Questions and Answers
High dividends can lead a business to be deprived of the necessary funding for reinvestment.
True
The primary goal of a firm's financial manager is to maximize expenses to ensure profitability.
False
Business finance and personal finance deal with the same types of decisions regarding income management.
False
An increasing price per share indicates that a firm's financial goals are being achieved.
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The cost approach in valuation answers the question of how much profit an asset can generate.
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The Discounted cash flow approach estimates the future value of an investment based on current cash flows.
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Wealth maximization seeks to increase shareholder wealth primarily through an increase in market capitalization.
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Shareholders are only entitled to dividends if the company shows a profit.
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Maximizing shareholder wealth involves taking on the highest possible risks without regard for profit.
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The income approach involves converting future cash flows into estimates of current market value.
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Under the Philippine Cooperative Code of 2008, members of a cooperative are entitled to multiple votes based on their shareholdings.
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Cooperatives generally face fewer formal business requirements, making them easier and less costly to form than traditional business entities.
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The Cooperative Code allows unrestricted distribution of a cooperative's profits to its members.
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Economics primarily focuses on the production and transfer of wealth without considering individual or collective choices.
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Marginal cost-benefit analysis is a key principle used in managerial finance to guide decision-making.
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Agency costs are incurred by shareholders as a result of benefits provided to management without checks and balances.
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Institutional investors can potentially exacerbate agency problems by ignoring the management's decisions.
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A corporation is governed by the Board of Trustees in case of a profit organization.
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Performance-based compensation plans are considered the most economical way to tackle agency problems.
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A properly constructed corporate governance structure aims to enhance management's ability to deviate from shareholder wealth maximization.
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Partnerships offer limited liability for all partners involved.
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Hostile takeovers serve as a deterrent that encourages managers to neglect the interests of shareholders.
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A cooperative requires a minimum of 10 individuals to be founded.
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A key disadvantage of a corporation is the ease of transferring ownership.
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In a partnership, the firm is dissolved when a partner withdraws or dies.
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Corporations must pay income tax on profits and dividend tax if profits are distributed.
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Cooperatives are owned by a single individual who makes all decisions.
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One advantage of a partnership is the combined managerial skills and talents of the partners.
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Study Notes
Key Financing Decisions
- Important decision involves retaining profits for reinvestment versus distributing as dividends.
- Excessive dividends can hinder growth potential due to lack of funding for reinvestment.
Personal Finance vs. Business Finance
- Personal finance: Concerns individual's income management including spending, saving, and investing.
- Business finance: Focuses on raising capital, investing wisely for profit, and deciding on reinvestment versus distribution to investors.
Financial Goals of Firms
- Profit maximization aims to increase profits and returns.
- Wealth maximization enhances the company’s value, directly linked to an increase in share prices.
- Other goals include sustaining liquidity, efficient resource allocation, and business sustainability.
Shareholders’ Wealth Maximization
- Corporate managers strive to maximize shareholders' wealth, evident through share price increase.
- Shareholder expectations revolve around returns from dividends and stock valuation.
Financial Manager’s Decision Rule
- Financial managers should pursue actions likely to increase share price.
- Alternatives that do not meet this criterion should be rejected.
Valuation Approaches
- Cost Approach: Determines reproduction or replacement costs of assets.
- Market Approach: Values assets based on selling prices of comparable items.
- Income Approach: Transforms expected income into a market value indicator.
- Discounted Cash Flow (DCF): Utilizes future cash flow estimates to assess investment value.
Types of Business Entities
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Partnerships:
- Advantages include combined skills and easier capital raising.
- Disadvantages entail unlimited liability, dissolution risks, and potential management conflicts.
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Corporations:
- Legally recognized as separate entities, limiting stockholder liability.
- Governed by a Board of Directors, facing stricter regulation and taxation on profits and dividends.
-
Cooperatives:
- Owned by multiple individuals, requires at least 15 founding members.
- Offers limited liability and generally tax exemptions but may face management challenges.
Definitions and Distinctions
- Economics: The social science of resource allocation in production, consumption, distribution, and wealth transfer.
- Finance: Focuses on financial allocation and decision-making, rooted in economic principles like marginal cost-benefit analysis.
Agency Problems
- Arise when management prioritizes personal interests over shareholder wealth maximization.
Agency Costs
- Costs incurred by shareholders to address agency problems.
Solutions to Agency Problems
- Implement strong corporate governance for checks and balances.
- Use structured compensation to align management performance with shareholder interests.
- Leverage large institutional investors to influence management decisions.
- Threat of hostile takeovers encourages managers to prioritize shareholder wealth.
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Description
Test your knowledge on key business finance concepts, including the impact of dividends on funding and the objectives of financial management. This quiz covers various valuation approaches and their relevance in financial decision-making.
