1. Financial Decisions. Give several examples of (a) investment decisions and (b) financing decisions
Purchase a new computer
Conduct research for a new drug
Shut down a factory
b. Take out a bank loan or sell bonds, issue shares of stock to raise funds, buy or lease new machinery.
Corporations. What are the key differences between a corporations and a sole proprietorship? What is the difference between a public and private corporation?
2. A sole proprietorship is a business that has a single owner who is responsible for the company when it comes to decisions.
A corporation holds a separate identity from the owners of the company, usually has more than one owner who may be shareholders of a corporation. A private corporation has its finances restricted from the public. A public corporation has their financial status disclosed to the public and is more refined to their investors. A public corporation is friendlier to allowing others to invest in their corporation.
5. Corporations. What do we mean when we say that a corporate income is subject to double taxation?
A corporation is double taxed, when earnings are paid out to the corporations’ shareholders and to itself. This is true only for earnings paid out to shareholders in the form of dividends -- that is, profits paid by the corporation to its shareholders in return for their investment in the company. This is not as frequently seen in a small corporation.
6. Real Versus Financial Assets. Which of the following are real assets. And which are financial?
A share of stock FINANCIAL A personal IOU FINANCIAL
A trademark REAL
A truck REAL
Undeveloped land REAL
The balance in the firm’s checking account. FINANCIAL
An experienced and hardworking sales force REAL
A bank loan agreement FINANCIAL
9. Value Maximization. Give an example of an action that might increase short-run profits but at the same time reduce stock price and the market value of the firm.
A firm can increase profits by cutting back on expensive materials that are being used to make products, which in return may or may not decrease the quality of the product. Once buyers start seeing the decrease in quality, stock prices fall. Because stock prices reflect present and future profitability, a firm is taking big risks when acting like this for a short-run profit.
10. Cost of Capital. Why do financial managers refer to the opportunity cost of capital? How would you find the opportunity cost of capital for a safe investment?
Financial managers refer to the opportunity cost of capital to determine if they making a good investment that is equivalent to what the shareholders can make without a financial manager. The opportunity cost of capital is considered to be a safe investment with a good rate of return, when that rate is larger than what the shareholders make with a risk-free investment.
11. Agency Costs. What are agency costs? List some ways by which agency costs are mitigated.
Agency costs are caused by conflicts of interest between managers and shareholders who are the owners of the firm. Within large corporations, the principals—or stockholders hire the agents, or managers to act on behalf of the principals in major decision-making that can affect the corporation and its owners. However, it’s unrealistic to believe that the agents’ actions will always be consistent.
4. Financial Markets. The stock and bond markets are not the only financial markets. Give two or three additional examples:
Primary and secondary markets
5. Financial Intermediaries. You are a beginning investor with only $5,000 in savings. How can you achieve a widely diversified portfolio at reasonable cost?