Finance Chapter 1: Getting Started

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Questions and Answers

Which of the following is NOT a characteristic of a corporation?

Easier to raise capital

Limited liability for the owner

Transfer of ownership is relatively simple

The corporation is taxed as a partnership, not as a separate entity (correct)

Which type of organization offers the tax benefits of a partnership while providing the liability protection of a corporation?

Limited Liability Company (LLC) (correct)

Traditional Corporation

Sole Proprietorship

S-type Corporation

What is the accepted goal of a financial manager within a corporation?

Minimizing operational costs

Balancing stakeholder interests

Expanding market share

Maximizing shareholder wealth (correct)

Profit maximization

Which of these is NOT a disadvantage of a corporation?

Limited liability for owners Signup and view all the answers

What is the main reason why financial managers need to focus on maximizing shareholder wealth?

If shareholders aren't satisfied, they can withdraw their investments, potentially causing the company to fail Signup and view all the answers

A firm can report profits despite having no cash if:

All sales are made on credit. Signup and view all the answers

What makes a market 'efficient'?

The speed at which investors react to new information and how prices respond to that information. Signup and view all the answers

How do investors in capital markets typically respond to good decisions made by a firm?

They buy more shares, causing the stock price to increase. Signup and view all the answers

Which of the following is NOT a key term related to financial markets?

Inflation Rate Signup and view all the answers

Which of the following is a type of business structure where the owners are personally liable for all debts and obligations of the business?

Sole Proprietorship Signup and view all the answers

What does the term 'capital budgeting' refer to?

The process of deciding which long-term investments a firm should make. Signup and view all the answers

What is the primary difference between a general partner and a limited partner in a partnership?

A general partner has unlimited liability, while a limited partner has limited liability. Signup and view all the answers

What does the term 'working capital management' refer to?

Managing a firm's short-term assets and liabilities. Signup and view all the answers

What defines an agency relationship within a corporation?

A principal contracts with an agent to make decisions. Signup and view all the answers

Which of the following scenarios is likely to create an agency problem?

Managers acting in their interest while shareholders lose value. Signup and view all the answers

How can monitoring help mitigate agency problems?

By ensuring regular audits and transparent reporting. Signup and view all the answers

What is the primary basis for the principle that money has a time value?

Investing a dollar today can generate interest over time. Signup and view all the answers

Which principle emphasizes the relationship between risk and expected return?

Risk-return trade-off. Signup and view all the answers

What is a significant characteristic of cash flows?

They represent the actual cash available for distribution. Signup and view all the answers

Which of these is NOT an example of a mechanism to reduce agency problems?

Increasing the number of projects undertaken by managers. Signup and view all the answers

What happens when managers have little or no ownership in the firm?

Agency problems are likely to increase. Signup and view all the answers

Which method is effective in aligning managers' interests with those of shareholders?

Implementing stock options as part of compensation. Signup and view all the answers

What role does the threat of being fired play in reducing agency problems?

It creates accountability and alignment with shareholders’ goals. Signup and view all the answers

What is one advantage of a sole proprietorship?

Easy to start Signup and view all the answers

Which of the following is a disadvantage of a partnership?

Unlimited liability for partners Signup and view all the answers

In a limited partnership, which partners have unlimited liability?

General partners Signup and view all the answers

What is a defining characteristic of a corporation?

Can sue and be sued as a separate entity Signup and view all the answers

Which statement about partnerships is true?

They are relatively easy to start Signup and view all the answers

How are corporations owned?

By stockholders Signup and view all the answers

What is the role of the board of directors in a corporation?

Appoint senior management of the firm Signup and view all the answers

What happens to a partnership when one partner dies?

It automatically ends Signup and view all the answers

Which of the following is true about a corporation's legal status?

It holds perpetual existence Signup and view all the answers

Study Notes

Chapter 1: Getting Started - Principles of Finance

Finance is the study of how individuals and businesses evaluate investments and raise capital to fund them.
Key questions addressed in finance include:
- What long-term investments should a firm undertake? (capital budgeting decisions)
- How should a firm fund these investments? (capital structure decisions)
- How can a firm best manage its cash flows? (working capital management decisions)
Studying finance is important for both professional and personal decision-making.
- Personal decisions like buying a house, planning for retirement, or leasing a car often require financial knowledge.

1.1 Finance: An Overview

The study of finance involves evaluating investments. It also encompasses raising capital to fund said investments.

1.2 Three Types of Business Organizations

Business organizations can be categorized into several types.
- Sole Proprietorship:
  - Owned by a single individual.
  - The owner receives all profits but is also responsible for all debts.
  - No separation between the business and the owner when it comes to debts or legal proceedings.
  - Often financed by personal loans from family/friends and business loans from banks.
  - Advantages: easy to start, decisions made without consulting others, taxed at a personal rate.
  - Disadvantages: owner is personally liable for business debts, business ceases upon the owner's death.
- Partnership:
  - Two or more persons operate a business together.
  - No distinction between the partners and the business in terms of debts or legal proceedings.
  - Advantages: relatively easy to start up, taxed at personal rates, access to funds from multiple sources.
  - Disadvantages: partners jointly share unlimited liability.
    - Limited Partnerships
      - Two types of partners: general partner (runs the business) and limited partner (liability limited to the investment).
      - General partners bear unlimited liability; limited partners are liable only up to their investment.
      - Transferring ownership is challenging.
- Corporation:
  - An artificial legal entity separate from its owners.
  - Corporations can sue and be sued, own property, and its employees can be held criminally responsible for corporate actions..
  - Legally owned by its stockholders.
  - Board of directors elected by shareholders appoints senior management
  - Advantages: limited liability (owners' liability limited to investment), perpetual life, transferable ownership, easier to raise capital
  - Disadvantages: more complex to set up, greater regulation, double taxation (corporate and personal) taxes on profits.
- Hybrid Organizations:
  - LLCs(Limited Liability Companies) combine the benefits of partnerships (no double taxation) with the liability protection of corporations.
    - Owners' liability is limited to their investment.
  - S-type corporations offer limited liability and taxation similar to partnerships (not double-taxed).

1.3 The Goal of the Financial Manager

The financial manager's goal aligns with the corporation's mission to maximize shareholder wealth.
This wealth is typically measured by the market price of the company's stock.

1.4 The Four Basic Principles of Finance

Money Has a Time Value: A dollar today is worth more than a dollar in the future due to potential investment returns.
There's a Risk-Return Trade-off: Higher risk typically equals higher expected return in investments.
Cash Flows Are the Source of Value: Profit is an accounting measure, while cash flow represents the actual cash generated by a business.
Market Prices Reflect Information: Current market prices incorporate all available information, making it difficult to consistently profit from known information.

Other Key Terms

Agency problem: Conflict of interest between management (agents) and shareholders (principals).
Capital budgeting: Decisions about long-term investments.
Capital structure: Decisions about how to finance investments.
Debt: Funding source through borrowing.
Equity: Funding source through owners' investment.
Financial market: A market where financial instruments (stocks, bonds, etc.) are traded.

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Description

Dive into the fundamentals of finance with this quiz covering Chapter 1: Getting Started. Explore key concepts like capital budgeting, capital structure, and working capital management. Gain insight into how finance influences both personal and professional decision-making.