Financial Theory & Practice Test #1 Questions
with Answers (100% Correct Answers)
Corporate finance provides the skills managers need to Answer: Identify and
select the corporate strategies and individual projects that add value to their
firm.
Forecast the funding requirements of their company, and devise strategies for
acquiring those funds.
Proprietorship Answer: Advantages:Ease of formation,Subject to few
regulations, and No corporate income taxes
Disadvantages:Limited life,Unlimited liability,Difficult to raise capital to
support growth
A partnership Answer: has roughly the same advantages and disadvantages as
a sole proprietorship.
A corporation Answer: is a legal entity separate from its owners and managers.
File papers of incorporation with state. Bylaws and Charter
Advantages:Unlimited life,Easy transfer of ownership,Limited liability, and
Ease of raising capital
Disadvantages:Double taxation and Cost of set-up and report filing
Initial Public Offering (IPO) of Stock Answer: Raises cash, Allows founders
and pre-IPO investors to "harvest" some of their wealth
,2
Agency problem Answer: managers may act in their own interests and not on
behalf of owners (stockholders)
Corporate governance Answer: is the set of rules that control a company's
behavior towards its directors, managers, employees, shareholders, creditors,
customers. Corporate governance can help control agency problems.
What should be management's primary objective? Answer: The primary
objective should be shareholder wealth maximization, which translates to
maximizing the fundamental stock price.
Should firms behave ethically?
Do firms have any responsibilities to society at large? Answer: YES!
YES! Shareholders are also members of society.
Is maximizing stock price good for society, employees, and customers?(1)
Answer: Employment growth is higher in firms that try to maximize stock
price. On average, employment goes up in:
firms that make managers into owners (such as LBO firms) and firms that were
owned by the government but that have been sold to private investors
Is maximizing stock price good?(2) Answer: Consumer welfare is higher in
capitalist free market economies than in communist or socialist economies.
Fortune lists the most admired firms. In addition to high stock returns, these
firms have:
high quality from customers' view
employees who like working there
What three aspects of cash flows affect an investment's value? Answer:
(1)Amount of expected cash flows (bigger is better)
(2)Timing of the cash flow stream (sooner is better)
, 3
(3)Risk of the cash flows (less risk is better)
Free Cash Flows (FCF) Answer: Free cash flows are the cash flows that are
available (or free) for distribution to all investors (stockholders and creditors).
FCF = sales revenues - operating costs - operating taxes - required investments
in operating capital.
What is the weighted average cost of capital (WACC)? Answer: WACC is the
average rate of return required by all of the company's investors.
WACC is affected by: Answer: Capital structure (the firm's relative use of debt
and equity as sources of financing)
Interest rates
Risk of the firm
Investors' overall attitude toward risk
What determines a firm's fundamental, or intrinsic, value? Answer: Intrinsic
value is the sum of all the future expected free cash flows when converted into
today's dollars
Intrinsic Value Answer: The intrinsic value is the actual value of a company or
an asset based on an underlying perception of its true value including all aspects
of the business, in terms of both tangible and intangible factors.
What do we call the price, or cost, of debt capital? Answer: The interest rate
What do we call the price, or cost, of equity capital? Answer: Cost of equity =
Required return = dividend yield + capital gain
What four factors affect the cost of money? Answer: Production opportunities
Time preferences for consumption
with Answers (100% Correct Answers)
Corporate finance provides the skills managers need to Answer: Identify and
select the corporate strategies and individual projects that add value to their
firm.
Forecast the funding requirements of their company, and devise strategies for
acquiring those funds.
Proprietorship Answer: Advantages:Ease of formation,Subject to few
regulations, and No corporate income taxes
Disadvantages:Limited life,Unlimited liability,Difficult to raise capital to
support growth
A partnership Answer: has roughly the same advantages and disadvantages as
a sole proprietorship.
A corporation Answer: is a legal entity separate from its owners and managers.
File papers of incorporation with state. Bylaws and Charter
Advantages:Unlimited life,Easy transfer of ownership,Limited liability, and
Ease of raising capital
Disadvantages:Double taxation and Cost of set-up and report filing
Initial Public Offering (IPO) of Stock Answer: Raises cash, Allows founders
and pre-IPO investors to "harvest" some of their wealth
,2
Agency problem Answer: managers may act in their own interests and not on
behalf of owners (stockholders)
Corporate governance Answer: is the set of rules that control a company's
behavior towards its directors, managers, employees, shareholders, creditors,
customers. Corporate governance can help control agency problems.
What should be management's primary objective? Answer: The primary
objective should be shareholder wealth maximization, which translates to
maximizing the fundamental stock price.
Should firms behave ethically?
Do firms have any responsibilities to society at large? Answer: YES!
YES! Shareholders are also members of society.
Is maximizing stock price good for society, employees, and customers?(1)
Answer: Employment growth is higher in firms that try to maximize stock
price. On average, employment goes up in:
firms that make managers into owners (such as LBO firms) and firms that were
owned by the government but that have been sold to private investors
Is maximizing stock price good?(2) Answer: Consumer welfare is higher in
capitalist free market economies than in communist or socialist economies.
Fortune lists the most admired firms. In addition to high stock returns, these
firms have:
high quality from customers' view
employees who like working there
What three aspects of cash flows affect an investment's value? Answer:
(1)Amount of expected cash flows (bigger is better)
(2)Timing of the cash flow stream (sooner is better)
, 3
(3)Risk of the cash flows (less risk is better)
Free Cash Flows (FCF) Answer: Free cash flows are the cash flows that are
available (or free) for distribution to all investors (stockholders and creditors).
FCF = sales revenues - operating costs - operating taxes - required investments
in operating capital.
What is the weighted average cost of capital (WACC)? Answer: WACC is the
average rate of return required by all of the company's investors.
WACC is affected by: Answer: Capital structure (the firm's relative use of debt
and equity as sources of financing)
Interest rates
Risk of the firm
Investors' overall attitude toward risk
What determines a firm's fundamental, or intrinsic, value? Answer: Intrinsic
value is the sum of all the future expected free cash flows when converted into
today's dollars
Intrinsic Value Answer: The intrinsic value is the actual value of a company or
an asset based on an underlying perception of its true value including all aspects
of the business, in terms of both tangible and intangible factors.
What do we call the price, or cost, of debt capital? Answer: The interest rate
What do we call the price, or cost, of equity capital? Answer: Cost of equity =
Required return = dividend yield + capital gain
What four factors affect the cost of money? Answer: Production opportunities
Time preferences for consumption
