Principles of Finance
Review Sheet—Exam 1
The exam will include multiple choice questions and problems. If you have worked and understand the end-of-chapter problems that were assigned, you should be able to work the problems on the exam. You should understand the topical areas given in the following list—the concept questions will be primarily based on these topics.
• Overview of Managerial Finance
o Why is it important to have some understanding of finance? ▪ Finance deals with decisions concerning cash flows (financing) and cash outflows (investing) so most decisions made in a firm are related to finance. ▪ Finance can also be seen in every other aspect of a company because most decisions cannot be made without considering the impact on the financial well being of the firm. o Understand the differences among the alternative forms of business. What are the advantages and disadvantages of each? In general, how is each taxed? ▪ Proprietorship- single owner who is personally responsible for all liabilities of the firm; represent 70-75% of all businesses • Adv- easy and inexpensive to form, affected by few regulations • Taxed**- as an individual rather than a corporation • Disadv- owner has unlimited personal liability for debts, life is limited, ownership transfer is difficult, firm’s credit dependent on financial strength of owner ▪ Partnership- two or more owners who are personally responsible for all liabilities of the firm; represent 8-10% of all businesses • Adv- easy and inexpensive to form, affected by few regulations • Taxed**- as an individual rather than a corporation • Disadv- owner has unlimited personal liability for debts, life is limited, ownership transfer is difficult, firm’s credit dependent on financial strength of owner ▪ Corporation- a legal entity in which owners have limited responsibility for liabilities of firm; represent 20% of all businesses (**generate nearly 85% of all sales**) • Adv- unlimited life, ownership transfer is simple, limited liability of owners (limited to investor’s initial investment) • Taxed**- can be taxed twice (once at corporate level and once when or if it’s distributed to stockholders as dividends) • Disadv- can be taxed twice, establishing a corp. is more complex, needs a corp. charter, needs bylaws o Corporate Charter- info about the corp. including the name, type of business, amount of stock, etc o Bylaws- how the corp. will be governed o What are some of the goals that are pursued by corporations? Why should the primary goal of a financial manager be to try to maximize shareholder wealth? ▪ PRIMARY GOAL: Maximize wealth
▪ Wealth maximization considers the impact of current decisions on the long-term financial health of the firm ▪ Improves the standard of living ▪ Social Responsibility- should be socially responsible at the same time they earn “normal” profits; otherwise they will go out of business o Understand what agency relationships are. What are some ways shareholders can reduce agency problems? ▪ Agency Relationship- person who make decisions that affect the firm are “agents” who are responsible for acting in the best interest of the owners (stockholders) of the firm ▪ Agency Problems- arise when managers satisfy their own interests rather than the owners’ interests ▪ Reduce Agency Problems By:
• Managerial compensation (incentives)
• Shareholder intervention
• Takeover threat
o Know how businesses in the United State differ in general from businesses in other countries. ▪ Foreign...
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