Corporate Finance Chapter 1

Which one of the following terms is defined as a conflict of interest between the corporate shareholders and the corporate managers? Articles of incorporation. Corporate breakdown. Agency problem. Bylaws. Legal liability.

Agency problem.

A stakeholder is:

Any person or entity other than a stockholder or creditor who potentially has a claim on the cash flows of a firm.

Why should financial managers strive to maximize the current value per share of the existing stock?

Because they have been hired to represent the interests of the current shareholders.

What methods can be used to encourage managers to act in the best interest of the shareholders?

Better Prospects to promotion Stock options and bonuses tie management to performance Managerial compensation tied to performance

A corporation receives cash from financial market by selling______ and ______.

Bonds and stock

NASDAQ-listed companies tend to be smaller and trade less actively. The exceptions are:

Both Microsoft and Intel trade OTC, for example.

The rules used by a corporation to regulate its existence are known as ___________.

Bylaws

The term that applies the mixture of debt and equity maintained by a firm

Capital Structure

Process of making and managing expenditures on long-term assets

Capital budgeting

Which one of the following terms is defined as the management of a firm's long-term investments? Working capital management. Financial allocation. Agency cost analysis. Capital budgeting. Capital structure.

Capital budgeting.

Which one of the following terms is defined as the mixture of a firm's debt and equity financing? Multiple Choice Working capital management. Cash management. Cost analysis. Capital budgeting. Capital structure.

Capital structure.

What positions generally report to the CFO?

Controller and Treasurer

A business created as a distinct legal entity and treated as a legal "person" is called a:

Corporation

A business created as a distinct legal entity and treated as a legal "person" is called a:

Corporation.

Corporate bylaws:

Determine how a corporation regulates itself.

Which one of these is a working capital management decision? Determining the minimum level of cash to be kept in a checking account. Determining the best method of producing a product. Determining the number of employees needed to work during a particular shift. Determining when to replace obsolete equipment. Determining if a competitor should be acquired.

Determining the minimum level of cash to be kept in a checking account.

Potential stakeholders in a firm include:

Employees Customers Suppliers Government Shareholders all have a financial interest in the firm

what companies were involved in the corporate scandal that led to Sarbanes-Oxley?

Enron WorldCom Tyco

True or False All secondary markets are auction markets.

False

True or False Dealer markets have a physical trading floor.

False

True or False Dealers arrange trades but never own the securities traded.

False

True or False Private placements must be registered with the SEC.

False

Whether managers will, in fact, act in the best interests of stockholders depends on two factors:

First, how closely are management goals aligned with stockholder goals? This question relates, at least in part, to the way managers are compensated. Second, can managers be replaced if they do not pursue stockholder goals?

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

First, managerial compensation, particularly at the top, is usually tied to financial performance in general and often to share value in particular. For example, managers are frequently given the option to buy stock at a bargain price. The more the stock is worth, the more valuable is this option. In fact, options are often used to motivate employees of all types, not just top managers. For example, in late 2016, Alphabet's more than 72,000 employees owned enough options to buy 3.3 million shares in the company. Many other corporations, large and small, have adopted similar policies. The second incentive managers have relates to job prospects. Better performers within the firm will tend to get promoted. More generally, managers who are successful in pursuing stockholder goals will be in greater demand in the labor market and thus command higher salaries.

A business formed by two or more individuals who each have unlimited liability for all of the firm's business debts is called a:

General Partnership

A business formed by two or more individuals who each have unlimited liability for all of the firm's business debts is called a:

General partnership.

Which of the following help convince managers to work in the best interest of the stockholders? Assume there are no golden parachutes. I. Compensation based on the value of the stock. II. Stock option plans. III. Threat of a company takeover. IV. Threat of a proxy fight. I and II only. III and IV only. I, II, and III only. I, III, and IV only. I, II, III, and IV.

I, II, III, and IV.

Which of the following accounts are included in working capital management? I. Accounts Payable II. Accounts Receivable III. Fixed Assets IV. Inventory I and II only. I and III only. II and IV only. I, II, and IV only. II, III, and IV only.

I, II, and IV only.

Which one of the following statements is correct? A general partnership is legally the same as a corporation. Income from both sole proprietorships and partnerships is taxed as individual income. Partnerships are the most complicated type of business to form. All business organizations have bylaws. Only firms organized as sole proprietorships have limited lives.

Income from both sole proprietorships and partnerships is taxed as individual income.

Which one of the following statements concerning a sole proprietorship is correct? The life of a sole proprietorship is potentially unlimited. A sole proprietor can generally raise large sums of capital quite easily. Transferring ownership of a sole proprietorship is easier than transferring ownership of a corporation. A sole proprietorship is taxed the same as a C corporation. It is easy to create a sole proprietorship.

