Chapter 1 Introduction to FM Flashcards
What are the three types of business organisations? What are their advantages and disadvantages?
- 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 - 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 - 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)
What are the financial goals of the management / corporation?
The primary financial goal of management is shareholder wealth maximization –> maximizing intrinsic value of the stock
How is the value of the stock price determined with regards to investors?
The value of the stock price is determined by the marginal investor’s perception of the intrinsic value of the stock
Is it true that in equilibrium, the stock price is equalled to the intrinsic value of the stock?
Yes, in equilibrium investors will be indifferent to buying or selling the stock due to the fact that they are both equal.
What are agency problems?
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
How should you solve agency problems?
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