OVERVIEW OF FINANCIAL MANAGEMENT

QUESTION:
What are the three main areas of finance?

Finance consists of three interrelated areas:

(1) money and capital markets,
(2) investments, and
(3) financial management.
 OVERVIEW OF FINANCIAL MANAGEMENT
MONEY AND CAPITAL MARKETS
-Deals with securities markets and
financial institutions.
INVESTMENTS
-Focuses on decisions made by investors as they
choose securities for their investment portfolio.
FINANCIAL MANAGEMENT
-Involves decisions within firms; the broadest
among all three areas.
 OVERVIEW OF FINANCIAL MANAGEMENT

WHY IS IT NECESSARY FOR BUSINESS

STUDENTS WHO DO NOT PLAN TO
MAJOR IN FINANCE TO UNDERSTAND
THE BASICS OF FINANCE?
 OVERVIEW OF FINANCIAL MANAGEMENT
QUESTION:
What are some specific activities with which a firm’s
finance staff is involved?

 The financial staff’s task is to obtain and use

funds so as to maximize the value of the firm.
 OVERVIEW OF FINANCIAL MANAGEMENT
1. Forecasting and planning. The financial staff must coordinate
the planning process.
2. Major investment and financing decisions.
3. Coordination and control. The financial staff must interact with
other personnel to ensure that the firm is operated as efficiently
as possible. All business decisions have financial implications,
and all managers—financial and otherwise—need to take this
into account.
4. Dealing with the financial markets. The financial staff must deal
with the money and capital markets.
5. Risk management. The financial staff is responsible for the
firm’s overall risk management program, including identifying
the risks that should be managed and then managing them in
the most efficient manner.
 OVERVIEW OF FINANCIAL MANAGEMENT
QUESTION:
Briefly describe the three major types of business
organization.
What are the advantages and disadvantages of
each?

 Sole Proprietorships
Partnerships
Corporations
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
The form of organization for a business is not
an important issue, as this decision has very
little effect on the income and wealth of the
firm's owners.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
The form of organization for a business is not
an important issue, as this decision has very
little effect on the income and wealth of the
firm's owners.
 OVERVIEW OF FINANCIAL MANAGEMENT
1. Sole Proprietorships- an unincorporated business owned by
one individual. Going into business as a sole proprietor is
easy—one merely begins business operations. However, even
the smallest businesses normally must be licensed by a
governmental unit.
Advantages: (1) It is easily and inexpensively formed,
(2) it is subject to few government regulations, and
(3) the business avoids corporate income taxes.
Limitations: (1) It is difficult for a proprietorship to obtain large sums of capital,
(2) the proprietor has unlimited personal liability for the business’s debts,
which can result in losses that exceed the money he or she has invested in the
company, and
(3) the life of a business organized as a proprietorship is limited to the life
of the individual who created it.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
Two disadvantages of a proprietorship are (1)
the relative difficulty of raising new capital and
(2) the owner's unlimited personal liability for
the business' debts.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
Two disadvantages of a proprietorship are (1)
the relative difficulty of raising new capital and
(2) the owner's unlimited personal liability for
the business' debts.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
The fact that a proprietorship, as a business,
pays no corporate income tax, and that it is
easily and inexpensively formed, are two key
advantages to that form of business.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
The fact that a proprietorship, as a business,
pays no corporate income tax, and that it is
easily and inexpensively formed, are two key
advantages to that form of business.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
The major advantage of a regular partnership or
a corporation as a form of business
organization is the fact that both offer their
owners limited liability, whereas proprietorships
do not.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
The major advantage of a regular partnership or
a corporation as a form of business
organization is the fact that both offer their
owners limited liability, whereas proprietorships
do not.
 OVERVIEW OF FINANCIAL MANAGEMENT
2. Partnerships- whenever two or more persons bind
themselves to contribute money, property, or industry to a
common fund, with the intention of dividing the profits among
themselves.
Advantages: (1) Low cost;
(2) ease of formation
Limitations: (1) unlimited liability,
(2) limited life of the organization,
(3) difficulty of transferring ownership, and
(4) difficulty of raising large amounts of
capital.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
There are three primary disadvantages of a
regular partnership: (1) unlimited liability, (2)
limited life of the organization, and (3) difficulty
of transferring ownership. These combine to
make it difficult for partnerships to attract large
amounts of capital and thus to grow to a very
large size.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
There are three primary disadvantages of a
regular partnership: (1) unlimited liability, (2)
limited life of the organization, and (3) difficulty
of transferring ownership. These combine to
make it difficult for partnerships to attract large
amounts of capital and thus to grow to a very
large size.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
The disadvantages associated with a
proprietorship are similar to those under a
partnership. One exception relates to the more
formal nature of the partnership agreement and
the commitment of all partners' personal assets.
As a result, partnerships do not have difficulty
raising large amounts of capital.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
The disadvantages associated with a
proprietorship are similar to those under a
partnership. One exception relates to the more
formal nature of the partnership agreement and
the commitment of all partners' personal assets.
As a result, partnerships do not have difficulty
raising large amounts of capital.
 OVERVIEW OF FINANCIAL MANAGEMENT
3. Corporations- an artificial being created by operation of
law, having the right of succession, and the powers, attributes
and properties expressly authorized by law or incident to its
existence.
Advantages: (1) Unlimited life. A corporation can continue after its
original owners and managers are deceased
(2) Easy transferability of ownership interest. Ownership
interests can be divided into shares of stock, which, in turn, can be
transferred far more easily than can proprietorship or partnership interests.
(3) Limited liability. Losses are limited to the actual funds
invested.
Limitations:(1) Corporate earnings may be subject to double taxation,
(2) Complex incorporation
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
One key value of limited liability is that it
lowers owners' risks and thereby enhances a
firm's value.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
One key value of limited liability is that it
lowers owners' risks and thereby enhances a
firm's value.
 OVERVIEW OF FINANCIAL MANAGEMENT
HYBRID FORMS OF BUSINESS ORGANIZATION

