facts about sole proprietorship (re: business formation, taxes, liability, business vs personal assets, and equity)

Answer 8

1. cheapest business to form. No formal charter and few gov. regs.
2. pays no corporate income taxes. All profits taxed as individual income
3. unlimited liability for business debts and obligations. No distinction btw personal and business assets.
4. life of sole proprietorship is limited by life of sole proprietor.
5. Equity raised by sole proprietory is limited bto the person’s personal wealth.

Question 9

What are the types of partnerships (and define them)?

Answer 9

1. General Partnership - all partners agree to provide some fraction of the work and cash and to share the profits and losses.
2. Limited partnerships = permits the libability of some of the partners be limited to the amount of cash contributed to the partnership. Requires at least one general partner and the limited partner doesn’t participate in managing the business.

Question 10

5 important facts about partnerships (re: business formation, taxes, liability, business vs personal assets, and equity)

Answer 10

1. Partnerships are usually inexpensive and easy to form.
2. General partners have unlimited liability for all debts.
3. The general partnership is terminated when a general partner dies or withdraws (but this is not so for a limited partner).
4. It is difficult for a partnership to raise large amounts of cash.
5. Income from a partnership is taxed as personal income to the partners.
6. Management control resides with the general partners.

Question 11

What don’t sole proprietorships and partnerships work on a large scale?

Answer 11

1. unlimited liability
2. limited life of enterprise
3. difficulty in transferring ownership
4. difficulty in raising cash

Question 12

Are corporations people?

Answer 12

Legally, yes.

Question 13

What are articles of incorporation?

Answer 13

Documents necessary to start a corporation.

Question 14

What are the 6 parts that must be included in articles of incorporation

Answer 14

1. Name of corporation
2. intended life of corporation
3. business purpose
4. number of shares of stock.
5. nature of the rights granted to shareholders?
6. number of membors of initial board of directors

Question 15

What are the three disinct interests within a corporation?

Answer 15

1. shareholders/owners
2. the directors
3. corporation officers ( the top management)

Question 16

3 benefits of corporation

Answer 16

1. no limit of transferability.
2. unlimited life
3. liabilities are limited to investment

Question 17

1 disadvantage of corporation

Answer 17

Corporate taxes on federal and state level

Question 18

What is an LLC?

Answer 18

an entity that’s taxed like a partnership but limited liabiltiy for owners. Must meet specific criteria for this to happen.

Question 19

How do financial managers create value?

Answer 19

Firm should create more cashflow for the shareholders and bondholders than it uses.

Question 20

How does accounting profit differ from cashflow?

Answer 20

accounting profit is based on the time that services are provided.

Corporate finance’s perspective is whether the cash came in or not…(account receivables isn’t enough for this perspective)

Question 21

How does timing affect value of an investment?

Answer 21

The value of an investment depends on the timing of cashflows? One dollar received today is more than a dollar received next year.

Question 22

How are possible financial goals usually grouped?

Answer 22

1. Profit maximization

2. Controlling risk

Question 23

What is the goal of financial management?

Answer 23

Goal: to maximize the current value per share of existing stock

Question 24

What is the goal when there’s no traded stock?

Answer 24

goal: to maximize the value of existing owner’s equity

Question 25

What is agency relationship?

Answer 25

It’s the relationship between stockholders and management. (the principal hires the agent to represent his/her interests)

Question 26

Define: agency cost

Answer 26

when management doesn’t take the investment and then the stockholders may lose a valuable opportunity.

Generally refers to the costs of the conflict of interest between stockholders and management.

Question 27

Define: Proxy fight

Answer 27

when a group solicits proxies in order to replace the existing board and thereby the entire existing management.

Question 28

Define: stakeholder

Answer 28

Someone other than a stockholder or creditor who potentially has a claim on cashflows.