Ch 1 & 2
You are the chief financial officer (CFO) of Gaga Enterprises, an edgy fashion design firm. Your firm needs $17 million to expand production. How do you think the process of raising this money will vary if you raise it with the help of a financial institution versus raising it directly in the financial markets? Select all the statements below which support this statement: A.The investment banking institution will allow the Gaga Enterprises CFO to raise more money at a lower cost per dollar raised. B. Financial institutions, such as investment banks, provide expertise in the acquisition of funds. C. Raising the money directly in the financial markets will allow the Gaga Enterprises CFO to avoid the investment bank's commissions and thus raise more money at a lower cost per dollar raised. D.Investment banking institutions are able to use the expertise developed through the acquisition of funds for many firms to reduce the effort and cost of acquiring funds for any single business.
A, B, D
For what kinds of needs do you think a firm would issue securities in the money market versus the capital market? (Select all the answers that apply.) A.transactions in short-term debt instruments, or marketable securities, take place in the money market. B. long-term securities—bonds and stocks—are traded in the capital market and the money market. C. capital markets are typically used for fixed assets, which a company will use over several years. D. money markets are short-term markets, so firms using these would be in need of funds for less than a year.
A, C, D
Which of the following statements are the advantages of a partnership compared to a corporation? A. Less expensive to organize. B. Ownership is readily transferable. C. Owners have limited liability. D. Long life of firm. E. Low income taxes
A, E
Explain why each of the following situations is an agency problem and what costs to the firm might result from it. Suggest how the problem might be handled short of firing the individual(s) involved. The front desk receptionist routinely takes an extra 20 minutes of lunch time to run personal errands. Select all that are correct. A. The front desk receptionist is being compensated for unproductive time. B. The company could install a time clock that would result in either (1) her returning on time or (2) reducing the cost to the firm. C. The management could bring the situation to the attention of the receptionist. The extra emphasis on meeting her duties may be all that is required. D. The company should do nothing. Any attempt to solve the problem would likely create an unhappy employee and only make the situation worse.
A,B,C
Explain why each of the following situations is an agency problem and what costs to the firm might result from it. Suggest how the problem might be handled short of firing the individual(s) involved. The firm's chief executive officer has had secret talks with a competitor about the possibility of a merger in which she would become the CEO of the combined firms. Which of the following statements correctly identifies the cost and possible solution for the agency problem in this case? (Choose all correct responses.) A. One agency cost is that the CEO may negotiate a deal with the merging competitor that is extremely beneficial to herself at the expense of selling the firm for less than its fair market value. B. A good way to reduce the loss of shareholder wealth would be to open the firm up for purchase bids from other firms once the manager makes it known that the firm is willing to merge. C. An open bidding process may encourage other firms to offer a price closer to the fair market value of the firm. D. There is no agency cost. Secrecy must be maintained in order to get the best possible price for the firm.
A,B,C
William Bradley is the founder and chief executive officer of a private firm called Robo-Tech Inc., which specializes in developing robotic limbs. Robo-Tech's sales are on the rise, gross profit margins are strong, and market share is growing, so Bradley feels that the timing is right to retool the manufacturing operation, expand the distribution network, and add new products in order to remain competitive and grow the firm's value. Robo-Tech needs to acquire additional financing resources, and Bradley has decided to take his company public in order to meet its long-term goals. Bradley understands that going from private to public requires some major adjustments. In particular, instead of reporting to a few private investors, management will be responsible to hundreds, or even thousands, of new "owners" who expect a good return on their investment. This public pressure may at times push the company to focus on short-term gains rather than long-term goals. In addition to dealing with new outside shareholders, Robo-Tech will have to comply with the SEC's stricter reporting requirements on public companies. For example, quarterly and annual reports must be filed with the Securities and Exchange Commission and an annual report must be sent to all shareholders. Under Bradley's management, Robo-Tech has had a history of strong financial performance and solid growth potential, and well developed strategic vision and business plan. In order to help with the process of going public, Robo-Tech has hired a team of professional advisors, including lawyers, investment bankers, and accountants. These professionals will assist Robo-Tech with the registration, valuation, marketing, and placement processes. Robo-Tech will also have to decide on a listing exchange, where its shares will continuous trade after the public offering. Options include the New York Stock Exchange, the American Stock Exchange, a regional exchange, or the Nasdaq Market. If all goes according plan, Robo-Tech will soon have access to a new valuable external financing resource, that it can use to finance it future growth potential. Once Robo-Tech has sold its shares to the public does it care whether capital markets are efficient? In other words, how does market efficiency affect Robo-Tech? (Select all the choices that apply.) A. If the market is efficient, prices are an unbiased estimate of firm value. B. If the market is efficient, the more confidence investors will have in the firm's market price. C. If the market is efficient, the firm will have an increased number of potential investors and this will help Robo-Tech sell shares now and in the future, as it continues to need funds to finance expansions. D. If the market is efficient, there is guarantee that the firm's market price will always increase, even in a bear market.
