Corporate Finance
sole proprietorship - (correct Answer) - 1 owner, owner receives all the profits, unlimited liab., 2 parts: 1.
initial investment and 2. personal wealth. Taxed based on personal income. Transfer of ownership is
hard. Must be willing to buy all assets.
partnership - (correct Answer) - 2 or more owners. profit is based on % invested shared. Unlimited liab.
between owners. Tax based on personal income. hard to transfer ownership.
limited partnership - (correct Answer) - same characteristics as partnership. Only looses money initially
invested by partner. Some protection. Tax based on personal income. Life of owners for co. life.
corporations - (correct Answer) - "legal person". distinct from the owners. Owners- several, profit split
among all owners. Liab. limited for shareholders. Double taxation(corp & owners). transfer of ownership
easy. Life is unlimited as long as shares still trading on the market. Financing is easy
s corporation - (correct Answer) - subchapter status- different taxation- passes all taxes to owner if they
meet criteria. (100 owners)...(taxed like sole proprietorship)
c corporation - (correct Answer) - standard corporation
LLC - (correct Answer) - hybrid of partnership and corporation. LLC=XX corporation. operates like
partnership w/ looks similar to corp.
goal of financial management - (correct Answer) - maximize the current value per share of the existing
stocks (shareholder's wealth). If no stocks, it's to maximize market value of existing owner's equity
sarbanes oxley requirement - (correct Answer) - 1. each co's annual report must have an assessment of
the companies internal control structure
2. top managers must review & sign the reports
Agency Cost problem - (correct Answer) - Shareholders(principal)
Managers(agents)
2 agency costs - (correct Answer) - direct( monitoring, bonding, etc) indirect(underinvestment, loss)
Agency cost of equity - (correct Answer) - conflict of equity holders vs. managers. Managers spending
investors money. Shareholders view on what managers will use money for. Residual loss(money lost for
jets, etc)
Agency cost of debt (asset Substitution) - (correct Answer) - debt holders vs. equity holders. Debt holders
will want you to take the project that is safest, equity will want to take project that is more risky, but has
better chance for big payoff.
agency cost of debt (underinvestment) - (correct Answer) - no profit for equity holders if project costs
, $10, interest $2 and pay off of $12, no profit
Agency cost of free cash flow - (correct Answer) - excess cash on hand in co. - no project to invest.
Shareholders want this cash in dividends. Managers want to hold cash, not pay dividends, bigger
compensation plan b/c makes co. look bigger
Agency Cost of overvalued equity - (correct Answer) - manager knows true value of co. is $10, but price
of stock on market is $20. overvalued. good for manager in short run, but in long run market won't trust
managers, and will be fired. manager should instead signal market that it's wrong and needs adj. may
damage reputations, hurt in short run but keep jobs & better in long run
solutions to agency probs - (correct Answer) - 1. internal controls- align compensation better internal
audit
2. external controls- merger & acquisitions (threat to managers & fire/hire new managers)
interaction with financial markets - (correct Answer) - 1. market issue $ to firm(+)
2. Firms invest $(-)
3.income $(+)
4. Pay tax to IRS $(-)
5. Either: A. Reinvest 4(+) or B. dividends/ buyback $(-)
stockholders - (correct Answer) - =shareholders, owners
stakeholders - (correct Answer) - someone other than shareholder who cares about the firm. has interest
in it. ex: competitors, suppliers, customers, gov.
Primary market - (correct Answer) - stocks initially issued and sold to initial buyers. companies selling to
large financial institutions
secondary market - (correct Answer) - individuals, brokers, investors, trade. previously bought or sold
before.
public offering - (correct Answer) - everyone/ anyone can buy your shares.
private placement - (correct Answer) - not listed. sell specific # of shares to prove party, not disclosed to
public.
dealer - (correct Answer) - someone actually owns the assets. OTC. Ex: NASDAQ buys it for their own
account, not for someone else
auction( broker) - (correct Answer) - 3rd party connects buyer and seller. doesn't own the asset. physical
locations. EX: NYSE
financial planning - (correct Answer) - trying to predict future, what to do in the future? what assets to
invest in?, leverage? reinvestment? daily operations?
