Self test Chapter 1 with complete solution question and answers

What three areas of finance does this book cover? Are these areas independent of one another, or are they interrelated in the sense that someone working in one area should know something about each of the other areas? Explain. The three areas are: financial management, capital markets, and investments. They're closely connected. A bank lending officer must understand corporate finance to do a business loan. A corporate treasurer must understand banking to loan something out. A security analyst must understand corporate finance and capital markets to determine true stock value. Who is the CFO, and where does this individual fit into the corporate hierarchy? What are some of his or her responsibilities? CFO- Chief financial officer, senior vice president, 3rd ranking, in charge of accounting, finance, credit policy, and decisions regarding assets acquisitions, and investor relations. Does it make sense for not-for-profit organizations such as hospitals and universities to have CFOs? Why or why not? Yes because they are publicly owned and they need to certify to the SEC reports released to stockholders, and especially the annual report. If they don't they're fined What are the key differences among proprietorship, partnerships, and corporations? Proprietorship -has one owner who pays personal income tax on profits and is personally responsible for any liabilities. Partnership- two or more owners share profits or losses. Corporation- is a legal entity distinct from its owners, limiting the owners' personal liability. What is the relationship among economics, finance, and accounting? Fiance grew into eco. and accounting. Eco. developed that an assets value is based on future cash flow it will provide. Accounting provided info. regarding the size of those cash flows How are LLCs and LLPs related to the other forms of organization? Similar to corps. by providing limited liability protection, but they are taxed as partnerships. What is an S corporation, and what is its advantage over a C corporation? Why don't firms such as IBM, GE, and Microsoft choose S corporation status? Aid to small business, taxed as proprietorship or partnerships/exempt from income tax. They have more than 100 stockholders What are some reasons why the value of a business other than a small one is generally maximized when it is organized as a corporation? Business other than small ones will be maximized because 1. they have limited liability. They are more protected if the company is sued. 2. corp can attract capital more easily than smaller ones so they grow faster 3. corp. are relatively liquid. meaning the time and effort it takes to sell the asset for cash at a fair market value. Suppose you are relatively wealthy and are looking for a potential investment. You do not plan to be active in the business. Would you be more interested in investing in a partnership or in a corporation? Why? Corp. because if they lose all their money. I only would lose the money I invested. Furthermore, they have unlimited lives and make easier to transfer stock What's the difference between a stock's current market price and its intrinsic value? Stock price: current market price Intrinsic value: represents the "true" value of the company's stock, can't be directly observed and must instead be estimated Do stocks have known and "provable" intrinsic values, or might different people reach different conclusions about intrinsic values? Explain No, Intrinsic values are estimates and different analysts with different data have different views. Should managers estimate intrinsic values or leave that to outside security analysts? Explain. Managers have the best information about a firm's future prospects, so their estimates are better than outside investors. However their estimates can be wrong. If a firm could maximize either its current market price or its intrinsic value, what would stockholders (as a group) want managers to do? Explain. Stockholders would want firms to maximize the intrinsic value not the current market value. Should a firm's managers help investors improve their estimates of the firm's intrinsic value? Explain. Managers should provide info that helps investors make better estimates of the firm's intrinsic value, which will keep the stock price closer to its equilibrium level. However, there are times when mgt cannot divulge the true situation because doing so would provide info that helps its competitors. What are three techniques stockholders can use to motivate managers to maximize their stock's long-run price? 1. reasonable compensation packages- this attracts and retains managers, but they should go beyond what is needed. 2. firing of managers who don't perform well 3. the threat of hostile takeovers. Should managers focus directly on the stock's actual market price or its intrinsic value, or are both important? Explain. Managers must communicate effectively with stockholders to keep the actual price close to the intrinsic value. It's bad for stockholders and managers when the intrinsic value is high but the actual price is low. In that situation, a raider may swoop in, buy the company at a bargain price, and fire the managers. Why might conflicts arise between stockholders and debtholders? Debt-holders generally receive fixed payments regardless of how well the company does, while stockholders do better when the company does better. This leads to conflicts between the two, to the extent that stockholders are typically more willing to take on risky projects. How might astute bondholders react if stockholders take on risky projects? n some cases the perceived risk may be so great that they will not invest in the company, unless the managers can credibly convince bondholders How can bondholders protect themselves from managers' actions that negatively impact bondholders? By including covenants in the bond agreements that limit firms' use of additional debt and constrain managers' actions in other ways. Is maximizing shareholder value inconsistent with being socially responsible? Explain. Yes. Managers understand that maximizing shareholder value does to mean that they are free to ignore the larger interests of society. When Boeing decides to invest $5 billion in a new jet airliner, are its managers certain of the project's effects on Boeing's future profits and stock price? Explain Not exactly certain, but the finance department's principle task is to evaluate the proposed decisions and judge how they will affect the stock price and thus shareholder wealth. Astute managers recognize that they also need to take into account how these decisions affect society at large Can a firm's executive compensation plan lead to unethical behavior? Explain Yes, the desire for stock options, bonuses, and promotions drives managers to take unethical actions such as fudging the books to make profits in the manager's division look good, holding back info about bad products Unethical acts are generally committed by unethical people. What are some things companies can do to help ensure that their employees act ethically? Firms have strong written codes of ethical behavior; companies also conduct training programs to ensure that employees understand proper behavior in different situations.