Chapters: 1,2,3,6,7,13,15,16,19,24
Pearson (2014) – Principles of managerial finance
Chapter 1 – The role of managerial finance
The three most common legal forms of business organization are the sole proprietorship, the
partnership, and the corporation.
• sole proprietorship A business owned by one person and operated for his or her own profit.
unlimited liability The condition of a sole proprietorship (or general partnership), giving creditors the
right to make claims against the owner’s personal assets to recover debts owed by the business.
• partnership A business owned by two or more people and operated for profit.
• corporation An entity created by law.
stockholders The owners of a corporation, whose ownership, or equity, takes the form of common stock
or, less frequently, preferred stock. limited liability A legal provision that limits stockholders’ liability for
a corporation’s debt to the amount they initially invested in the firm by purchasing stock.
common stock The purest and most basic form of corporate ownership.
dividends Periodic distributions of cash to the stockholders of a firm.
1
,board of directors Group elected by the firm’s stockholders and typically responsible for approving
strategic goals and plans, setting general policy, guiding corporate affairs, and approving major
expenditures.
president or chief executive officer (CEO) Corporate official responsible for managing the firm’s day- to-
day operations and carrying out the policies established by the board of directors.
Limited partnership (LP) A partnership in which one or more partners have limited liability as long as at
least one partner (the general partner) has unlimited liability. The limited partners are passive investors
that cannot take an active role in the firm’s management
S corporation (S corp) A tax-reporting entity that allows certain corporations with 100 or fewer
stockholders to choose to be taxed as partnerships. Its stockholders receive the organizational benefits
of a corporation and the tax advantages of a partnership.
Limited liability company (LLC) Permitted in most states, the LLC gives its owners limited liability and
taxation as a partnership. But unlike an S corp, the LLC can own more than 80% of another corporation,
and corporations, partnership, or non-U.S. Residents can own LLC shares.
Limited liability partnership (LLP) Permitted in most states, LLP partners are liable for their own acts of
malpractice, but not for those of other partners. The LLP is taxed as a partnership and is frequently used
by legal and accounting professionals.
The goal of the firm, and also of managers, should be to maximize the wealth of the owners for whom it
is being operated, which in most instances is equivalent to maximize the stock price.
The key variables that managers must consider when making business decisions are return (cash flows)
and risk.
earnings per share (EPS) The amount earned during the period on behalf of each outstanding share of
common stock, calculated by dividing the period’s total earnings available for the firm’s common
stockholders by the number of shares of common stock outstanding.
risk averse Requiring compensation to bear risk.
stakeholders Groups such as employees, customers, suppliers, creditors, owners, and others who have a
direct economic link to the firm
Ethical behavior is therefore viewed as necessary for achieving the firm’s goal of owner wealth
maximization.
2
,treasurer The firm’s chief financial manager, who manages the firm’s cash, oversees its pension plans,
and manages key risks.
controller The firm’s chief accountant, who is responsible for the firm’s accounting activities, such as
corporate accounting, tax management, financial accounting, and cost accounting.
foreign exchange manager The manager responsible for managing and monitoring the firm’s exposure
to loss from currency fluctuations.
marginal cost–benefit analysis Economic principle that states that financial decisions should be made
and actions taken only when the added benefits exceed the added costs.
accrual basis In preparation of financial statements, recognizes revenue at the time of sale and
recognizes expenses when they are incurred.
cash basis Recognizes revenues and expenses only with respect to actual inflows and outflows of cash.
corporate governance The rules, processes, and laws by which companies are operated, controlled, and
regulated.
principal–agent relationship An arrangement in which an agent acts on the behalf of a principal. For
example, shareholders of a company (principals) elect management (agents) to act on their behalf
agency problems Problems that arise when managers place personal goals ahead of the goals of
shareholders.
agency costs Costs arising from agency problems that are borne by shareholders and represent a loss of
shareholder wealth.
incentive plans Management compensation plans that tie management compensation to share price;
one example involves the granting of stock options.
stock options Options extended by the firm that allow management to benefit from increases in stock
prices over time.
3
, performance plans Plans that tie management compensation to measures such as EPS or growth in EPS.
Performance shares, cash bonuses, or both are used as compensation under these plans.
Chapter 1 answers
P1-1. Liability comparisons (LG 5; Basic)
a. John has unlimited personal liability, so he is liable for the firm’s $120,000 in
outstanding debt.
b. Initially, John is liable for $60,000 (50% of total unpaid debts), but if his partner cannot
cover half the debt, he is liable for the full amount.
c. John has limited liability; he cannot lose more than his $50,000 investment.
P1-2. Accrual income vs. cash flow for a period (LG 4; Basic)
a. Sales $500,000
Cost of goods sold 400,000
Net profit $100,000
b. Cash receipts $150,000
Cost of goods sold 400,000
Net cash flow −$250,000
c. Accountant: The firm made a profit of $100,000, which the accountant will find more
useful. Financial manager: Since the firm has negative cash flows, it will not be useful to
the financial manager.
