Finance Chapter 1

According to Figure 1.2, where does cash generated by a corporation typically go?

to pay corporate taxes reinvested in the firm paid to shareholders and creditors

Which of these have been noted as unintended consequences of the Sarbanes-Oxley Act? -more accurate financial disclosures -firms going public outside of the U.S. market -eliminating public disclosure for many firms -public firms "going dark" and leaving the stock market

-firms going public outside of the U.S. market -eliminating public disclosure for many firms -public firms "going dark" and leaving the stock market

Corporations in other countries are often called:

-joint stock companies -public limited companies -limited liability companies

The five basic areas of finance

1. Corporate finance 2. Investments 3. Financial institutions 4. International finance

No matter what type of business you started you would have to answer the following three questions in some form or another:

1. What long term investments should you take on? that is, what lines of business will you be in and what sorts of buildings machinery and equipment will you need? 2. Where will you get the long term financing to pay for your investments? Will you bring in other owners or will you borrow the money? 3. How will you manage your everyday financial activities such as collecting from customers and paying suppliers?

working capital

A firm's short-term assets and liabilities.

A general partnership has which of the following characteristics?

All the partners share in gains or losses of the partnership. Each owner has unlimited liability for all firm debts.

________ budgeting is the process of planning and managing a firm's long-term assets.

Capital

Which of the following are reasons that the corporation is the most important form of business? -Corporations are separate legal entities. -Corporations can enter contracts. -Corporations can vote in general elections. -Corporations can sue and be sued.

Corporations are separate legal entities. Corporations can enter contracts. Corporations can sue and be sued.

When are corporate profits taxed?

Corporations pay taxes on corporate profits. Individuals pay taxes on corporate dividends.

Growth can summarize various aspects of a firm's __________ and ___________ policies.

Financial, investment

Business finance is broadly concerned with which of the following? -How to finance long-term investments? -How to manage day-to-day finances of the firm? -How to set up the audit committee? -Which long-term investment to make?

How to finance long-term investments? How to manage day-to-day finances of the firm? Which long-term investment to make?

Why don't large businesses organize as sole proprietorships or partnerships?

It can be difficult to raise cash for investment in these forms, and that limits the ability of the business to grow.

Which of the following are true of a sole proprietorship? -It is one of the simplest types of businesses to form. -A sole proprietor can issue stock to raise capital. -The owner has limited liability for business debts. -A proprietorship has a limited life.

It is one of the simplest types of businesses to form. A proprietorship has a limited life.

How does the Sarbanes-Oxley Act primarily work to make sure that companies tell the truth in financial statements?

It makes management personally responsible for the accuracy of a company's financial statements.

In an over-the-counter market, which of the following is true? -Most of the buying and selling is done by the dealer. -Only stocks are bought and sold. -Many dealers are also connected electronically. -An over-the-counter market is also called an auction market

Most of the buying and selling is done by the dealer. Many dealers are also connected electronically.

How is ownership transferred in a corporation?

Ownership is transferred by gifting or selling shares of stock

Why would the threat of a takeover motivate a manager to act in stockholders' interest?

Running the firm well and acting in the stockholders' interest makes the firm a less attractive takeover target to begin with. (Profit potential at poorly run firms is far higher than for well-run firms, which makes them attractive takeover targets. To prevent this, managers may try to do a good job and act in stockholders' interest.)

True or False To generate a coherent plan, goals and objectives will have to be modified, and priorities will have to be established.

TRUE

What is the main goal of financial management?

To maximize current share value

partnership

a business owned by two or more people

managing the firm's working capital is

a day-to-day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions. This involves a number of activities related to the firms receipt and disbursement of cash.