It is easy to create a sole proprietorship.

A business partner whose potential financial loss in the partnership will not exceed his or her investment in that partnership is called a:

Limited partner.

Sam, Alfredo, and Juan want to start a small U.S. business. Juan will fund the venture but wants to limit his liability to his initial investment and has no interest in the daily operations. Sam will contribute his full efforts on a daily basis but has limited funds to invest in the business. Alfredo will be involved as an active consultant and manager and will also contribute funds. Sam and Alfredo are willing to accept liability for the firm's debts as they feel they have nothing to lose by doing so. All three individuals will share in the firm's profits and wish to keep the initial organizational costs of the business to a minimum. Which form of business entity should these individuals adopt?

Limited partnership.

Since ownership in a corporation can be dispersed over a huge number of stockholders, it can be argued that ______ effectively controls the firm.

Management

Which one of the following best states the primary goal of financial management? Maximize current dividends per share. Maximize the current value per share. Increase cash flow and avoid financial distress. Minimize operational costs while maximizing firm efficiency. Maintain steady growth while increasing current profits.

Maximize the current value per share.

In 1971, the National Association of Securities Dealers (NASD) made available to dealers and brokers an electronic quotation system called:

NASDAQ (which originally stood for NASD Automated Quotation system and is pronounced "naz-dak").

Organized auction markets include:

New York Stock Exchange

How is ownership transferred in a corporation?

Ownership is transferred by gifting or selling shares of stock

When a corporation raises funds in the financial market, the transactions occurs on the:

Primary Market

Which one of the following is a primary market transaction?

Sale of a new share of stock to an individual investor.

In response to corporate scandals at companies such as Enron, WorldCom, Tyco, and Adelphia, Congress enacted the:

Sarbanes-Oxley Act in 2002. The act, better known as "Sarbox," is intended to protect investors from corporate abuses.

Financial managers should primarily focus on the interests of: Multiple Choice Stakeholders. The vice president of finance. Their immediate supervisor. Shareholders. The board of directors.

Shareholders

A business owned by a solitary individual who has unlimited liability for its debt is called a:

Sole proprietorship.

A stakeholder is

Someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm. Such groups will also attempt to exert control over the firm, perhaps to the detriment of the owners.

____________ are frequently used to encourage key managers to maximize the value of the firms' stock

Stock Options

The officer responsible for corporate tax reporting is:

The Controller

Direct Agency Costs come in two forms;

The first type is a corporate expenditure that benefits management but costs the stockholders. Perhaps the purchase of a luxurious and unneeded corporate jet would fall under this heading. The second type of direct agency cost is an expense that arises from the need to monitor management actions. Paying outside auditors to assess the accuracy of financial statement information could be one example.

What limitation often means that the business is unable to exploit new opportunities because of insufficient capital.

The life of a sole proprietorship is limited to the owner's life span, and the amount of equity that can be raised is limited to the amount of the proprietor's personal wealth.

Agency relationship:

The relationship between stockholders and management exists whenever someone (the principal) hires another (the agent) to represent his or her interests

why is the corporate form superior for raising cash?

The relative ease of transferring ownership, the limited liability for business debts, and the unlimited life of the business are

Corporate Finance

The study of ways to answer these questions: Where will you get the long term financing for those investments? Will you bring in other owners or will you borrow the money? How will you manage your everyday financial activities such as collecting from customers and paying suppliers? What long term investments should you take on? That is, what lines of business will you be in what sorts of buildings, machinery, and equipment will you need?

The goal of maximizing the value of the stock avoids:

There is no ambiguity in the criterion, and there is no short-run versus long-run issue. We explicitly mean that our goal is to maximize the current stock value.

The bylaws may be:

These bylaws may be a simple statement of a few rules and procedures, or they may be quite extensive for a large corporation. amended or extended from time to time by the stockholders.

True or False Auction markets match buy and sell orders.

True

True or False Ownership of a sole proprietorship may be difficult to transfer because this transfer requires the sale of the entire business to a new owner.

True

What is defined as a firm's short-term assets and its short-term liabilities?

Working Capital

A sole proprietorship is:

a business owned by one person

A proxy fight develops when:

a group solicits proxies in order to replace the existing board and thereby replace existing managers.

An indirect agency cost is:

a lost opportunity, such as the one we have just described.

An important mechanism by which unhappy stockholders can act to replace existing management is called

a proxy fight

Financial markets function as:

both primary and secondary markets for debt and equity securities.

The first question for the financial manager concerns the process of planning and managing a firm's long-term investments is called

capital budgeting

The second question for the financial manager concerns ways in which the firm obtains and manages the long-term financing it needs to support its long-term investments is called:

capital structure

The controller's office handles:

cost and financial accounting, tax payments, and management information systems.