A,B,C
William Bradley is the founder and chief executive officer of a private firm called Robo-Tech Inc., which specializes in developing robotic limbs. Robo-Tech's sales are on the rise, gross profit margins are strong, and market share is growing, so Bradley feels that the timing is right to retool the manufacturing operation, expand the distribution network, and add new products in order to remain competitive and grow the firm's value. Robo-Tech needs to acquire additional financing resources, and Bradley has decided to take his company public in order to meet its long-term goals. Bradley understands that going from private to public requires some major adjustments. In particular, instead of reporting to a few private investors, management will be responsible to hundreds, or even thousands, of new "owners" who expect a good return on their investment. This public pressure may at times push the company to focus on short-term gains rather than long-term goals. In addition to dealing with new outside shareholders, Robo-Tech will have to comply with the SEC's stricter reporting requirements on public companies. For example, quarterly and annual reports must be filed with the Securities and Exchange Commission and an annual report must be sent to all shareholders. Under Bradley's management, Robo-Tech has had a history of strong financial performance and solid growth potential, and well developed strategic vision and business plan. In order to help with the process of going public, Robo-Tech has hired a team of professional advisors, including lawyers, investment bankers, and accountants. These professionals will assist Robo-Tech with the registration, valuation, marketing, and placement processes. Robo-Tech will also have to decide on a listing exchange, where its shares will continuous trade after the public offering. Options include the New York Stock Exchange, the American Stock Exchange, a regional exchange, or the Nasdaq Market. If all goes according plan, Robo-Tech will soon have access to a new valuable external financing resource, that it can use to finance it future growth potential. For Robo-Tech, what are the disadvantages of being a publicly listed company? (Select all the choices that apply.) A. One disadvantage to going public is that there is no guarantee that shareholders will want to invest in one's firm. If they avoid its shares, it will be priced below expected value. B. One disadvantage to going public is that going publicly leaves the owner open to the potential that an individual or firm might purchase all the publicly available shares, or at least enough to control the board of directors, and remove the founder from the management team. C. One disadvantage to going public is that the company will have a hard time raising money through other means, such as bonds or preferred shares. D. One disadvantage to going public is that there may be low trading volume for the company's shares
A,B,D
Explain why each of the following situations is an agency problem and what costs to the firm might result from it. Suggest how the problem might be handled short of firing the individual(s) involved. Division managers are padding cost estimates so as to show short-term efficiency gains when the costs come in lower than the estimates. Which of the following statements correctly identifies the cost and possible solution for the agency problem in this case? (Choose all correct responses.) A. One agency cost is that money budgeted to cover the project proposal is not available to fund other projects that may help to increase shareholder wealth. B. There is no agency cost in this problem. C. One way to reduce the agency cost is to base the reward system on how close the employee's estimates come to the actual cost rather than having them come in below cost. D. A reward system based on increasing shareholder wealth might motivate the division managers to make more accurate estimates in order to be able to take on additional profitable projects.
A,C,D
Ann and Jack have been partners for several years. Their firm, A & J Tax Preparation, has been very successful, as the pair agree on most business-related questions. One disagreement, however, concerns the legal form of their business. For the past two years, Ann has tried to convince Jack to incorporate. She believes that there is no downside to incorporating and sees only benefits. Jack strongly disagrees; he thinks that the business should remain a partnership forever. What information would you want if you were asked to make the decision for Ann and Jack? A. Age of the current owners. B. Risk tolerance of the owners. C. Marital status and tax situation of each partner. D. Growth prospects of the firm. E. Capital needs of the firm.
All are correct
Explain why each of the following situations is an agency problem and what costs to the firm might result from it. Suggest how the problem might be handled short of firing the individual(s) involved. A branch manager lays off experienced full-time employees and staffs customer service positions with part-time or temporary workers to lower employment costs and raise this year's branch profit. The manager's bonus is based on profitability. Which of the following statements correctly identifies the cost and possible solution for the agency problem in this case? (Choose all correct responses.) A. Generally part-time or temporary workers are not as productive as full-time employees. These workers have not been on the job as long to increase their work efficiency. B. This manager is getting rid of good employees to increase short-term profits. C. One approach to reducing the problem would be to give the manager performance shares if certain stated goals are met. D. Implementing a stock incentive plan tying management compensation to share price would also encourage the manager to retain quality employees.