financial planning process - (correct Answer) - 1. time horizon ( short term, less than 1 yr /long term, 2-5
sole proprietorship - (correct Answer) - 1 owner, owner receives all the profits, unlimited liab., 2 parts: 1.
initial investment and 2. personal wealth. Taxed based on personal income. Transfer of ownership is
hard. Must be willing to buy all assets.
partnership - (correct Answer) - 2 or more owners. profit is based on % invested shared. Unlimited liab.
between owners. Tax based on personal income. hard to transfer ownership.
limited partnership - (correct Answer) - same characteristics as partnership. Only looses money initially
invested by partner. Some protection. Tax based on personal income. Life of owners for co. life.
corporations - (correct Answer) - "legal person". distinct from the owners. Owners- several, profit split
among all owners. Liab. limited for shareholders. Double taxation(corp & owners). transfer of ownership
easy. Life is unlimited as long as shares still trading on the market. Financing is easy
s corporation - (correct Answer) - subchapter status- different taxation- passes all taxes to owner if they
meet criteria. (100 owners)...(taxed like sole proprietorship)
c corporation - (correct Answer) - standard corporation
LLC - (correct Answer) - hybrid of partnership and corporation. LLC=XX corporation. operates like
partnership w/ looks similar to corp.
goal of financial management - (correct Answer) - maximize the current value per share of the existing
stocks (shareholder's wealth). If no stocks, it's to maximize market value of existing owner's equity
sarbanes oxley requirement - (correct Answer) - 1. each co's annual report must have an assessment of
the companies internal control structure
2. top managers must review & sign the reports
Agency Cost problem - (correct Answer) - Shareholders(principal)
Managers(agents)
2 agency costs - (correct Answer) - direct( monitoring, bonding, etc) indirect(underinvestment, loss)
Agency cost of equity - (correct Answer) - conflict of equity holders vs. managers. Managers spending
investors money. Shareholders view on what managers will use money for. Residual loss(money lost for
jets, etc)
Agency cost of debt (asset Substitution) - (correct Answer) - debt holders vs. equity holders. Debt holders
will want you to take the project that is safest, equity will want to take project that is more risky, but has
better chance for big payoff.
agency cost of debt (underinvestment) - (correct Answer) - no profit for equity holders if project costs
, $10, interest $2 and pay off of $12, no profit
Agency cost of free cash flow - (correct Answer) - excess cash on hand in co. - no project to invest.
Shareholders want this cash in dividends. Managers want to hold cash, not pay dividends, bigger
compensation plan b/c makes co. look bigger
Agency Cost of overvalued equity - (correct Answer) - manager knows true value of co. is $10, but price
of stock on market is $20. overvalued. good for manager in short run, but in long run market won't trust
managers, and will be fired. manager should instead signal market that it's wrong and needs adj. may
damage reputations, hurt in short run but keep jobs & better in long run
solutions to agency probs - (correct Answer) - 1. internal controls- align compensation better internal
audit
2. external controls- merger & acquisitions (threat to managers & fire/hire new managers)
interaction with financial markets - (correct Answer) - 1. market issue $ to firm(+)
2. Firms invest $(-)
3.income $(+)
4. Pay tax to IRS $(-)
5. Either: A. Reinvest 4(+) or B. dividends/ buyback $(-)
stockholders - (correct Answer) - =shareholders, owners
stakeholders - (correct Answer) - someone other than shareholder who cares about the firm. has interest
in it. ex: competitors, suppliers, customers, gov.
Primary market - (correct Answer) - stocks initially issued and sold to initial buyers. companies selling to
large financial institutions
secondary market - (correct Answer) - individuals, brokers, investors, trade. previously bought or sold
before.
public offering - (correct Answer) - everyone/ anyone can buy your shares.
private placement - (correct Answer) - not listed. sell specific # of shares to prove party, not disclosed to
public.
dealer - (correct Answer) - someone actually owns the assets. OTC. Ex: NASDAQ buys it for their own
account, not for someone else
auction( broker) - (correct Answer) - 3rd party connects buyer and seller. doesn't own the asset. physical
locations. EX: NYSE
financial planning - (correct Answer) - trying to predict future, what to do in the future? what assets to
invest in?, leverage? reinvestment? daily operations?
financial planning process - (correct Answer) - 1. time horizon ( short term, less than 1 yr /long term, 2-5