Inventory is a:

current asset and part of working capital

The need to monitor management is an example of a___________ agency cost

direct

an increase in firms value sometimes increases

dividends

some of the cash flow generated by a firm goes back to the financial markets in the form of

dividends and debt payments

The stockholders:

elect the board of directors, who then select the managers. In principle, stockholders control the corporation because they elect the directors.

Controllers responsibility

financial accounting

Employees, customers, suppliers, and even the government all have a:

financial interest in the firm

A treasurer's responsibilities include:

handling cash flows making financial plans making capital expenditure decisions

In capital budgeting, the financial manager tries to:

identify investment opportunities that are worth more to the firm than they cost to acquire. This means that the value of the cash flow generated by an asset exceeds the cost of that asset.

A good financial decision aims at?

increase the market value of shareholder's equity Increase the value of the firms' existing stock

An increase in the cost of capital will limit the firm's:

investment opportunities, which decrease the firm's value

When a corporation is formed it is granted that:

it has the legal power to sue ability to issue stock state citizenship for jurisdictional purposes

A financial market, like any market, is:

just a way of bringing buyers and sellers together. In financial markets, it is debt and equity securities that are bought and sold.

Advantage of The owner of a sole proprietorship

keeps all the profits.

A corporation is a:

legal "person," separate and distinct from its owners it has many of the rights, duties, and privileges of an actual person.

Business are motivated to organize as corporations because stockholders in a corporation have _______ liability for corporate debt.

limited

Since ___________ and ownership are separated, a corporation's life is unlimited.

management

The treasurer's office is responsible for:

managing the firm's cash and credit, its financial planning, and its capital expenditures.

The goal of a for-profit organization is to__________ existing owner's equity

maximize

A firm's capital structure (or financial structure) is the specific:

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

The equity shares of most of the large firms in the United States trade in:

organized auction markets

Ownership in a Corporation (represented by shares of stock) can be:

readily transferred, and the life of the corporation is therefore not limited.

Agency Cost

refers to the costs of the conflict of interest between stockholders and management. These costs can be indirect or direct.

because shareholders get paid last after all obligations are satisfied, they are called:

residual owners

The bylaws are:

rules describing how the corporation regulates its existence. For example, the bylaws describe how directors are elected.

Managers are charged with:

running the corporation's affairs in the stockholders' interests.

In a large corporation, the stockholders and the managers are usually:

separate groups.

Equities are, of course, issued ___________ and Debt securities are issued _________

solely by corporations. by both governments and corporations.

The owners of a corporation are called:

stockholders or shareholders

Another way that managers can be replaced is by:

takeover Firms that are poorly managed are more attractive as acquisitions because a greater profit potential exists. Thus, avoiding a takeover gives management another incentive to act in the stockholders' interests.

in large corporations ownership can be spread over a huge number of stockholders. This dispersion of ownership arguably means:

that management effectively controls the firm.

A partnership is similar to a proprietorship except

that there are two or more owners (partners).

the stockholders in a firm are residual owners means:

that they are entitled to only what is left after employees, suppliers, and creditors (and anyone else with a legitimate claim) are paid their due. If any of these groups go unpaid, the stockholders get nothing. So, if the stockholders are winning in the sense that the leftover, residual portion is growing, it must be true that everyone else is winning also.

The largest such market is:

the New York Stock Exchange (NYSE). There is also a large OTC market for stocks

Disadvantage of The owner of a sole proprietorship

the owner has unlimited liability for business debts. This means that creditors can look beyond business assets to the proprietor's personal assets for payment. Similarly, there is no distinction between personal and business income, so all business income is taxed as personal income. **However, with the passage of the Tax Cuts and Jobs Act of 2017, up to 20 percent of business income may be exempt from taxation (the specific rules are too complex to cover here).**

Agency Problem

the possibility of conflict of intrest between the stockholder and the management of the firm

Dealing with a for-profit organization: The total value of the stock in a corporation is simply equal to:

the value of the owners' equity. Therefore, a more general way of stating our goal is as follows: Maximize the market value of the existing owners' equity.

The secondary markets are:

those in which these securities are bought and sold after the original sale.

The goal of financial management is

to maximize the current value per share of the existing stock.

The primary market refers:

to the original sale of securities by governments and corporations.

Nonetheless, the total value of NASDAQ stocks is much less than the:

total value of NYSE stocks.

Financial markets differ in detail, however. The most important differences concern the:

types of securities that are traded, how trading is conducted, and who the buyers and sellers are.

Stockholders (owners) are

usually not involved in the decision making day-to-day process

A proxy is the authority to:

vote someone else's stock.

The third question refers to a firm's short-term assets, such as inventory, and its short-term liabilities, such as money owed to suppliers.

working capital management