Financial Management Overview and Shareholder Value
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Questions and Answers

What is a significant disadvantage of a proprietorship?

  • Easier to set up than a partnership
  • Subject to high corporate taxes
  • Limited ability to raise capital (correct)
  • Unlimited personal liability (correct)

    • Which option correctly describes double taxation?

  • A tax imposed on partnerships
  • Tax on corporate earnings and again on dividends (correct)
  • Only the corporation's earnings are taxed
  • Tax on individual income only

    • Which form of business organization typically has an unlimited life?

  • Corporation (correct)
  • Limited Liability Company
  • Partnership
  • Proprietorship

    • What is the main goal of financial management?

    <p>Maximize shareholder’s wealth</p> Signup and view all the answers

    What is a common conflict that arises between managers and shareholders?

    <p>Divergent goals regarding business growth</p> Signup and view all the answers

    What advantage does a corporation have over a partnership?

    <p>Easier to raise capital</p> Signup and view all the answers

    Which of the following is NOT a characteristic of a limited liability company?

    <p>Double taxation like corporations</p> Signup and view all the answers

    What is the primary disadvantage of forming a partnership?

    <p>Unlimited personal liability for debts</p> Signup and view all the answers

    What is market risk also referred to as?

    <p>Systematic risk</p> Signup and view all the answers

    In the Capital Asset Pricing Model (CAPM), what does the variable 'beta' measure?

    <p>Market risk</p> Signup and view all the answers

    What does a beta value of 1.0 indicate about a stock's risk?

    <p>Equally risky as the average stock</p> Signup and view all the answers

    What does the Market Risk Premium represent in the Security Market Line equation?

    <p>Expected return above the risk-free rate</p> Signup and view all the answers

    What happens to a stock with a beta less than 1.0?

    <p>Its returns are less volatile than the market</p> Signup and view all the answers

    What is the primary goal of management in financial management?

    <p>Maximizing shareholder wealth</p> Signup and view all the answers

    Which option correctly describes intrinsic value?

    <p>It is an estimate based on available risk and return data.</p> Signup and view all the answers

    How is stock price determined in the market?

    <p>By demand and supply in the market.</p> Signup and view all the answers

    Why is maximizing a firm's expected profits not the same as maximizing shareholder wealth?

    <p>Managers can manipulate accounting to inflate profits.</p> Signup and view all the answers

    What could be a consequence of corporations focusing solely on shareholder value?

    <p>Increased likelihood of lawsuits and negative publicity.</p> Signup and view all the answers

    Who sets the intrinsic value of a stock?

    <p>The marginal investor based on perceived value.</p> Signup and view all the answers

    Which of the following best illustrates the relationship between intrinsic value and stock price at market equilibrium?

    <p>Intrinsic value and stock price are equal.</p> Signup and view all the answers

    What could happen if a company prioritizes cutting expenses over long-term growth?

    <p>Higher immediate profits with jeopardized future viability.</p> Signup and view all the answers

    What is the purpose of considering the Effective Annual Rate (EFF%) in investments?

    <p>To compare investments with different compounding intervals.</p> Signup and view all the answers

    What does the outstanding loan principal represent in an amortized loan?

    <p>The present value of all remaining payments.</p> Signup and view all the answers

    In the process of constructing a loan amortization schedule, what is the first step?

    <p>Find the required annual payment using the present value formula.</p> Signup and view all the answers

    How is the interest paid in the first year of an amortized loan calculated?

    <p>By multiplying the beginning balance by the interest rate.</p> Signup and view all the answers

    Which of the following factors is crucial in the capital allocation process?

    <p>Efficient flow of capital from suppliers to demanders.</p> Signup and view all the answers

    What does the term structure of interest refer to?

    <p>The relationship between interest rates and the time to maturity on debt.</p> Signup and view all the answers

    What typically determines the shape of the yield curve?

    <p>Market interest rates for different maturities of debt.</p> Signup and view all the answers

    Which of the following is NOT true regarding amortized loans?

    <p>Interest paid increases with each payment.</p> Signup and view all the answers

    What does the risk premium represent in an investment context?

    <p>The difference between the expected return on a risky asset and a riskless asset</p> Signup and view all the answers

    Which factors affect a stock's required rate of return according to the concept of risk aversion?

