ACF #1 Exam Solution.

The Law of One Price states... - correct answer that we can use market prices to determine the value of an investment opportunity to the firm Sole Proprietorship: As soon as the firm reaches point where it can borrow w/o owner being personally liable... - correct answer owners typically convert business into a form that limits liability Corporate governance - correct answer 1. shareholders elect board of directors 2. board makes rules, policy, monitors, and elects CEO 3. CEO runs corp by instituting rules and policy (can be chairman of the board as well) Corporate financing benefits - correct answer Have more stable equity base to support growth/disperse risk increased access to large public debt markets publically traded securities for acquisition and employee rewards Purpose of Dodd-Frank - correct answer end "too big to fail", end taxpayer bailouts, improve accountability and transparency, protect consumers from abusive financial services practices Low stock prices create a.... - correct answer profit opportunity--hostile takeovers since poor leadership can drag down firms stock price, an outside individual/org. ("corporate raider") may purchase a large fraction of stock and acquire enough votes to replace the board of directors and CEO if new mgmt is better, resulting price rise would be large profit for raider and other shareholders Thus, public trading (and subsequent threat of takeover) causes mngers and directors to act in best interests of stakeholders (who control stock price via buy/sell) When a firm fails to repay its debts, the end result is... - correct answer a change in ownership of the firm, with control passing from equity holders to debt holders not necessarily liquidation, b/c in debt holders interest to run the firm in most profitable way possible Primary market - correct answer where a corporation issues new shares of stock to public (IPO's and just PO's as well) Secondary market - correct answer where trading occurs between investors w/o involvement of corporation NYSE (Auction markets) - correct answer market makers (specialists) match buyers and sellers specialist stands ready to buy at bid price and sell at ask price (ask bid, always) bid-ask spread is transaction cost investors pay to trade, for market makers taking on risk to keep mkt liquid NASDAQ (dealer) market - correct answer what? confused here Stockholders' equity is... - correct answer an accounting measure of the firm's worth Depreciation (affect on cash) - correct answer NOT A CASH EXPENSE--actually increases expenses, decreasing taxable income and thus increasing cash on hand A firm's market cap. measures... - correct answer the mkt value of the firm's equity, or the value that remains after the firm has paid its debts Two reasons that net income does not correspond to cash earned - correct answer 1. Non-cash entries on IS (dep. and amort.) 2. Certain uses of cash (purch. of building, expenditures, inventory, etc.) are not reported on the IS For investing trying to value the firm, which financial statement is most important? - correct answer Statement of cash flows In financial statements to shareholders, mgmt is required to disclose... - correct answer any OFF BALANCE SHEET TRANSACTIONS--transactions or arrangements that can have material impact on the firm's future performance yet do not appear on the BS notes to fin. statements also include accounting assumptions, subsidiaries, stock-based comp. plans, acquisitions, spin-offs, leases, taxes, debt repayment schedules, risk mgmt Enron - correct answer bankrupt in 2001, largest filing at that time sold assets at inflated prices to firms w/promise to buy back, but recorded the "borrowed" cash as revenue Sarbanes-Oxley Act - correct answer overall intent was to improve the accuracy of information given to both boards and shareholders three ways: 1. overhaul incentives and auditing process 2. stiffening penalties for false info 3. forcing companies to validate their internal financial control processes placing liability on CEO and CFO Depreciation - correct answer the systematic write-down of the cost of an asset over the life of the asset