FUNDAMENTALS OF FINANCIAL MANAGEMENT EXAM WITH COMPLETE QUESTIONS AND CORRECT DETAILED ANSWERS WITH RATIONALES (VERIFIED ANSWERS) |ALREADY GRADE

Market Analysis pg. 5 - ANSWERSdeals with the issue of whether stock and bond markets at any given time are too high, too low, or about right. Included in market analysis is, Behavioral Finance Behavioral Finance pg. - ANSWERSwhere investor psychology is examined in an effort to determine whether stock prices have been bid up to unreasonable heights in a speculative bubble or driven down to unreasonable lows in a fit of irrational pessimism. Sarbanes-Oxley Act pg. 5 - ANSWERSA law passed by Congress that requires the CEO and CFO to certify that their firm's financial statements are accurate. (Enron) 4 Main Forms of Business Organizations pg. 7 - ANSWERS1. Proprietorships 2. Partnerships 3. Corporations 4. Limited Liability Companies (LLCS) and Limited Liability Partnerships (LLP) Proprietorship pg. 7 - ANSWERSAn unincorporated business owned by one individual. 3 Important Advantages: 1. Easy and inexpensive to form. 2. Subject to few government regulations. 3. They are subject to lower income taxes than corporations. 3 Important Limitations: 1. unlimited personal liability for the business' debts, so can lose more than the amount of money they invested in the company. 2. The life of the business is limited to the life of the individual who created it, requires change of structure to bring in new equity. 3.Because the first two points, it is difficult to obtain large sums of capital, used primarily for small businesses. Can be converted to corporations when growth results in the disadvantages outweighing the advantages. Partnership pg. 7 - ANSWERSAn unincorporated business owned by two or more persons. Established easily and inexpensively. Income is allocated on a pro rata basis to partners, taxed on an individual basis. Avoids corporate income tax. All partners generally subjected to unlimited personal liability. Unlimited liability makes it difficult for partnerships to raise large amounts of capital. Corporation pg. 8 - ANSWERSA legal entity created by a state, separate and distinct from its owners and managers, having unlimited life, easy transferability of ownership, and limited liability. Separation limits stockholders' losses to the amount they invested in the firm, corporation can lose all money but the owners can lose only the funds that they invested. Can have unlimited lives, easier to transfer shares of stock. Much easier for corporations to raise the capital necessary to operate large businesses. MAJOR DRAWBACK: Taxes. Most corp's earnings are subject to double taxation, earnings are taxed, then when after tax earnings are paid out as dividends, those earnings are taxed again as personal income to the stockholders. S Corporations pg. 8 - ANSWERSA special designation that allows small businesses that meet qualifications to be taxed as if they were a proprietorship or a partnership rather than a corporation. Exempt from Corporate income tax. To qualify, can have no more than 100 stockholders, which limits their use to relatively small privately owned firms. Large corps are known as C Corporations Limited Liability Company pg. 8 - ANSWERS(LLC) A popular type of organization that is a hybrid between a partnership and a corporation. Limited Liability Partnership pg. 8 - ANSWERSSimilar to an LLC but used for professional firms in the fields of accounting, law, and architecture. It provides personal asset protection from business debts and liabilities but is taxed as a partnership. Hire a good lawyer when establishing LLC or LLP REasons pg. 8 - ANSWERS1. Limited liability reduces the risks borne by investors; and other things held constant, the lower the firm's risk, the higher its value. 2. A firm's value is dependent on its growth opportunities, which are dependent on its ability to attract capital. Because corporations can attract capital more easily than other types of businesses, they are better able to take advantage of growth opportunities. 3. The value of an asset also depends on its liquidity, which means the time and effort it takes to sell the asset for cash at a fair market value. Because the stock of a corporation is easier to transfer to a potential buyer than is an interest in a proprietorship or partnership, and because more investors are willing to invest in stocks than in partnerships (with their potential unlimited liability), a corporate investment is relatively liquid. This too enhances the value of a corporation. Main Financial Goal pg. 9 - ANSWERSCreate Value for investors Intrinsic Value pg. 10 - ANSWERSAn estimate of a stock's "true" value based on accurate risk and return data. The intrinsic value can be estimated, but not measured precisely. Market Price pg. 10 - ANSWERSThe stock value based on perceived but possibly incorrect information as seen by the marginal investor. Marginal Investor pg. 10 - ANSWERSAn investor whose views determine the actual stock price. Equilibrium pg. 10 - ANSWERSThe situation in which the actual market price equals the intrinsic value, so investors are indifferent between buying and selling a stock. pg. 10 - ANSWERSIndeed, estimating intrinsic values is what security analysis is all about and is what distinguishes successful from unsuccessful investors. pg. 11 - ANSWERSManagement's goal should be to take actions designed to maximize the firm's intrinsic value, not its current market price. Useful Motivational Tools pg. 13 - ANSWERS1. Reasonable Compensation Packages 2. Firing of managers who don't perform well 3. The threat of hostile takeovers Corporate Raiders pg. 15 - ANSWERSIndividuals who target corporations for takeover because they are undervalued. Hostile Takeover pg. 15 - ANSWERSThe acquisition of a company over the opposition of its management. Important Quote pg. 15 - ANSWERSManagers should try to maximize their stock's intrinsic value