Chapter 1: Roles of Managerial Finance

Question 1

Financial Services

Answer 1

The area of finance concerned with the design and delivery of advice and financial products to individuals, businesses, and governments.

Question 2

Managerial Finance

Answer 2

Concerns the duties of the financial manager in a business

Question 3

Financial Manager

Answer 3

Actively manages the financial affairs of all types of businesses, whether private or public, large or small, profit seeking or not for profit.

Question 4

Sole Proprietorship

Answer 4

A business owned by one person and operated for his or her own profit.

Question 5

Unlimited Liability

Answer 5

The condition of a sole proprietorship (or general partnership), giving creditors the right to make claims against the owner’s personal assets to recover debts owed by the business.

Question 6

Partnership

Answer 6

A business owned by two or more people and operated for profit.

Question 7

Articles of Partnership

Answer 7

The written contract used to formally establish a business parntership.

Question 8

Stockholders

Answer 8

The owners of a corporation whose ownership, or equity, takes the form of common stock or, less frequently, preferred stock.

Question 9

Limited Liability

Answer 9

A legal provision that limits stockholders’ liability for a corporation’s debt to the amount they initially invested in the firm by purchasing stock.

Question 10

Common Stock

Answer 10

The purest and most basic form of corporate ownership.

Question 11

Dividends

Answer 11

The periodic distributions of cash to the stockholders of a firm.

Question 12

Board of Directors

Answer 12

Group elected by the firm’s stockholders and typically responsible for approving strategic goals and plans, setting general policy, guiding corporate affairs, and approving major expenditures.

Question 13

President or CEO

Answer 13

Corporate official responsible for managing the firm’s day-to-day operations and carrying out the policies established by the board of directors.

Question 14

Limited Partnership (LP)

Answer 14

A partnership in which one or more partners have limited liability as long as at least one partner (the general partner)has unlimited liability. The limited partners are passive investors that cannot take an active role in the firms management.

Question 15

Risk

Answer 15

The chance that actual outcomes may differ from those expected.

Question 16

Risk Averse

Answer 16

Requiring compensation to bear risk.

Question 17

Business Ethics

Answer 17

Standards of conduct or moral judgement that apply to persons engaged in commerce.

Question 18

Treasurer

Answer 18

The firm’s chief financial manager, who manages the firm’s cash, oversees its pension plans, and manages key risks.

Question 19

Controller

Answer 19

The firms chief accountant, who is responsible for the firm’s accounting activities, such as corporate accounting, tax management, financial accounting, and cost accounting.

Question 20

Marginal Cost-Benefit Analysis

Answer 20

Economic principle that states that financial decisions should be made and actions taken only when the added benefits exceed added costs.

Question 21

Accrual Basis

Answer 21

In preparation of financial statements, recognizes revenue at the time of sale and recognizes expenses when they are incurred.

Question 22

Cash Basis

Answer 22

Recognizes revenues and expenses only with respect to actual inflows and outflows of cash.

Question 23

Corporate Governance

Answer 23

The rules, processes, and laws by which companies are operated, controlled, and regulated.

Question 24

Individual Investors

Answer 24

Investors who own relatively small quantities of shares so as to meet personal investment goals.

Question 25

Institutional Investors

Answer 25

Investment professionals such as banks, insurance comp., mutual funds, and pension funds that are paid to manage and hold large quantities of securities on behalf of ogthers.

Question 26

Principal-Agent Relationship

Answer 26

An arrangement in which an agent acts on the behalf of a principal. Ex. shareholders of a company (principals) elect management (agents) to act on their behalf.

Question 27

Agency Problems

Answer 27

Arise when managers place personal goals ahead of the goals of stakeholders.

Question 28

Agency Costs

Answer 28

Arising from agency problems that are borne by shareholders and represent a loss of shareholder wealth.

Question 29

Incentive Plans

Answer 29

Management compensation plans that tie management compensation to share price; one example involves the granting of stock options.

Question 30

Stock Options

Answer 30

Extended by the firm that allow management to benefit from increases in stock prices over time.

Question 31

Performance Plan

Answer 31

Plans that tie management compensation to measures such as EPS or growth in EPS. Can also include performance shares and cash bonuses.

Question 32

Performance Shares

Answer 32

Shares of stock given to management for meeting stated performance goals.

Question 33

Cash Bonuses

Answer 33

Cash paid to management for achieving certain performance goals.

Question 34

Finance

Answer 34

The science and art of managing money

Question 35

Define finance and the managerial finance function.

Answer 35

Finance is the science and art of managing money. It affects virtually all aspects of business. Managerial finance is concerned with the duties of financial mangers working in a business. Financial managers administer the financial affairs of all types of business: Private and Public, large and small, profit and not for profit. They perform such varied tasks such as developing a financial plan or budget, extending credit to customers, evaluating proposed large expenditures, and raising money to fund the firm’s operations.

Question 36

Describe the legal forms of business organization.

Answer 36

The legal forms f business organization are the sole proprietorship, the partnership, and the corporation. The corporation is dominant in terms of business receipts and its owners are its stockholders. Stockholders expect to receive a return by receiving dividends or by realizing gains through increased share price.

Question 37

Describe the goals of a firm. Explain why maximizing value of the firm is an appropriate goal for business.

Answer 37

The goal of a firm is to maximize its value and therefore the wealth of its shareholders. Maximizing the value of a firm means running the business in the interest of those who own it, the shareholders.
Because shareholders are paid after other stakeholders, it is generally necessary to satisfy the interests of other stakeholders to enrich shareholders.

Question 38

Describe how the managerial finance function is related to economics and accounting.

Answer 38

All areas of responsibility within the firm interact with finance personnel and procedures. The financial manager must understand the economic environment and rely heavily on the economic principle of marginal cost-benefit analysis to make financial decisions. Financial managers use accounting but concentrate on cash flows and decision making.

Question 39

Identify the primary activities of the financial manager.

Answer 39

The primary activities of the financial manager, in addition to ongoing financial analysis and planning, are making investing decision and financing decisions.

Question 40

Describe the nature of the principal - agent relationship between the owners and managers of a corporation, and explain how various corporate governance mechanisms attempt to manage agency problems.

Answer 40

This separation of owners and managers of the typical firm is representative of the classic principal - agent relationship, where the shareholders are the principals and managers are the agents. This arrangement works well when the agent makes decisions which are in the principal’s best interests, but it can lead to agency problems when the interests of the principal and agent differ.
A firm’s corporate governance structure is intended to help ensure that managers act in the best interests of the firm’s shareholders and other stakeholders, and it is usually influenced by both internal and external factors.