    <p>Inflation expectations and investors' risk tolerance</p> Signup and view all the answers

    How is the coefficient of variation (CV) calculated?

    <p>Standard deviation divided by expected return</p> Signup and view all the answers

    When comparing investments with different expected returns, which measure is most useful?

    <p>Coefficient of variation</p> Signup and view all the answers

    What characterizes stand-alone risk?

    <p>The risk an investor faces when holding only one asset</p> Signup and view all the answers

    Which statement best describes expected return in finance?

    <p>The return an investor anticipates based on calculated probabilities</p> Signup and view all the answers

    What indicates a higher stand-alone risk when evaluating different investments?

    <p>Higher standard deviation of returns</p> Signup and view all the answers

    What role does the capital asset pricing model (CAPM) play?

    <p>It determines a stock's required rate of return based on its risk</p> Signup and view all the answers

    What does a tighter probability distribution of returns imply for an investment?

    <p>Lower volatility and risk</p> Signup and view all the answers

    How does diversification affect market risk for investors?

    <p>It reduces diversifiable risk but not market risk</p> Signup and view all the answers

    Study Notes

    Financial Management Overview

    • Businesses are organized primarily as proprietorships, partnerships, corporations, or limited liability companies (LLCs).
    • Advantages of proprietorships: easy formation, minimal regulations, lower taxes, but face unlimited liability, limited life, and capital-raising difficulties.
    • Partnerships allow for no corporate taxes and easier transfer of ownership but entail setup costs and similar liability issues.
    • Corporations offer unlimited life, limited liability, and ease of capital raising but suffer from double taxation where profits and dividends are taxed separately.
    • LLCs combine benefits of partnerships and corporations, providing limited liability and tax flexibility while needing legal support for establishment.

    Shareholder Value

    • Primary goal of financial management is to maximize shareholder wealth through long-run value maximization of common stock.
    • Financial decisions should balance maximizing profits with social responsibility to maintain corporate reputation and stakeholder relationships.
    • Actions solely aimed at increasing profits may jeopardize long-term viability if they neglect worker, customer, or community welfare.

    Intrinsic Value and Stock Prices

    • Intrinsic value reflects the “true” value of a stock and depends on future performance, estimable but imprecise, and influenced by new information.
    • Stock prices are determined by market conditions, where equilibrium occurs when intrinsic value matches the stock price.
    • Effective Annual Rate (EFF%) is vital for comparing investments with varying compounding intervals.

    Amortized Loans

    • Amortized loans are repaid in equal payments over time, with interest costs decreasing as principal is paid down.
    • The total payment (PMT) consists of principal plus interest, which can be calculated through specific formulas to track payment schedules.
    • Loan amortization calculations involve multiple steps to find principal repaid and ending balances after each payment.

    Financial Markets and Institutions

    • Financial markets facilitate efficient capital allocation, connecting suppliers (those with excess funds) with demanders (those needing funds).
    • Key financial statements reflect a company's financial performance, including income statements, balance sheets, and cash flow statements.
    • Tax treatment varies between dividends (often taxed again at personal income tax rates) and interest expense (usually deductible).
    • Interest rates are influenced by various factors including inflation expectations, monetary policy, and economic conditions.

    Risk and Rates of Return

    • Stand-alone risk refers to the risk associated with holding a single asset, while portfolio risk considers the diversification effect.
    • Investors' risk aversion leads to higher required returns on riskier investments, captured in the risk premium.
    • Coefficient of Variation (CV) measures risk per unit of return, useful for comparing investments with differing expected returns.
    • Market risk affects all stocks and is represented by beta, with values indicating relationship to market risk: beta of 1 equals market risk, greater than 1 indicates higher risk, and less than 1 indicates lower risk.

    Capital Asset Pricing Model (CAPM)

    • CAPM links required return on a stock to its risk, represented by beta, reflecting systematic risk post-diversification.
    • Security Market Line (SML) represents a relationship between risk and expected return, helping investors assess whether a stock is undervalued or overvalued.
    • Market risk premium measures additional return required over the risk-free rate and reflects investor risk aversion.

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    Description

    This quiz covers the basics of financial management, including different business structures such as proprietorships, partnerships, corporations, and LLCs. It also examines the primary goal of maximizing shareholder value and the importance of balancing profit maximization with social responsibility.

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