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Chapter One : Introduction to Corporate Finance
Based off Connect Practice
Terms in this set (59)
What is the main goal of financial management?
maximize the current value per share of the existing stock
Other possible financial goals
Avoid financial distress and bankruptcy.
Beat the competition.
Maximize sales or market share.
Maintain steady earnings growth.
What are the two basic classifications under which most potential financial goals fall?
Earning or increasing profits;
residual owners in a firm
What does stockholders being residual owners mean?
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 Sarbanes-Oxley Act requires corporate officers to do which of the following?
1. List any deficiencies in internal controls; 2. Confirm the validity of the annual financial report;
3. Accept responsibility for material errors in the annual report.
What is bought and sold in financial markets?
Debt and equity securities
What positions generally report to the Chief Financial Officer (CFO)?
Controller and Treasurer
Which corporate officer is responsible for accurate financial reporting of the firm's activities?
The officer responsible for managing the firm's cash flows is the_______.
The Controller's office handles what responsibilities?
Handles cost and financial accounting, tax payments, and management information systems.
A Treasurer's responsibilities typically include:
Handling cash flows; Managing capital expenditure decisions; Making financial plans.
Capital budgeting is concerned with planning and managing a firm's______.
long term investments
The mixture of debt and equity maintained by a firm.
A firm's short-term assets and liabilities.
Inventory is a:
- part of working capital
- current asset
Imagine that you were to start your own business. No matter what type 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 investment? 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?
Since ownership in a corporation can be dispersed over a huge number of stockholders, it can be argued that ______ effectively controls the firm.
In a large corporation, what would the financial manager be in charge of?
Long-term investment decisions; Financing decisions;
Financial aspects of operations, such as collections of accounts receivables.
Relationship between stockholders and management. Such a relationship exists whenever someone (the principal) hires another (the agent) to represent his or her interests.
Ex: You might hire someone (an agent) to sell a car you own while you are away at school.
The possibility of conflict of interest between the stockholders and management of a firm.
The costs of the conflict of interest between stockholders and management. (These costs can be indirect or direct)
A lost opportunity.
Ex: A firm is considering a new investment that will favorably impact the share value, but is a risky venture. The owners want to take investment, but management does not in fear of it turning out badly. If management does not take the investment, then the stockholders may lose a valuable opportunity.
Direct Cost (comes in two terms)
1. A corporate expenditure that benefits management but costs the stockholders.
Ex: Perhaps the purchase of a luxurious and unneeded corporate jet.
2. An expense that arises from the need to monitor management actions.
Ex: Paying outside auditors to assess the accuracy of financial statement information.
What incentives can be used to encourage managers to act In the best interests of shareholders?
Managerial compensation tied to performance;
Better prospects of promotion.
What is an important mechanism used by unhappy stockholders to replace current management?
A proxy is the authority to vote someone else's stock. A proxy fight develops when a group solicits proxies in order to replace the existing board and thereby replace existing managers.
What is another way managers can be replaced?
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.
Someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm
A business owned by one person
Advantages of Sole Proprietorship
Easiest to start;
Single owner keeps all the profits;
Taxed once as personal income.
Disadvantages of Sole Proprietorship
Limited to life of owner;
Equity capital limited to owner's personal wealth;
Difficult to sell ownership interest.
A business without separate legal authority formed by two or more people.
All partners share in gains and losses, each owner has unlimited liability for all firm debts, it is difficult to transfer ownership.
A partnership consisting of one or more general partners will run the business, but there will be one or more limited partners who will not actively participate in the business.
In a limited partnership, a limited partner's liability for business debts is_______.
Limited to their cash contribution to the partnership.
Advantages of Partnership
Two or more owners;
More capital available;
Relatively easy to start;
Income taxed once as personal income.
Disadvantages of Partnership
Partnership dissolves when one partner dies or wishes to sell;
Difficult to transfer ownership.
A business created as a distinct legal entity composed of one or more individuals or entities.
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.
Forming a corporation involves...
Preparing articles of incorporation (or a charter) and a set of bylaws.
articles of incorporation
a written legal document that contains the corporation's name, it's intended life, it's business purpose, the # of shares that can be issues, etc.
Rules describing how the corporation regulates its existence.
Ex: the bylaws describe how directors are elected. These bylaws may be a simple statement of a few rules and procedures, or they may be quite extensive for a large corporation. The bylaws may be amended or extended from time to time by the stockholders.
The owners of a corporation are called______.
The life of a corporation______.
The liability of a shareholder is a corporation is limited to what?
The amount the shareholder invested in the corporation.
The federal government taxes which of the following?
Corporate earnings and shareholders dividends. (Double Taxation)
A limited liability company is taxed like a ______ and its owners have _______ liability.
A corporation receives cash from financial markets by selling what?
bonds and stocks.
Advantages of a Corporation
Separation of ownership and management
Transfer of ownership is easy
Easier to raise capital
Disadvantages of a Corporation
Financial markets function as both primary and secondary markets for debt and securities. (T/F)
Refers to the original sale of securities by governments and corporations.
Corporations engage in two types of primary market transactions: Public Offerings and Private Placements.
A primary market issue which involves selling securities to the general public.
A primary market issue which is a negotiated sale involving a specific buyer.
During a primary market transaction...
The corporation is the seller, and the transaction raises money for the corporation.
Markets in which securities and other financial assets are bought and sold after the original sale.
There are two kinds of secondary markets: Auction Markets and Dealer Markets
Dealer markets in stocks and long-term debt are called over-the-counter (OTC) markets. 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. Today, a significant fraction of the market for stocks and almost all of the market for long-term debt have no central location; the many dealers are connected electronically.
- An auction market or exchange has a physical location (like Wall Street).
- In a dealer market, most of the buying selling is done by the dealer.
- The primary purpose of an auction market, on the other hand, is to match those who wish to sell with those who wish to buy.
- Dealers play a limited role.
The equity shares of most of the large firms in the United States trade in organized auction markets. (T/F)
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