Finance 301 Exam 1: Ch. 1, 2, 20
A company's _____ is (are) potentially the most effective instrument of good corporate governance.
board of directors
Taxability
considers the expected tax consequences of the security
The _______ deductible expenses, the _________ the corporation pays in taxes.
fewer; more
The ________ the depreciaiton charges, the _________ the tax.
higher; lower
The market price of a share of common stock is determined by:
individuals buying and selling the stock
Agency Theory
is a branch of economics relating to the behavior of principals and their agents
Inflation
is a rise in the average level of prices of goods and services. The greater inflation expectations, then the greater the expected return.
Alternative Minimum Tax
is a special tax which equals 20% of alternative minimum taxable income (generally not equal to taxable income). Corporations pay the maximum of AMT or regular tax liability.
Maturity
is concerned with the life of the security; the amount of time before the principal amount of a security becomes due
Marketability
is the ability to sell a significant volume of securities in a short period of time in the secondary market without significant price concession.
Cash Dividend
is the cash distribution of earnings to shareholders and is NOT a tax deductible expense.
Default Risk
is the failure to meet the terms of a contract
Interest Expense
is the interest paid on outstanding debt and is tax deductible
What is the purpose of Financial Markets?
is to efficiently allocate savings to ultimate users.
Limited Partnership
limited partners have liability limited to their capital contribution (investors only). At least one general partner is required and all general partners have unlimited liability.
Profit Maximization
maximizing a firm's profits after taxes
Earning per share Maximization
maximizing earnings after taxes divided by shares outstanding
Embedded Options
provide the opportunity to change specific attributes of the security.
Corporate Governance
represents the system by which corporations are managed and controlled
Depreciation
represents the systematic allocation of the cost of a capital asset over a period of time for financial reporting purposes, tax purposes, or both.
Quarterly Tax Payments
require corporations to pay 25% of their estimated annual tax liability on the 15th of April, June, September, and December.
Common Stock
securities that represent the ultimate ownership (and risk) position in a corporation.
Maturity (Chapter 20)
the stated time when the company is obligated to pay the bondholder the part-value of the bond.
What are the earnings per share (EPS) for a company that earned $100,000 last year in after-tax profits, has 200,000 common shares outstanding and $1.2 million in retained earning at the year end?
$0.50
Problems with Profit Maximization
1) Could increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy T-bills, etc.) 2) Ignores changes in the risk level of the firm
Problems with Earning per share Maximization
1) Does not specify timing or duration of expected returns 2) Ignores changes in the risk level of the firm 3) Calls for a zero payout dividend policy
What are the 2 types of Partnerships?
1) General 2) Limited
What questions does Asset Management Decisions cover?
1) How do we manage existing assets effectively? 2) Financial manager has varying degrees of operating responsibility over assets 3) Greater emphasis on CURRENT ASSET MANAGEMENT than FIXED ASSET MANAGEMENT
What does the Sarbanes-Oxely Act of 2002 (SOX) do?
1) Imposes new penalties for violations of securities laws 2) Established the Public Company Accounting Oversight Board (PCAOB) to adopt auditing, quality control, ethics, disclosure standards for public companies and their auditors, and policing authority 3) Generally increasing the standards for Corporate Governance
What are the 4 Standard Corporation Characteristics?
1) Limited Liability 2) Centralized Management 3) Unlimited Life 4) Transfer of ownership without other owners' prior consent
What are the typical responsibilities of the Board of Directors?
1) Set company-wide policy 2) Advise the CEO and other senior executives 3) Hire, Fire, and set the compensation of the CEO 4) Review and Approve strategy, significant investments, and acquisitions 5) Oversee operating plans, capitol budgets, and financial reports to common shareholders
What are the 4 Basic forms of Business Organization in the U.S.?
1) Sole-Proprietorships 2) Partnerships (general and limited) 3) Corporations 4) Limited Liability Companies
Strengths of Shareholder Wealth Maximization
1) Takes account of: current and future profits and EPS; the timing, duration, and risk of profits and EPS; dividend policy; and all other relevant factors 2) Thus, Share Price serves as a barometer for business performance
What questions does Investment Decisions cover?
1) What is the optimal firm size? 2) What specific assets should be acquired? 3) What assets (if any) should be reduced or eliminated?
Trustee
A person or institution designated by a bond issuer as the official representative of the bondholders. Trustee authenticates the bond issue's legality, monitors the financial condition and behavior of the bond issuer, makes sure all contractual obligations are carried out and initiates appropriate action if obligations are not met. Typically, a bank serves as trustee.
Cumulative Dividends Feature
A requirement that all cumulative unpaid dividends (arrears) on the preferred stock be paid before a dividend may be paid on the common stock.
Preferred Stock
A type of stock that promises a (usually) fixed dividend, but at the discretion of the board of directors. Par value and Dividend rate is specified during issue. Preferred stockholder's claim on assets comes after that of creditors, but before that of common stockholders.
Which of the following enjoys limited liability?
A) A general partnership. B) A corporation. C) A sole proprietorship. D) None of the above Answer:B
A bond issue may be retired by:
A) Calling the bonds if there is a call feature. B) Converting the bonds (if convertible) into common stock. C) Making a single-sum payment at final maturity.
The controller's responsibilities are primarily _____ in nature, while the treasurer's responsibilities are primarily related to _____.
Accounting; Financial Management
The purpose of financial markets is to:
Allocate Savings Efficiently
A call provision, a sinking fund, and/or conversion are used to retire:
Bonds and Preferred Stock
Generally, the sale of a "Capital Asset" (as defined by the IRS) generates a:
Capital Gain (asset sells for more than original cost) or Capital Loss (asset sells for less than original cost)
The Treasurer is responsible for:
Cash Management, Raising Capital, and Banking relationships
Dual classes of ___________ are common in new ventures where promotional ____________ usually goes to the founders.
