Created By: Solution Stuvia
SOLUTION MANUAL FOR Foundations of Financial
Management, 18th Edition by Stanley Block, Geoffrey Hirt,
Bartley Danielsen Chapter 1-21 A+
Chapter 1
The Goals and Functions of Financial Management
Discussion Questions
1-1 What effect did the recession of 2007-2009 have on government regulation?
It was greatly increased.
1-2 What advantages does a sole proprietorship offer? What is a major drawback of this type
of organization?
A sole proprietorship offers the advantage of simplicity of decision making and low
organizational and operating costs. A major drawback is that there is unlimited liability to the
owner.
1-3 What form of partnership allows some of the investors to limit their liability? Explain
briefly.
1
,Created By: Solution Stuvia
A limited partnership allows some of the partners to limit their liability. Under this arrangement,
one or more partners are designated general partners and have unlimited liability for the debts of
the firm; other partners are designated limited partners and are liable only for their initial
contribution. The limited partners are normally prohibited from being active in the management
of the firm.
1-4 In a corporation, what group has the ultimate responsibility for protecting and managing
the stockholders’ interests?
The board of directors.
1-5 What document is necessary to form a corporation?
The articles of incorporation.
1-6 What issue does agency theory examine? Why is it important in a public corporation
rather than in a private corporation?
Agency theory examines the relationship between the owners of the firm and the managers of the
firm. In privately owned firms, management and the owners are usually the same people.
Management operates the firm to satisfy its own goals, needs, financial requirements and the
like. As a company moves from private to public ownership, management now represents all
2
,Created By: Solution Stuvia
owners. This places management in the agency position of making decisions in the best interest
of all shareholders.
1-7 What are institutional investors important in today’s business world?
Because institutional investors such as pension funds and mutual funds own a large percentage of
major U.S. companies, they are having more to say about the way publicly owned companies are
managed. As a group, they have the ability to vote large blocks of shares for the election of a
board of directors, which is supposed to run the company in an efficient, competitive manner.
The threat of being able to replace poor performing boards of directors makes institutional
investors quite influential. Since these institutions, like pension funds and mutual funds,
represent individual workers and investors, they have a responsibility to see that the firm is
managed in an efficient and ethical way.
1-8 Why is profit maximization, by itself, an inappropriate goal? What is meant by the goal
of maximization of shareholder wealth?
The problem with a profit maximization goal is that it fails to take account of risk, the timing of
the benefits is not considered, and profit measurement is a very inexact process. The goal of
shareholders’ wealth maximization implies that the firm will attempt to achieve the highest
possible total valuation in the marketplace. It is the one overriding objective of the firm and
should influence every decision.
3
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1-9 When does insider trading occur? What government agency is responsible for protecting
against the unethical practice of insider trading?
Insider trading occurs when anyone with non-public information buys or sells securities to take
advantage of that private information. The Securities and Exchange Commission is responsible
for protecting markets against insider trading. In the past, people have gone to jail for trading on
non-public information. This has included company officers, investment bankers, printers who
have information before it is published, and even truck drivers who deliver business magazines
and read positive or negative articles about a company before the magazine is on the newsstands
and then place trades or have friends place trades based on that information. The SEC has
prosecuted anyone who profits from inside information.
1-10 In terms of the life of the securities offered, what is the difference between money and
capital markets?
Money markets refer to those markets dealing with short-term securities that have a life of one
year or less. Capital markets refer to securities with a life of more than one year.
1-11 What is the difference between a primary and a secondary market?
A primary market refers to the use of the financial markets to raise new funds for the
corporation. After the securities are sold to the public (institutions and individuals), they trade in
the secondary market between investors. It is in the secondary market that prices are continually
changing as investors buy and sell securities based on the expectations of corporate prospects.
4
SOLUTION MANUAL FOR Foundations of Financial
Management, 18th Edition by Stanley Block, Geoffrey Hirt,
Bartley Danielsen Chapter 1-21 A+
Chapter 1
The Goals and Functions of Financial Management
Discussion Questions
1-1 What effect did the recession of 2007-2009 have on government regulation?
It was greatly increased.
1-2 What advantages does a sole proprietorship offer? What is a major drawback of this type
of organization?
A sole proprietorship offers the advantage of simplicity of decision making and low
organizational and operating costs. A major drawback is that there is unlimited liability to the
owner.
1-3 What form of partnership allows some of the investors to limit their liability? Explain
briefly.
1
,Created By: Solution Stuvia
A limited partnership allows some of the partners to limit their liability. Under this arrangement,
one or more partners are designated general partners and have unlimited liability for the debts of
the firm; other partners are designated limited partners and are liable only for their initial
contribution. The limited partners are normally prohibited from being active in the management
of the firm.
1-4 In a corporation, what group has the ultimate responsibility for protecting and managing
the stockholders’ interests?
The board of directors.
1-5 What document is necessary to form a corporation?
The articles of incorporation.
1-6 What issue does agency theory examine? Why is it important in a public corporation
rather than in a private corporation?
Agency theory examines the relationship between the owners of the firm and the managers of the
firm. In privately owned firms, management and the owners are usually the same people.
Management operates the firm to satisfy its own goals, needs, financial requirements and the
like. As a company moves from private to public ownership, management now represents all
2
,Created By: Solution Stuvia
owners. This places management in the agency position of making decisions in the best interest
of all shareholders.
1-7 What are institutional investors important in today’s business world?
Because institutional investors such as pension funds and mutual funds own a large percentage of
major U.S. companies, they are having more to say about the way publicly owned companies are
managed. As a group, they have the ability to vote large blocks of shares for the election of a
board of directors, which is supposed to run the company in an efficient, competitive manner.
The threat of being able to replace poor performing boards of directors makes institutional
investors quite influential. Since these institutions, like pension funds and mutual funds,
represent individual workers and investors, they have a responsibility to see that the firm is
managed in an efficient and ethical way.
1-8 Why is profit maximization, by itself, an inappropriate goal? What is meant by the goal
of maximization of shareholder wealth?
The problem with a profit maximization goal is that it fails to take account of risk, the timing of
the benefits is not considered, and profit measurement is a very inexact process. The goal of
shareholders’ wealth maximization implies that the firm will attempt to achieve the highest
possible total valuation in the marketplace. It is the one overriding objective of the firm and
should influence every decision.
3
, Created By: Solution Stuvia
1-9 When does insider trading occur? What government agency is responsible for protecting
against the unethical practice of insider trading?
Insider trading occurs when anyone with non-public information buys or sells securities to take
advantage of that private information. The Securities and Exchange Commission is responsible
for protecting markets against insider trading. In the past, people have gone to jail for trading on
non-public information. This has included company officers, investment bankers, printers who
have information before it is published, and even truck drivers who deliver business magazines
and read positive or negative articles about a company before the magazine is on the newsstands
and then place trades or have friends place trades based on that information. The SEC has
prosecuted anyone who profits from inside information.
1-10 In terms of the life of the securities offered, what is the difference between money and
capital markets?
Money markets refer to those markets dealing with short-term securities that have a life of one
year or less. Capital markets refer to securities with a life of more than one year.
1-11 What is the difference between a primary and a secondary market?
A primary market refers to the use of the financial markets to raise new funds for the
corporation. After the securities are sold to the public (institutions and individuals), they trade in
the secondary market between investors. It is in the secondary market that prices are continually
changing as investors buy and sell securities based on the expectations of corporate prospects.
4
