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.