All of them
William Bradley is the founder and chief executive officer of a private firm called Robo-Tech Inc., which specializes in developing robotic limbs. Robo-Tech's sales are on the rise, gross profit margins are strong, and market share is growing, so Bradley feels that the timing is right to retool the manufacturing operation, expand the distribution network, and add new products in order to remain competitive and grow the firm's value. Robo-Tech needs to acquire additional financing resources, and Bradley has decided to take his company public in order to meet its long-term goals. Bradley understands that going from private to public requires some major adjustments. In particular, instead of reporting to a few private investors, management will be responsible to hundreds, or even thousands, of new "owners" who expect a good return on their investment. This public pressure may at times push the company to focus on short-term gains rather than long-term goals. In addition to dealing with new outside shareholders, Robo-Tech will have to comply with the SEC's stricter reporting requirements on public companies. For example, quarterly and annual reports must be filed with the Securities and Exchange Commission and an annual report must be sent to all shareholders. Under Bradley's management, Robo-Tech has had a history of strong financial performance and solid growth potential, and well developed strategic vision and business plan. In order to help with the process of going public, Robo-Tech has hired a team of professional advisors, including lawyers, investment bankers, and accountants. These professionals will assist Robo-Tech with the registration, valuation, marketing, and placement processes. Robo-Tech will also have to decide on a listing exchange, where its shares will continuous trade after the public offering. Options include the New York Stock Exchange, the American Stock Exchange, a regional exchange, or the Nasdaq Market. If all goes according plan, Robo-Tech will soon have access to a new valuable external financing resource, that it can use to finance it future growth potential. For Robo-Tech, what are the advantages of being a publicly listed company?(Select all the choices that apply.) A.Being a publicly-listed company provides access to the money they need to grow. B.By going public, the owner can diversify their portfolio. In fact, without going public, it is difficult to determine the value of their firm. C.Going public gives the owner the chance to get a return for his or her hard effort. D.For a publicly-listed company shareholders provide cash without having an ability to take the company to bankruptcy court if a payment is not made.
All of them
Which of the following statements are the advantages of a corporation compared to a partnership? A. Less expensive to organize. B. Ownership is readily transferable. C. Owners have limited liability. D. Long life of firm. E. Low income taxes.
B, C, D
Nerissa Smith has invested $47,000 in Northeast Productions Company. The firm has recently declared bankruptcy and has $108,000 in unpaid debts. Explain the nature of Nerissa's personal liability , if any, in each of the following situations. Northeast Productions Company is a 50-50 general partnership of Nerissa Smith and Roger Brown. A. Ms. Smith has unlimited liability, which means creditors can only claim against the $47,000 she invested. B. Ms. Smith has lost her $47,000 investment and shares unlimited liability with her partner. Initially, Ms. Smith is liable for $54,000 (50% of total unpaid debts). But if her partner cannot cover half the debt, Ms. Smith is liable for the full amount. C. Ms. Smith has limited liability, which guarantees that she cannot lose more than the $47,000 she invested. D. Ms. Smith has limited liability, which is $54,000, or half of the $108,000 in unpaid debts.
B.