Common Stock; Common Stock
Treasury stock is:
Common stock that has been repurchased and is being held by the issuing company.
What is Financial Management?
Concerns the acquisition, financing, and management of assets with some overall goal in mind
What questions does Financing Decisions cover?
Determine how the assets (LHS of Balance Sheet) will be financed (RHS of Balance Sheet) 1) What is the best type of financing? 2) What is the best financing mix? 3) What is the best dividend policy? 4) How will the funds be physically acquired
Money market mutual funds:
Enable individuals and small businesses to invest indirectly in money-market instruments.
The Chief Financial Officer is responsible for:
Financial policy and Corporate Planning
What kind of bond offers the investor the most protection?
First-mortgage Bonds
The call-option value of a callable bond is likely to be high when:
Interest Rates are Volatile
According to the text's authors, what is the most important of the three financial management decisions?
Investment Decisions
What are the 3 Fundamental Financial Management decisions?
Investment Decisions, Financing Decisions, and Asset Management Decisions
The decision function of financial management can be broken down into the ______________ decisions.
Investment, Financing, and Asset Management
Who created the Agency Theory?
Jensen and Meckling
Which of the 4 Standard Corporation Characteristics does an LLC usually have?
Limited Liability and Centralized Management
A major advantage of the corporate form of organization is:
Limited Owner Liability
Depreciation ___________ taxable income.
Lowers
Which rate does one consider for making investment decisions?
Marginal Tax Rate
What is the goal of the firm?
Maximization of Shareholder's wealth
The long-run objective of financial management is to:
Maximize the value of the firm's common stock
A corporation in which you are a shareholder has just gone bankrupt. Its liabilities are far in excess of its assets. You will be called on to pay:
NOTHING
Sarbanes-Oxely Act of 2002 (SOX)
addresses corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information
Preferred shareholders' claims on assets and income of a firm come_______ those of creditors _________those of common shareholders.
after; but before
General Partnership
all partners have unlimited liability and are liable for all obligations of the partnership
Par Value
amount to be paid to the bondholder at the the bond's maturity. Also called Face Value or Principal. PV is usually $1,000
Financial Markets
are composed of all institutions and procedures for bringing buyers and sellers of financial instruments together
Capital Losses
are deductible only against capital gains
What are examples of Incentives?
Stock Options, Perquisites, and Bonuses
___________ refers to meeting the needs of the present without compromising the ability of future generations to meet their own needs.
Sustainability
Average Tax Rate =
Taxes Paid -------------- Taxable Income
How are funds allocated efficiently in a market economy?
The economic unit that is willing to pay the highest expected return receives the funds.
Indenture
The legal agreement, also called the deed of trust, between the corporation issuing bonds and the trustee (who represents bondholders), establishing the terms of the bond issue and naming the trustee.
Authorized Shares
The maximum number of shares that a company can issue. It is specified in the company charter.
Protective covenants are:
To Protect Bondholders
The After-Tax Cost of Debt =
(Interest Expense) X (1-Tax Rate) thus, debt financing has a tax advantage
Issued Shares
Number of shares issued. When authorized shares are sold, they become issued shares.
The Controller is responsible for:
Preparation of Financial Statements, Accounting, Taxes
The Agency Theory states that:
Principals must provide incentives so that management acts in the principal's best interests and then monitor results.
In the US, the_______ has been given the power to adopt auditing, quality control, ethics, and disclosure standards for public companies and their auditors as well as investigate and discipline those involved.
Public Company Accounting Oversight Board (PCAOB)
Protective Covenants
Restrictions placed on the bond issuer to protect bondholders. Protective covenants are listed in the Indenture.
A 30-year bond issued by Gary's Plaid Pants Warehouse, Inc., in 1997 would now trade in the:
Secondary Capital Market
Using the Modern Corporation model, there exists a ___________ between owners and managers.
Separation
Book Value (per share)
Shareholder's equity (as listed on the balance sheet) DIVIDED by the number of shares outstanding.
What systems does Corporate Governance include?
Shareholders, Board of Directors, and Senior Management
What is the oldest form of business organization?
Sole-Proprietorships
Sole-Proprietorship
a business form for which there is one owner. This single owner has unlimited liability for all debts of the firm. Business income is accounted for on the owner's personal income tax form.
Partnership
a business form in which two or more individuals act as owners. Business income is accounted for on each partner's personal income tax form.
Corporation
a business form legally separate from its owners. It is an artificial entity that can own assets and incur liabilities. Business income is accounted for on the income tax form of the corporation
Limited Liability Companies
a business form that provides its owners (called "members") with corporate style limited personal liability and federal-tax treatment of a partnership. Business income is accounted for on each "member's" individual income tax form.
Michael Cohn is a "member" (a type of owner) of a marine supply business. Michael's business is:
a limited liability company
Bond
a long-term debt instrument with a final maturity generally being 10 years or more
The Sarbanes-Oxley Act of 2002 (SOX) was largely a response to:
a series of corporate scandals involving Enron,WorldCom, Global Crossing, Tyco and numerous others.
A(n) _____ would be an example of a principal, while a _____ would be an example of an agent.
shareholder; manager
Coupon Rate
stated rate of interest. If coupon rate is 13%, a $1,000 par-value bond pay bondholders $130 per year or $65 semi-annually
Market Value (per share)
the current price at which the stock is currently trading
"Shareholder Wealth" in a firm is represented by:
the market price per share of the firm's corporate stocks
Treasury Stock
the number of shares held by the issuing company. The company can repurchase part of its issued stock and hold it as treasury stock
Outstanding Shares
the number of shares issued and actually held by the public
