FINC 3610 Harrelson - Exam 1 Questions
FINC 3610 — Harrelson
Exam 1 Questions & Answers| Latest Update| Pass Guaranteed
1. What are the three main areas of study in corporate finance, often called the three
foundational questions of finance?
Answer: Capital budgeting, capital structure, and working capital management.
Rationale: These three areas define the core decisions a financial manager makes:
what long-term investments to undertake, how to finance those investments, and
how to manage day-to-day short-term finances.
2. What is 'capital budgeting'?
Answer: The process of planning and managing a firm's long-term investments in
fixed assets.
Rationale: Capital budgeting addresses which long-lived assets or projects the firm
should invest in, focusing on the size, timing, and risk of future cash flows those
investments generate.
3. What is the 'capital structure' decision?
Answer: The decision regarding the mix of debt and equity a firm uses to finance its
operations and investments.
Rationale: Capital structure determines how a firm raises the money needed for its
investments, balancing the proportions of debt versus equity financing.
4. What does 'working capital management' refer to?
Answer: The management of a firm's short-term assets and short-term liabilities
(day-to-day operations).
Rationale: Working capital management ensures the firm has sufficient resources to
continue its operations and avoid interruptions, managing items like inventory,
receivables, and payables.
5. What is net working capital?
Answer: Current assets minus current liabilities.
Rationale: Net working capital measures the short-term financial cushion available to
a firm; positive NWC indicates that cash inflows over the near term exceed cash
outflows.
6. What is the primary financial goal of a corporation according to traditional
corporate finance theory?
Page 1
, FINC 3610 Harrelson - Exam 1 Questions
Answer: To maximize the current value per share of existing stock (shareholder
wealth maximization).
Rationale: This goal is unambiguous and forward-looking, accounting for risk and
timing of cash flows, unlike vague goals such as 'maximizing profit,' which ignores
timing and risk.
7. Why is 'maximize profit' considered an insufficient goal for a corporation compared
to maximizing shareholder wealth?
Answer: Because it ignores the timing and risk of cash flows and can be
manipulated through accounting choices.
Rationale: Profit maximization does not account for the time value of money or risk,
and accounting profits can differ from actual cash flow and economic value creation.
8. What is a sole proprietorship?
Answer: A business owned by a single individual.
Rationale: A sole proprietorship is the simplest business form, with the owner directly
entitled to all profits but also personally liable for all business debts.
9. What is the primary disadvantage of a sole proprietorship regarding liability?
Answer: The owner has unlimited personal liability for all business debts.
Rationale: Because there is no legal separation between the owner and the business,
personal assets are at risk to satisfy business debts and obligations.
10. What is a key limitation of a sole proprietorship's ability to raise capital?
Answer: Equity financing is limited to the owner's personal wealth, restricting
growth potential.
Rationale: Since a sole proprietorship cannot sell shares of ownership, it depends on
the owner's personal funds and borrowing capacity, limiting its ability to raise large
amounts of capital.
11. What is a general partnership?
Answer: A business owned by two or more people (partners) who share in the
profits and are jointly liable for the debts.
Rationale: In a general partnership, all partners share responsibility for management
and unlimited liability for business obligations, similar to a sole proprietorship but
with multiple owners.
12. What distinguishes a limited partnership from a general partnership?
Page 2
, FINC 3610 Harrelson - Exam 1 Questions
Answer: A limited partnership includes at least one general partner with unlimited
liability and one or more limited partners whose liability is limited to their
investment.
Rationale: Limited partners enjoy liability protection (similar to shareholders) but
typically cannot participate in day-to-day management without risking their limited
liability status.
13. What is a corporation?
Answer: A legal entity separate and distinct from its owners (shareholders),
capable of entering contracts, owning assets, and incurring liabilities in its own
name.
Rationale: Because the corporation is a distinct legal 'person,' it can sue and be sued,
own property, and enter contracts independent of its shareholders.
14. What is the primary advantage of the corporate form regarding owner liability?
Answer: Limited liability — shareholders are only liable up to the amount they
invested in the company.
Rationale: Unlike sole proprietorships and general partnerships, corporate
shareholders' personal assets are protected from claims against the corporation's
debts.
15. What is 'double taxation' in the context of corporations?
Answer: Corporate profits are taxed at the corporate level, and then dividends paid
to shareholders are taxed again at the individual level.
Rationale: Double taxation is a key disadvantage of the traditional C-corporation
structure, as the same income is effectively taxed twice before reaching the
shareholder as after-tax income.
16. What is an agency relationship in corporate finance?
Answer: A relationship in which one party (the principal) hires another party (the
agent) to act on the principal's behalf.
Rationale: In a corporation, shareholders (principals) hire managers (agents) to run
the company on their behalf, creating the potential for a divergence of interests.
17. What is an 'agency problem'?
Answer: A conflict of interest that arises when managers (agents) act in their own
self-interest rather than in the best interest of shareholders (principals).
