Chapter 1 - Introduction to Financial Management

Question 1

Four Basic Areas in Finance

Answer 1

Financial management
Capital markets
Investments
International finance

Question 2

What are we talking about when we say - maximizing the

value of the stock?

Answer 2

We mean the true, long-run value, which may be different

from the current stock price.

Question 3

What is Financial Management?

Answer 3

Also called corporate finance, focuses on decisions relating
to how much and what types of assets to acquire, how to raise the capital needed to purchase assets, and how to run the firm so as to maximize its value

Capital budgeting (investment decision)
Capital structure (financing decision)
Dividend policy

Question 4

What are Capital markets?

Answer 4

The stock market, the bond market. And functions and characteristics of various financial institutions such as banks.

Question 5

What is the Federal Reserve System?

Answer 5

A governmental organization which

regulates banks and controls the supply of money

Question 6

What is the SEC?

Answer 6

A governmental organization which regulates the trading of stocks and bonds in public markets

Question 7

What is the board of directors?

Answer 7

The top governing body of a company that is elected, and the chairperson of the board is generally the highest-ranking individual in an organization.

Question 8

What is a CEO?

Answer 8

Chief Executive Officer, the chairperson of the board often also serves as the CEO of a business.
For a publicly owned company, he/she must certify to the
SEC that reports released to stockholders, and especially the annual report, are accurate. If inaccuracies later emerge, the CEO and the CFO could be fined or even
jailed.

Question 9

What is a COO?

Answer 9

Chief operating officer, often also designated as a firm’s president.
The COO directs the firm’s operations, which
include marketing, manufacturing, sales, and other operating departments.

Question 10

What is a CFO?

Answer 10

Chief financial officer, generally a senior vice president and the third-ranking officer. in charge of accounting, finance, credit policy, decisions regarding asset acquisitions, and investor relations, which involves communications with stockholders and the press.

For a publicly owned company, he/she must certify to the
SEC that reports released to stockholders, and especially the annual report, are accurate. If inaccuracies later emerge, the CEO and the CFO could be fined or even
jailed.

Question 11

What is the Sarbanes-Oxley Act?

Answer 11

A law passed in 2002 by Congress that requires the CEO and CFO to
certify that their firm’s financial statements are accurate.

The Act was passed by Congress in the wake of a series of corporate scandals involving now-defunct companies such as Enron and WorldCom, where investors, workers, and suppliers lost billions of dollars due to false information released by those companies.

Question 12

What are the four main forms of business

organizations?

Answer 12

(1) proprietorships
(2) partnerships
(3) corporations
(4) limited liability companies (LLCs) and limited liability partnerships (LLPs)

Question 13

What is a proprietorship?

Answer 13

An unincorporated business owned by one individual. Primarily for small businesses.

Question 14

What are the advantages of a proprietorship?

Answer 14

Advantages include: easy and inexpensive to form, subject to few government regulations, subject to lower income taxes than are corporations.

Question 15

What are the disadvantages of a proprietorship?

Answer 15

Disadvantages include: unlimited personal liability for the business’ debts, so they can lose more than the amount of money they invested in the company, life of the business is limited to the life of the individual who created it; and to bring in new equity, investors require a change in the structure of the business. Proprietorships have difficulty obtaining large sums of capital; hence, proprietorships are used primarily for small businesses.

Question 16

What is a partnership?

Answer 16

An unincorporated business (legal arrangement) owned by two or more persons.

Question 17

What are the advantages of a partnership?

Answer 17

Established relatively easily and inexpensively
Firm’s income is allocated on a pro rata (proportional) basis to the partners and is taxed on an individual basis, avoiding corporate income tax.

Question 18

What are the disadvantages of a partnership?

Answer 18

All of the partners are generally subject to unlimited personal liability, which means that if a partnership goes bankrupt and any partner is unable to meet his or her pro rata share of the firm’s liabilities, the remaining partners will be responsible for making good on the
unsatisfied claims.

Unlimited liability makes it difficult for partnerships to
raise large amounts of capital.

Question 19

What is a public corporation?

Answer 19

A legal entity created by a state, separate and distinct from its owners and managers, having unlimited life, easy transferability of ownership, and limited liability.

Company shares are traded in the stock market.

Question 20

What are the advantages of a corporation?

Answer 20

Limits stockholders’ losses to the amount they invested in the firm
Have unlimited lives, and it is easier to transfer shares of stock in a corporation than one’s interest in an unincorporated business. These factors make it much easier for corporations to raise the capital necessary to operate large businesses.

Question 21

What are the disadvantages of a corporation?

Answer 21

Taxes - corporations’ earnings are subject to double taxation—the corporation’s earnings are taxed; and then when its after-tax earnings are paid out as dividends, those earnings are taxed again as personal income to the stockholders.

Question 22

What are s corporations?

Answer 22

A Congress created corporation to aid small businesses.
Are taxed as if they were proprietorships or partnerships; thus, they are exempt from the corporate income tax. To qualify for S corporation status, a firm can have no more than 100 stockholders, which limits their use to relatively small, privately owned firms.

Question 23

What are s LLC’s/LLP’s?

Answer 23

Limited liability company - a hybrid between a partnership and a corporation

Limited liability partnership - limited liability partnership
Both offer limited liability protection, but they are taxed as partnerships. unlike limited partnerships, where the general partner has full control of the business, the investors in an LLC or LLP have votes in proportion to their ownership interest.

LLCs and LLPs have been gaining in popularity in recent years, but large companies still find it advantageous to be C corporations because of the
advantages in raising capital to support growth.

Question 24

What is the stockholder-debt holder conflict?

Answer 24

Debtholders, which include the company’s bankers and its bondholders, generally receive fixed payments regardless of how well the company does, while stockholders do better when the company does better.

This situation leads to conflicts between these two groups, to the extent that stockholders are typically more willing to take on risky projects.