LLC

a hybrid of a partnership and a corporation

The relationship between stockholders and management can best be described as a(n) ______ relationship.

agency

If you hire a real estate company to sell your house, you are most apt to encounter which one of the following?

agency problem

general partnership

all the partners share and gains or losses and all have *unlimited liability* for all partnership debts not just some particular share

the process of planning and managing a firm's long term investments is called

capital budgeting

What three subjects is the financial manager concerned with?

capital budgeting working capital management capital structure

Which term applies to the mixture of debt and equity maintained by a firm?

capital structure

management

charged with running the corporation's affairs in the stockholders interests

In large firms, financial activity is usually associated with which top officer?

chief financial officer

agency problem

conflict of interest between the principal and the agent

stockholders

control the corporation because they elect the directors

Public limited companies and joint stock companies are other names for____________

corporations

the controller's office handles

cost and financial accounting tax payments and management information systems

Which of the following are included in a firm's capital structure? -current assets -net sales -equity -long-term debt

current assets, long-term debt

"Increasing shareholder wealth" means increasing the _________

current common stock value

A bad financial decision is defined as a decision that ______ shareholder wealth.

decreases

Which of the following are considered non-owner stakeholders in a company? -employees -suppliers -stockholders -government

employees suppliers government

various groups called stakeholders

employees, customers, suppliers, and even the government

True or false: The Sarbanes-Oxley Act provides incentives for companies to go public in U.S. markets.

false

An example of Agency Cost

imagine that a corporation is considering a new investment. the new investment is expected to favorably affect the stock price, but it is also a relatively risky venture. the owners of the firm will wish to take the investment (because the share value will rise), good management may not because there is the possibility that things will turn out badly and management jobs will be lost. if management does not take the investment, then the stockholders may lose a valuable opportunity

Good financial decisions ___________ the market value of the owners equity and poor financial decisions ______________ it

increase; decrease

Businesses are motivated to organize as corporations because stockholders in a corporation have ______ liability for corporate debts.

limited

What type of partnership involves both general and limited partners to run the business?

limited partnership

In a limited partnership, a limited partner's liability for business debts is ______.

limited to their cash contribution to the partnership

Capital budgeting is concerned with making and managing expenditures on ____________

long-term assets

Agency costs occur when ______ and stockholder interests are not in line with each other.

management

In a shareholder-manager relationship, who is the agent?

managers

secondary markets

markets in which securities and other financial assets are traded among investors after original sale

primary market

markets in which the original sale of securities by governments and corporations

The goal of a "for-profit" business is to ______ the value of shareholders' wealth.

maximize

the goal of financial management is to

maximize the current value per share of the existing stock

limited partnership

one or more general partners will run the business and have unlimited liability but there will be one or more limited partners who do not actively participate in the business -for business debts is limited to the amount that partner contributes to the partnership with -this form of organization is common in real estate ventures for example

The corporate form has several advantages such as

ownership represented by shares of stock can be readily transferred, and the life of the corporation is, therefore, not limited The corporation borrows money in its own name. As a result, the stockholders in a corporation have limited liability for corporate debts. The most they can lose is what they have invested.

When one owner or creditor sells to another, the transaction takes place in the ______ market.

secondary

in a large corporation, the stockholders and the managers are usually __________________

separate groups.

The owners of a corporation are called:

shareholders

How is ownership of a corporation represented?

shares of stock

A(n) ______ is someone other than an owner or a creditor who potentially has a claim on the cash flows of the firm.

stakeholder

Managerial compensation is often tied to financial performance. One way to make this tie explicit is to offer payment in terms of:

stock options.

Who elects the board of directors and ultimately maintains control of the firm?

stockholders

The good and bad news of owning a sole-proprietorship:

the good news: the owner of a sole proprietorship keeps all the profits the bad news: the owner has *unlimited liability* for business debts. -this means that creditors can look to the proprietors personal assets for payment. -similarly there is no distinction between personal and business income so *all business income is taxed as personal income*

today all 50 states have enacted laws allowing for the creation of a relatively new form of business organization called

the limited liability company (LLC)

Capital Structure

the mix of equity and long-term debt a firm uses to meet its permanent financing needs

True or false: A corporation borrows money in its own name.

true

A sole proprietor has ______ personal liability for all business debts and obligations.

unlimited

Ensuring that the firm has sufficient funds to continue operations on a day-to-day basis comes under the heading of ______ management.

working capital

Firms that are poorly managed are more attractive as acquisitions than well managed firms because

a greater profit potential exists. Thus, avoiding a takeover by another firm gives management another incentive to act in the stockholders interests.