4
Pearson (2014) – Principles of managerial finance
Chapter 1 – The role of managerial finance
The three most common legal forms of business organization are the sole proprietorship, the
partnership, and the corporation.
• sole proprietorship A business owned by one person and operated for his or her own profit.
unlimited liability The condition of a sole proprietorship (or general partnership), giving creditors the
right to make claims against the owner’s personal assets to recover debts owed by the business.
• partnership A business owned by two or more people and operated for profit.
• corporation An entity created by law.
stockholders The owners of a corporation, whose ownership, or equity, takes the form of common stock
or, less frequently, preferred stock. limited liability A legal provision that limits stockholders’ liability for
a corporation’s debt to the amount they initially invested in the firm by purchasing stock.
common stock The purest and most basic form of corporate ownership.
dividends Periodic distributions of cash to the stockholders of a firm.
1
,board of directors Group elected by the firm’s stockholders and typically responsible for approving
strategic goals and plans, setting general policy, guiding corporate affairs, and approving major
expenditures.
president or chief executive officer (CEO) Corporate official responsible for managing the firm’s day- to-
day operations and carrying out the policies established by the board of directors.
Limited partnership (LP) A partnership in which one or more partners have limited liability as long as at
least one partner (the general partner) has unlimited liability. The limited partners are passive investors
that cannot take an active role in the firm’s management
S corporation (S corp) A tax-reporting entity that allows certain corporations with 100 or fewer
stockholders to choose to be taxed as partnerships. Its stockholders receive the organizational benefits
of a corporation and the tax advantages of a partnership.
Limited liability company (LLC) Permitted in most states, the LLC gives its owners limited liability and
taxation as a partnership. But unlike an S corp, the LLC can own more than 80% of another corporation,
and corporations, partnership, or non-U.S. Residents can own LLC shares.
Limited liability partnership (LLP) Permitted in most states, LLP partners are liable for their own acts of
malpractice, but not for those of other partners. The LLP is taxed as a partnership and is frequently used
by legal and accounting professionals.
The goal of the firm, and also of managers, should be to maximize the wealth of the owners for whom it
is being operated, which in most instances is equivalent to maximize the stock price.
The key variables that managers must consider when making business decisions are return (cash flows)
and risk.
earnings per share (EPS) The amount earned during the period on behalf of each outstanding share of
common stock, calculated by dividing the period’s total earnings available for the firm’s common
stockholders by the number of shares of common stock outstanding.
risk averse Requiring compensation to bear risk.
stakeholders Groups such as employees, customers, suppliers, creditors, owners, and others who have a
direct economic link to the firm
Ethical behavior is therefore viewed as necessary for achieving the firm’s goal of owner wealth
maximization.
2
,treasurer The firm’s chief financial manager, who manages the firm’s cash, oversees its pension plans,
and manages key risks.
controller The firm’s chief accountant, who is responsible for the firm’s accounting activities, such as
corporate accounting, tax management, financial accounting, and cost accounting.
foreign exchange manager The manager responsible for managing and monitoring the firm’s exposure
to loss from currency fluctuations.
marginal cost–benefit analysis Economic principle that states that financial decisions should be made
and actions taken only when the added benefits exceed the added costs.
accrual basis In preparation of financial statements, recognizes revenue at the time of sale and
recognizes expenses when they are incurred.
cash basis Recognizes revenues and expenses only with respect to actual inflows and outflows of cash.
corporate governance The rules, processes, and laws by which companies are operated, controlled, and
regulated.
principal–agent relationship An arrangement in which an agent acts on the behalf of a principal. For
example, shareholders of a company (principals) elect management (agents) to act on their behalf
agency problems Problems that arise when managers place personal goals ahead of the goals of
shareholders.
agency costs Costs arising from agency problems that are borne by shareholders and represent a loss of
shareholder wealth.
incentive plans Management compensation plans that tie management compensation to share price;
one example involves the granting of stock options.
stock options Options extended by the firm that allow management to benefit from increases in stock
prices over time.
3
, performance plans Plans that tie management compensation to measures such as EPS or growth in EPS.
Performance shares, cash bonuses, or both are used as compensation under these plans.
Chapter 1 answers
P1-1. Liability comparisons (LG 5; Basic)
a. John has unlimited personal liability, so he is liable for the firm’s $120,000 in
outstanding debt.
b. Initially, John is liable for $60,000 (50% of total unpaid debts), but if his partner cannot
cover half the debt, he is liable for the full amount.
c. John has limited liability; he cannot lose more than his $50,000 investment.
P1-2. Accrual income vs. cash flow for a period (LG 4; Basic)
a. Sales $500,000
Cost of goods sold 400,000
Net profit $100,000
b. Cash receipts $150,000
Cost of goods sold 400,000
Net cash flow −$250,000
c. Accountant: The firm made a profit of $100,000, which the accountant will find more
useful. Financial manager: Since the firm has negative cash flows, it will not be useful to
the financial manager.
4