William Bradley is the founder and chief executive officer of a private firm called Robo-Tech Inc., which specializes in developing robotic limbs. Robo-Tech's sales are on the rise, gross profit margins are strong, and market share is growing, so Bradley feels that the timing is right to retool the manufacturing operation, expand the distribution network, and add new products in order to remain competitive and grow the firm's value. Robo-Tech needs to acquire additional financing resources, and Bradley has decided to take his company public in order to meet its long-term goals. Bradley understands that going from private to public requires some major adjustments. In particular, instead of reporting to a few private investors, management will be responsible to hundreds, or even thousands, of new "owners" who expect a good return on their investment. This public pressure may at times push the company to focus on short-term gains rather than long-term goals. In addition to dealing with new outside shareholders, Robo-Tech will have to comply with the SEC's stricter reporting requirements on public companies. For example, quarterly and annual reports must be filed with the Securities and Exchange Commission and an annual report must be sent to all shareholders. Under Bradley's management, Robo-Tech has had a history of strong financial performance and solid growth potential, and well developed strategic vision and business plan. In order to help with the process of going public, Robo-Tech has hired a team of professional advisors, including lawyers, investment bankers, and accountants. These professionals will assist Robo-Tech with the registration, valuation, marketing, and placement processes. Robo-Tech will also have to decide on a listing exchange, where its shares will continuous trade after the public offering. Options include the New York Stock Exchange, the American Stock Exchange, a regional exchange, or the Nasdaq Market. If all goes according plan, Robo-Tech will soon have access to a new valuable external financing resource, that it can use to finance it future growth potential. If Robo-Tech prefers that its shares trade on a centralized exchange, what listing exchanges make the most sense for Robo-Tech and why? (Select all the choices that apply.) A. Not enough information is provided to determine whether Robo-Tech meets the listing requirements to be on the Tokyo Stock Exchange. That would be the goal because it is the largest and have the largest number of potential investors. B. Not enough information is provided to determine whether Robo-Tech meets the listing requirements to be on the Chicago Mercantile Exchange. That would be the goal because it is the largest and have the largest number of potential investors. C. Not enough information is provided to determine whether Robo-Tech meets the listing requirements to be on the NYSE Euronext. That would be the goal because it is the largest and have the largest number of potential investors. D. Not enough information is provided to determine whether Robo-Tech meets the listing requirements to be on the NASDAQ. That would be the goal because it is the largest and have the largest number of potential investors.
C
Explain why the accrual and cash accounting methods show different net profits. How do the two profit figures provide different information to the financial manager? (Select the best answer below.) A. The income statement is more useful because it recognizes revenues at the time of sale (whether payment has been received or not) and recognizes expenses when they are incurred. B. A financial manager will find the income statement more useful. Accounting net income includes uncollected revenues that do not contribute to owner wealth. Cash flows, not accounting profits, matter to shareholders. The income statement is more useful because it recognizes amounts that will not be collected and, as a result, will not contribute to the wealth of the owners. C. A financial manager will find the cash flow statement more useful. Accounting net income includes uncollected revenues that do not contribute to owner wealth. Cash flows, not accounting profits, matter to shareholders. The cash flow statement is more useful because it recognizes amounts that will not be collected and, as a result, will not contribute to the wealth of the owners. D. The cash flow statement is more useful because it recognizes revenues at the time of sale (whether payment has been received or not) and recognizes expenses when they are incurred.
C.
Nerissa Smith has invested $47,000 in Northeast Productions Company. The firm has recently declared bankruptcy and has $108,000 in unpaid debts. Explain the nature of Nerissa's personal liability , if any, in each of the following situations. Northeast Productions Company is a limited partnership where Nerissa Smith is a limited partner. A. Ms. Smith has unlimited liability, which means creditors can claim against her personal assets. B. Ms. Smith has unlimited liability which means creditors can claim against the $47,000 she invested as well as her other personal assets. C. Ms. Smith has lost her $47,000 investment, but she has limited liability, so she is not personally liable for the firm's $108,000 in unpaid debts. D. Ms. Smith has unlimited liability which means that creditors can only claim against her personal assets.
C.
Nerissa Smith has invested $47,000 in Northeast Productions Company. The firm has recently declared bankruptcy and has $108,000 in unpaid debts. Explain the nature of Nerissa's personal liability , if any, in each of the following situations. Northeast Productions Company is a sole proprietorship owned by Ms. Smith. A. Ms. Smith has limited liability, which guarantees that she cannot lose more than the $47,000 she invested. B. Ms. Smith has unlimited liability, which means creditors can only claim against the $47,000 she invested. C. Ms. Smith has lost her $47,000 investment and has unlimited personal liability, so she is also liable for the firm's $108,000 in unpaid debts. D. Ms. Smith has limited liability, which is the amount of $108,000 in unpaid debts.
C.
Nerissa Smith has invested $47,000 in Northeast Productions Company. The firm has recently declared bankruptcy and has $108,000 in unpaid debts. Explain the nature of Nerissa's personal liability , if any, in each of the following situations. Northeast Productions Company is a corporation. A. Ms. Smith has limited liability, which is the amount of $108,000 in unpaid debts. B. Ms. Smith has unlimited liability, which means creditors can only claim against the $47,000 she invested. C. Ms. Smith has unlimited liability, which means creditors can claim against her personal assets. D. Ms. Smith has limited liability, which guarantees that she cannot lose more than the $47,000 she invested and is not liable for the firm's $108,000 in unpaid debts.
D.
