Ch.1 Introduction to Corporate Finance

What is the capital budgeting decision?
In capital budgeting decision the financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire. That is, the value of the cash flow generated by an asset exceeds the cost of that asset.
What do you call the specific mixture of long-term debt and equity that a firm chooses to use?
capital structure
Into what category of financial management does cash management fall?
Working Capital—-short-term liabilities
What are the three forms of business organizations?
1. Sole Proprietorship
2. Partnership
What are the primary advantages and disadvantages of sole proprietorship and partnerships?
SOLE PROPRIETORSHIP: Advantages–Keeps all the profits. Disadvantages–unlimited liability for business debts meaning creditors can look to the proprietor’s personal assets for payment.

PARNTERSHIP: Disadvantages–unlimited liability for business debts on the part of the owners, limited life of the business, difficulty of transferring ownership.= (central problem) the ability of such businesses to grow can be seriously limited by an inability to raise cash for investment.

What is the difference b/w a general and a limited partnership?
General Partnership–all the partners share in gains or losses, an all have unlimited liability for all partnership debts, not just some particular share.

Limited Partnership– one or more general partners will run the business and have unlimited liability, but there will be one or more limited partners who wil not actively participate in the business.

Why is the corporate form superior when it comes to raising cash?
for the relative ease of transferring ownership, the limited liability for business debts, and the unlimited life of the business are why the corporate form is superior for raising cash. Ex: a corp. needs new equity, it can then sell new shares of stock and attract new investors.
What is the goal of financial management?
the goal of financial management is to maximize the current value per share of the existing stock. The financial manager acts in the shareholders’ best interests by making decisions that increase the value of the stock.
Can you give a definition of corporate finance?
corporate finance is the study of the relationship b/w business decisions and the value of the stock in the business.
What are some shortcomings(failures) of the goal of profit maximization?
shareholders are entitled to what is left over after employees, suppliers, and creditors are paid their due. If none is left then shareholders are left w/ nothing.
What is an agency relationship?
the relationship b/w stockholders and management.
What are agency problems and how do they come about? What are agency costs?
AGENCY COSTS: refers to the costs of the conflict of interest b/w stockholders and management. They can come in 2 forms Indirect Agency Cost–lost opportunity, Direct Agency Cost 2 forms– 1) corporate expenditure that benefits management but cost steh stockholders (ex. purchase of a luxurious unneeded jet). 2) expense taht arises frmo the need to monitor management actions (ex: paying outside auditors to assess accuracy of financial statements.
What incentives do managers in large corporations have to maximize share value?
1) managerial compensation– usu. tied to financial performance in general and often to share value in particular. ex: managers are given the option to buy stock at a bargain price. 2) job prospects– better performers within the firm will get promoted.
What is a dealer market? How do a dealer and auction markets differ?
dealers buy and sell for themselves at their own risk, most of the buying and selling is done by the dealer. Auction market–1.has a physical location (like wall st) 2. match those who wish to sell w/ those who wish to buy.
What does OTC stand for? What is the large OTC market for stocks called?
OTC-over the counter (they have no physical location), Nasdaq- National Association of Securities Dealers Automated Quotation.
What is the largest auction market in the United States?
NYSE – New York Stock Exchange