A shareholder's liability is limited to which of these? a. the amount the shareholder invested in the corporation b. the percentage of corporate debt that equals the shareholder's ownership percentage c. the corporation's outstanding long-term debt d. the corporation's current liabilities

a. the amount the shareholder invested in the corporation

The costs incurred due to a conflict of interest between stockholders and management are called ______ costs.

agency

Forming a corporation involves preparing ___________________ and a set of _________________

articles of incorporation (or a charter); bylaws

The Sarbanes-Oxley Act requires corporate officers to:

be responsible for errors in the annual report. confirm the validity of the financial statements.

A corporation receives cash from financial markets by selling ______ and ______.

bonds stocks

The Sarbanes-Oxley Act is intended to strengthen protection against:

corporate accounting fraud and financial malpractice

Which of the following is a disadvantage of sole proprietorships and partnerships?

difficulty of transferring ownership

The controller is responsible for which of the following tasks? -financial accounting -tax reporting and payments -raising capital -capital expenditures

financial accounting tax reporting and payments

A partnership in which partners share in gains or losses and carry unlimited liability for all partnership debts is called a ______.

general partnership

A good financial decision will do which of the following? -increase the value of the firm's existing stock -increase market value of shareholders' equity -increase the cost of capital -increase current dividends per share

increase the value of the firm's existing stock increase market value of shareholders' equity

Working capital includes ?

inventory short-term assets cash

sole proprietorship

is a business owned by one person. - this is the simplest type of business to start and is the least regulated form of organization. - there are more proprietorships than any other type of business, and many businesses that later become large corporations start out as small proprietorships

A sole proprietorship is a business that _________

is owned by one person

variations of corporate firms are called

joint stock companies, public limited companies, or limited liability companies

A corporation is a distinct ______ entity and as such can have a name and take advantage of the legal powers of natural persons.

legal

today, a significant fraction of the market for stocks and almost all of the markets for long term debt have _____________________; the money dealers are connected electronically

no central location

A limited liability company is taxed like a ______, but retains ______ for owners.

partnership; limited liability

Financial markets function as both

primary and secondary markets for debt and equity securities

Which of these topics is not of especial interest to a financial manager? -capital structure -working capital management -product development -capital budgeting

product development

What's an important mechanism used by unhappy stockholders to replace current management?

proxy fight

A firm's capital structure or financial structure

refers to the specific mixture of long term debt and equity the firm uses to finance its operations

stakeholder

someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm

Control of the firm control of the firm ultimately rests with ___________________________. They elect the board of directors who intern hires and fires management

stockholders

The threat of ______ motivates managers to make good decisions.

takeover

Another way that management can be replaced is by

takeover.

proxy

the authority to vote someone else's stock

the financial management function is usually associated with a top officer of the firm often called

the chief financial officer, CFO, or vice of president of finance

profit maximization

the most commonly cited business goal, but this is not a very precise objective

In a for-profit business, owners' equity is equivalent to:

the total value of stock in a corporation.

Which positions generally report to the chief financial officer (CFO)?

treasurer controller

Auction markets (exchanges)

-has a physical location, like Wall Street -the primary purpose is to match those who wish to sell with those who wish to buy

When evaluating financial planning steps, we must consider 3 steps:

1) We first find the planning horizon which is financial planning for the coming 2 to 5 years 2) Then we find the Level of aggregation in which all small projects are added up for one big project. This includes the total need investment in drawing up a financial plan. 3) Lastly we find alternative sets of assumptions being worst case, normal case, and best case scenarios.

some questions about working capital that must be answered are the following:

1. how much cash and inventory should we keep on hand? 2. should we sell on credit to our customers? 3. how will we obtain any needed short-term financing? 4. if we borrow in the short term how and where should we do it?

Is profit maximization the primary objective of a business?

No; profit maximization may not take into account other strategic objectives necessary to maximize shareholder value.

management will frequently have a significant economic incentive to increase share value for two reasons

1. managerial compensation is usually tied to financial performance in general and oftentimes to share value in particular. -for example, managers are frequently given the option to buy stock at a fixed price. The more the stock is worth the more valuable is this option. 2. job prospects better performers within the firm will tend to get promoted. More generally, those managers who are successful in pursuing stockholder goals will be in greater demand in the labor market and thus command higher salaries

the primary disadvantages of sole proprietorships and partnerships as forms of business organization are:

1. unlimited liability for business debts on the part of the owners 2. limited life of the business 3. difficulty of transferring ownership these three disadvantages add up to a single central problem: the ability of such businesses to grow can be seriously limited by an inability to raise cash for investment

A partnership must have at least Blank______ owners.