Page 3
FINC 3610 — Harrelson
Exam 1 Questions & Answers| Latest Update| Pass Guaranteed
1. What are the three main areas of study in corporate finance, often called the three
foundational questions of finance?
Answer: Capital budgeting, capital structure, and working capital management.
Rationale: These three areas define the core decisions a financial manager makes:
what long-term investments to undertake, how to finance those investments, and
how to manage day-to-day short-term finances.
2. What is 'capital budgeting'?
Answer: The process of planning and managing a firm's long-term investments in
fixed assets.
Rationale: Capital budgeting addresses which long-lived assets or projects the firm
should invest in, focusing on the size, timing, and risk of future cash flows those
investments generate.
3. What is the 'capital structure' decision?
Answer: The decision regarding the mix of debt and equity a firm uses to finance its
operations and investments.
Rationale: Capital structure determines how a firm raises the money needed for its
investments, balancing the proportions of debt versus equity financing.
4. What does 'working capital management' refer to?
Answer: The management of a firm's short-term assets and short-term liabilities
(day-to-day operations).
Rationale: Working capital management ensures the firm has sufficient resources to
continue its operations and avoid interruptions, managing items like inventory,
receivables, and payables.
5. What is net working capital?
Answer: Current assets minus current liabilities.
Rationale: Net working capital measures the short-term financial cushion available to
a firm; positive NWC indicates that cash inflows over the near term exceed cash
outflows.
6. What is the primary financial goal of a corporation according to traditional
corporate finance theory?
Page 1
, FINC 3610 Harrelson - Exam 1 Questions
Answer: To maximize the current value per share of existing stock (shareholder
wealth maximization).
Rationale: This goal is unambiguous and forward-looking, accounting for risk and
timing of cash flows, unlike vague goals such as 'maximizing profit,' which ignores
timing and risk.
7. Why is 'maximize profit' considered an insufficient goal for a corporation compared
to maximizing shareholder wealth?
Answer: Because it ignores the timing and risk of cash flows and can be
manipulated through accounting choices.
Rationale: Profit maximization does not account for the time value of money or risk,
and accounting profits can differ from actual cash flow and economic value creation.
8. What is a sole proprietorship?
Answer: A business owned by a single individual.
Rationale: A sole proprietorship is the simplest business form, with the owner directly
entitled to all profits but also personally liable for all business debts.
9. What is the primary disadvantage of a sole proprietorship regarding liability?
Answer: The owner has unlimited personal liability for all business debts.
Rationale: Because there is no legal separation between the owner and the business,
personal assets are at risk to satisfy business debts and obligations.
10. What is a key limitation of a sole proprietorship's ability to raise capital?
Answer: Equity financing is limited to the owner's personal wealth, restricting
growth potential.
Rationale: Since a sole proprietorship cannot sell shares of ownership, it depends on
the owner's personal funds and borrowing capacity, limiting its ability to raise large
amounts of capital.
11. What is a general partnership?
Answer: A business owned by two or more people (partners) who share in the
profits and are jointly liable for the debts.
Rationale: In a general partnership, all partners share responsibility for management
and unlimited liability for business obligations, similar to a sole proprietorship but
with multiple owners.
12. What distinguishes a limited partnership from a general partnership?
Page 2
, FINC 3610 Harrelson - Exam 1 Questions
Answer: A limited partnership includes at least one general partner with unlimited
liability and one or more limited partners whose liability is limited to their
investment.
Rationale: Limited partners enjoy liability protection (similar to shareholders) but
typically cannot participate in day-to-day management without risking their limited
liability status.
13. What is a corporation?
Answer: A legal entity separate and distinct from its owners (shareholders),
capable of entering contracts, owning assets, and incurring liabilities in its own
name.
Rationale: Because the corporation is a distinct legal 'person,' it can sue and be sued,
own property, and enter contracts independent of its shareholders.
14. What is the primary advantage of the corporate form regarding owner liability?
Answer: Limited liability — shareholders are only liable up to the amount they
invested in the company.
Rationale: Unlike sole proprietorships and general partnerships, corporate
shareholders' personal assets are protected from claims against the corporation's
debts.
15. What is 'double taxation' in the context of corporations?
Answer: Corporate profits are taxed at the corporate level, and then dividends paid
to shareholders are taxed again at the individual level.
Rationale: Double taxation is a key disadvantage of the traditional C-corporation
structure, as the same income is effectively taxed twice before reaching the
shareholder as after-tax income.
16. What is an agency relationship in corporate finance?
Answer: A relationship in which one party (the principal) hires another party (the
agent) to act on the principal's behalf.
Rationale: In a corporation, shareholders (principals) hire managers (agents) to run
the company on their behalf, creating the potential for a divergence of interests.
17. What is an 'agency problem'?
Answer: A conflict of interest that arises when managers (agents) act in their own
self-interest rather than in the best interest of shareholders (principals).
Page 3
