Corporate Finance Revision Questions with Answers

sole proprietorship - Correct Answer 1 owner, owner receives all the profits, unlimited liab., 2 parts: 1.
initial investment and 2. personal wealth. Taxed based on personal income. Transfer of ownership is
hard. Must be willing to buy all assets.



partnership - Correct Answer 2 or more owners. profit is based on % invested shared. Unlimited liab.
between owners. Tax based on personal income. hard to transfer ownership.



limited partnership - Correct Answer same characteristics as partnership. Only looses money initially
invested by partner. Some protection. Tax based on personal income. Life of owners for co. life.



corporations - Correct Answer "legal person". distinct from the owners. Owners- several, profit split
among all owners. Liab. limited for shareholders. Double taxation(corp & owners). transfer of ownership
easy. Life is unlimited as long as shares still trading on the market. Financing is easy



s corporation - Correct Answer subchapter status- different taxation- passes all taxes to owner if they
meet criteria. (100 owners)...(taxed like sole proprietorship)



c corporation - Correct Answer standard corporation



LLC - Correct Answer hybrid of partnership and corporation. LLC=XX corporation. operates like
partnership w/ looks similar to corp.



goal of financial management - Correct Answer maximize the current value per share of the existing
stocks (shareholder's wealth). If no stocks, it's to maximize market value of existing owner's equity



sarbanes oxley requirement - Correct Answer 1. each co's annual report must have an assessment of the
companies internal control structure

2. top managers must review & sign the reports



Agency Cost problem - Correct Answer Shareholders(principal)

, Managers(agents)



2 agency costs - Correct Answer direct( monitoring, bonding, etc) indirect(underinvestment, loss)



Agency cost of equity - Correct Answer conflict of equity holders vs. managers. Managers spending
investors money. Shareholders view on what managers will use money for. Residual loss(money lost for
jets, etc)



Agency cost of debt (asset Substitution) - Correct Answer debt holders vs. equity holders. Debt holders
will want you to take the project that is safest, equity will want to take project that is more risky, but has
better chance for big payoff.



agency cost of debt (underinvestment) - Correct Answer no profit for equity holders if project costs $10,
interest $2 and pay off of $12, no profit



Agency cost of free cash flow - Correct Answer excess cash on hand in co. - no project to invest.
Shareholders want this cash in dividends. Managers want to hold cash, not pay dividends, bigger
compensation plan b/c makes co. look bigger



Agency Cost of overvalued equity - Correct Answer manager knows true value of co. is $10, but price of
stock on market is $20. overvalued. good for manager in short run, but in long run market won't trust
managers, and will be fired. manager should instead signal market that it's wrong and needs adj. may
damage reputations, hurt in short run but keep jobs & better in long run



solutions to agency probs - Correct Answer 1. internal controls- align compensation better internal audit

2. external controls- merger & acquisitions (threat to managers & fire/hire new managers)



interaction with financial markets - Correct Answer 1. market issue $ to firm(+)

2. Firms invest $(-)

3.income $(+)

4. Pay tax to IRS $(-)

5. Either: A. Reinvest 4(+) or B. dividends/ buyback $(-)