2

over the counter OTC markets

Dealer markets in stocks and long-term debt. Literally used to be sold "over the counter." -most trading in debt securities takes place over the counter. The expression "over-the-counter" refers to days of old when securities were literally bought and sold at counters in offices around the country

Which of the following are defining features of the primary market? -It is the market where initial public offerings are made. -It only involves seasoned equity offerings. -Proceeds from the sale of securities go to the issuing firm. -It is the market where shareholders and bondholders buy and sell to each other.

It is the market where initial public offerings are made. Proceeds from the sale of securities go to the issuing firm.

A) B) C) D) E) F)

A) cash flows to the firm from the financial markets B) the firm invests the cash in current and fixed or long term assets C) these assets generate some cash D) some of which goes to pay corporate taxes E) after taxes are paid some of this cash flow is reinvested in the firm F) the rest goes back to the financial markets as cash paid to creditors and shareholders

Sarbanes-Oxley Act

An act passed into law by Congress in 2002 to establish strict accounting and reporting rules in order to make senior managers more accountable and to improve and maintain investor confidence. -intended to strengthen protection against corporate accounting fraud and financial malpractice -companies such as Enron, worldcom, Tyco, and Adelphia were involved in corporate scandals before this act was passed

by laws

are rules describing how the corporation regulates its own existence -for example they describe how directors are elected. -may be amended or extended from time to time by the stockholders

two kinds of secondary markets are

auction markets and dealer markets

Since ______ and ownership are separated, a corporation's life is unlimited. a. profitability b. management c. taxation d. debt

b. management

The corporate form has several disadvantages such as

because a corporation is a legal person it must pay taxes. Moreover money paid out to stockholders in the form of dividends is taxed again as income. -To those stockholders, this is *double taxation* meaning that corporate profits are taxed twice: at the corporate level when they are earned and again at the personal level when they are paid out

ownership of the sole proprietorship may be difficult to transfer

because this requires the sale of the entire business to a new owner

The stockholders elect the ________________ who then select the ___________________

board of directors; managers.

dealers

buy and sell for themselves at their own risk -most of the buying and selling is done by them -play a limited role -a car dealer for example buys and sells automobiles

Which corporate officer is responsible for accurate financial accounting of the firm's activities?

controller

The ______ office is responsible for corporate tax reporting.

controller's

The five basic areas of finance include investments, financial institutions, fintech, international finance, and _____________ finance.

corporate

corporation

is a legal person separate and distinct from its owners and it has many of the rights duties and privileges of an actual person -can borrow money and own property can sue and be sued and can enter into contracts -can even be a general partner or a limited partner in a partnership, and a corporation can own stock in another corporation -is the most important form (in terms of size) of business organization in the United states

When a corporation is formed, it is granted what rights?

legal powers to sue the ability to issue stock

A limited liability company's owners have ______ liability.

limited

the articles of incorporation must contain a number of things including

the corporations name, it's intended life which can be forever, it's business purpose, and the number of shares that can be issued -this information must normally be supplied to the state in which the firm will be incorporated -for most legal purposes, the corporation is a "resident" of that state.

proxy fight

the mechanism by which unhappy stockholders can act to replace existing management -develops when a group solicits representatives in order to replace the existing board and thereby replace existing management

agency relationship

the relationship between stockholders and management -exists whenever someone (the principal) hires another (the agent) to represent his or her interest. For example you might hire someone (an agent) to sell a car that you own while you are away at school.

the total value of the stock in a corporation is equal to

the value of the owner's equity

The term working capital refers to

to affirm short term assets such as inventory and it's short term liabilities such as money owed to suppliers

What is the primary objective of an auction market?

to bring buyers and sellers together

more general way of stating the goal of financial management is

to maximize the market value of the existing owners equity

the goal of the limited liability company (LLC) is

to operate and be taxed like a partnership but retain limited liability for owners

The life of the sole proprietorship is limited to _________.

to the owners lifespan and importantly the amount of equity that can be raised is limited to the proprietors personal wealth ---this limitation often means that the business is unable to exploit new opportunities because of insufficient capital.