Corporate Finance Solution Quiz 1
List and briefly describe the three basic questions addressed by a financial manager. What should be the goal of the financial manager of a corporation? Why? What advantages does the corporate form of organization have over sole proprietorships or partnerships? If the corporate form of business organization has so many advantages over the sole proprietorship, why is it so common for small businesses to initially be formed as sole proprietorships?
The three areas are:
1. Capital budgeting: The financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire.
2. Capital structure: This refers to the specific mixture of long-term debt and equity a firm uses to finance its operations.
3. Working capital management: This refers to a firm's short-term assets and short-term liabilities. Managing the firm's working capital is a day-to-day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions.
The correct goal is to maximize the current value of the outstanding stock. This goal focuses on enhancing the returns to stockholders who are the owners of the firm. Other goals, such as maximizing earnings, focus too narrowly on accounting income and ignore the importance of market values in managerial finance.
The advantages of the corporate form of organization over sole proprietorships and partnerships are the ease of transferring ownership, the owners' limited liability for business debts, the ability to raise more capital, and the opportunity of an unlimited life of the business.
A significant advantage of the sole proprietorship is that it is cheap and easy to form. If the sole proprietor has limited capital to start with, it may not be desirable to spend part of that capital forming a corporation. Also, limited liability for business debts may not be a significant advantage if the proprietor has limited capital, most of which is tied up in the business
The three areas are:
1. Capital budgeting: The financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire.
2. Capital structure: This refers to the specific mixture of long-term debt and equity a firm uses to finance its operations.
3. Working capital management: This refers to a firm's short-term assets and short-term liabilities. Managing the firm's working capital is a day-to-day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions.
The correct goal is to maximize the current value of the outstanding stock. This goal focuses on enhancing the returns to stockholders who are the owners of the firm. Other goals, such as maximizing earnings, focus too narrowly on accounting income and ignore the importance of market values in managerial finance.
The advantages of the corporate form of organization over sole proprietorships and partnerships are the ease of transferring ownership, the owners' limited liability for business debts, the ability to raise more capital, and the opportunity of an unlimited life of the business.
A significant advantage of the sole proprietorship is that it is cheap and easy to form. If the sole proprietor has limited capital to start with, it may not be desirable to spend part of that capital forming a corporation. Also, limited liability for business debts may not be a significant advantage if the proprietor has limited capital, most of which is tied up in the business