Your broker calls to offer you the investment opportunity of a lifetime, the chance to invest in mortgage-backed securities. The broker explains that these securities are entitled to the principal and interest payments received from a pool of residential mortgages. List some of the questions you would ask your broker that would help in assessing the risk of this investment opportunity. A. Real estate location (after all, the three most important determinants of real estate price are "location, location, location"). B. Type of real estate (commercial properties offer less liquidity if the market turns sour, because empty homes can be rented for revenue). C. What percentage of borrowers are behind on their mortgage payments? D. Percentage of properties in the region that are "under water" (homeowners owe more than they borrowed) or in foreclosure. E. Quality of the real estate (is it in a good condition, or would there need to be repairs prior to sale?). F. Creditworthiness of borrowers (how likely is it that borrowers will lose their job and be unable to make payments on a timely basis?). G. Will borrowers soon be experiencing an interest rate increase because they took out a mortgage with a low initial rate that was adjustable after a period of time? H. Precedence in bankruptcy (would other lenders have a senior claim to properties in bankruptcy?). I. All of the above.
I
What do you think the consequences might be in financial markets if individuals consumed more of their incomes and thereby reduced the supply of funds available to financial institutions?
If individuals consume more, fewer dollars will be available for investment. This would reduce the amount of money available for new projects and drive up the required return (i.e., required return of investors to buy bonds). Over time, employment, salaries, and gross domestic product would decline.
As CFO, you are responsible for weighing the pros and cons of the investment opportunities developed by your company's research and development division. You are currently evaluating two competing 15-year projects that differ in several ways. Relative to your firm's current EPS, the first project is expected to generate above-average EPS during the first 5 years, average EPS during the second 5 years, and below-average EPS in the last 5 years. The second project is expected to generate below-average EPS during the first 5 years, average EPS in the second 5 years, and well-above-average EPS in the last 5 years. Is the choice obvious if you expect that the second investment will result in a larger overall earnings increase?
No. The firm can earn a return on funds it receives, therefore, the receipt of funds is preferred sooner rather than later. The first project generates an above-average return in the first 5 years, while the second project generates below-average returns in the same period.
If there is a shortage of cash, what are a few options?
You can borrow money from your bank or withdraw money from an existing savings/investing account. Another alternative is to cut down on any unnecessary expenses.
If there is a surplus of cash, what are a few options?
You can use the monthly surplus to open a savings/investing account or increase the balance on an existing account. Alternatively, you could reduce debt by paying more for some obligations like your auto loan, credit cards or mortgage. In order to maintain your monthly surplus you should maintain your current level of expenses.
You have been made treasurer for a day at AIMCO, Inc. AIMCO develops technology for video conferencing. A manager of the satellite division has asked you to authorize a capital expenditure in the amount of $100,000. The manager states that this expenditure is necessary to continue a long-running project designed to use satellites to allow video conferencing anywhere on the planet. The manager admits that the satellite concept has been surpassed by recent technological advances in telephony, but he feels that AIMCO should continue the project because $2.5 million has already been spent over the past 15 years on this project. Although you believe the project will generate future cash outflows that exceed its inflows, the manager believes it would be a shame to waste the money and time already spent. Use marginal cost-benefit analysis to make your decision regarding whether you should authorize the $100,000 expenditure to continue the project. Should you authorize the $100,000 expenditure, if it will generate a positive net present value?
You should authorize the $100,000 expenditure to continue the project if the project will generate a positive net present value. The marginal cost-benefit analysis treats the $2.5 million as a cost that is irrelevant to the current decision making.
Over time, government regulation of financial institutions and markets has ebbed and flowed or, as some economists might argue, has ebbed and flooded. Although the laws and regulatory agencies created by the government have various defined and not-so-well defined goals, what might you argue is the biggest intended benefit of financial regulation?
the resulting trust and confidence in the financial institutions and markets derived by society.
What does it mean when we say that individuals as a group are net suppliers of funds for financial institutions?
Individuals, as a whole, spend less than they make. The excess is invested, making it available for businesses and governments.
As CFO, you are responsible for weighing the pros and cons of the investment opportunities developed by your company's research and development division. You are currently evaluating two competing 15-year projects that differ in several ways. Relative to your firm's current EPS, the first project is expected to generate above-average EPS during the first 5 years, average EPS during the second 5 years, and below-average EPS in the last 5 years. The second project is expected to generate below-average EPS during the first 5 years, average EPS in the second 5 years, and well-above-average EPS in the last 5 years. Given the goal of the firm, what issues will you consider before making a final decision?
Timing, cash flows, and risk.
