Chapter 1 Introduction to FM Flashcards

1
Q

What are the three types of business organisations? What are their advantages and disadvantages?

A
  1. Sole Proprietorship - A business owned by only 1 individual.
    Advantages: Easy to set up, less regulations, no corporate income taxes
    Disadvantages: Hard to raise capital, unlimited liability, limited life of the business
  2. Partnership - An unincorporated business owned by two or more people.
    Advantages: Easy to set up, less regulations, no corporate income taxes
    Disadvantages: Hard to raise capital, unlimited liability, limited life of the business
  3. Corporation - An incorporated business owned by many shareholders.
    Advantages: Long business life, easy to transfer ownership, limited liability, ease of raising capital
    Disadvantages: Regulations, hard to set up, double taxation on dividends (corporate tax and owners have to pay dividend tax)
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2
Q

What are the financial goals of the management / corporation?

A

The primary financial goal of management is shareholder wealth maximization –> maximizing intrinsic value of the stock

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3
Q

How is the value of the stock price determined with regards to investors?

A

The value of the stock price is determined by the marginal investor’s perception of the intrinsic value of the stock

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4
Q

Is it true that in equilibrium, the stock price is equalled to the intrinsic value of the stock?

A

Yes, in equilibrium investors will be indifferent to buying or selling the stock due to the fact that they are both equal.

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5
Q

What are agency problems?

A

Agency problems are when managers are naturally inclined to act in their own best interest and not in the interest of the company/corporation.

It is a conflict between shareholders and managers

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6
Q

How should you solve agency problems?

A

1) Managerial compensation packages that rewards managers on long-run intrinsic value of the stock.
2) Direct intervention by shareholders
3) Threat of firing
4) Threat of taking over

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