Limited Partnership
Limited Liability Company/Partnership
Professional Corporation/Association
 OVERVIEW OF FINANCIAL MANAGEMENT
HYBRID FORMS OF BUSINESS ORGANIZATION

Limited Partnership- A hybrid form of

organization consisting of general partners, who
have unlimited liability for the partnership’s debts,
and limited partners, whose liability is limited to
the amount of their investment.
 OVERVIEW OF FINANCIAL MANAGEMENT
HYBRID FORMS OF BUSINESS ORGANIZATION

Limited Liability Partnership (Limited Liability

Company)- A hybrid form of organization in
which all partners enjoy limited liability for the
business’s debts. It combines the limited liability
advantage of a corporation with the tax
advantages of a partnership.
 OVERVIEW OF FINANCIAL MANAGEMENT
HYBRID FORMS OF BUSINESS ORGANIZATION

Professional Corporation (Professional

Association)- A type of corporation common
among professionals that provides most of the
benefits of incorporation but does not relieve the
participants of malpractice liability.
 OVERVIEW OF FINANCIAL MANAGEMENT

WHO ARE THE OWNERS OF A CORPORATION?

 OVERVIEW OF FINANCIAL MANAGEMENT

WHAT DO YOU THINK IS THEIR PRIMARY

GOAL?
 OVERVIEW OF FINANCIAL MANAGEMENT

STOCKHOLDERS
ELECT
Management is
supposed to operate
BOARD OF DIRECTORS in the best interests
of the stockholders.
SELECTS

MANAGEMENT TEAM
 OVERVIEW OF FINANCIAL MANAGEMENT

The primary goal of management should be to

maximize stockholders’ wealth, and this means
maximizing the firm’s stock price. Note
though, that actions that maximize stock prices
also increase social welfare.
 OVERVIEW OF FINANCIAL MANAGEMENT

IF A FIRM ATTEMPTS TO MAXIMIZE ITS STOCK

PRICE, IS THIS GOOD OR BAD FOR SOCIETY?
 OVERVIEW OF FINANCIAL MANAGEMENT
In general, it is good. Why?
1. Stock price maximization requires efficient, low-cost
businesses that produce high-quality goods and services at the
lowest possible cost.
2. Stock price maximization requires the development of products
and services that consumers want and need, so the profit motive
leads to new technology, to new products, and to new jobs.
3. Stock price maximization necessitates efficient and courteous
service, adequate stocks of merchandise, and well-located
business establishments—these are the factors that lead to
sales, which in turn are necessary for profits.
Therefore, most actions that help a firm increase the price of its stock
also benefit society at large.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
If a firm's goal is to maximize its earnings per
share, this is the best way to maximize the
price of the common stock and thus
shareholders' wealth.
 OVERVIEW OF FINANCIAL MANAGEMENT

TRUE OR FALSE:
If a firm's goal is to maximize its earnings per
share, this is the best way to maximize the
price of the common stock and thus
shareholders' wealth.
 OVERVIEW OF FINANCIAL MANAGEMENT
QUESTION:
If you were the president of a large, publicly owned
corporation, would you make decisions to
maximize stockholders’ welfare or your own
personal interests? Why?
 OVERVIEW OF FINANCIAL MANAGEMENT
QUESTION:
What are some actions stockholders could take to
ensure that management’s interests and those of
stockholders coincided? What actions could be
taken to remove a management team if it departs
from the goal of maximizing shareholder wealth?
 OVERVIEW OF FINANCIAL MANAGEMENT
An agency relationship arises whenever one or
more individuals, called principals, hire another
individual or organization, called an agent, to
perform some service and delegate decision-
making authority to that agent. In financial
management, the primary agency relationships
are those between
(1) stockholders and managers and
(2) managers and debtholders
 OVERVIEW OF FINANCIAL MANAGEMENT
(1) Stockholders versus Managers.
A potential agency problem arises whenever the manager of a
firm owns less than 100 percent of the firm’s common stock.
However, managers can be encouraged to act in stockholders’
best interests through incentives that reward them for good
performance but punish them for poor performance. Some
specific mechanisms used to motivate managers to act in
shareholders’ best interests include:
• Managerial compensation
• Direct intervention by shareholders
• The threat of firing
• The threat of takeovers
 OVERVIEW OF FINANCIAL MANAGEMENT

• Managerial compensation.
Managers are more likely to focus on maximizing stock prices if
they are themselves large shareholders. Often, companies grant
senior managers performance shares, where the executive
receives a number of shares dependent upon the company’s
actual performance and the executive’s continued service. Most
large corporations also provide executive stock options,
which allow managers to purchase stock at some future time at
a given price.
 OVERVIEW OF FINANCIAL MANAGEMENT
• Direct intervention by shareholders.
• The threat of firing.
• The threat of takeovers.
In a hostile takeover, the managers of the acquired firm
are generally fired, and any who manage to stay on lose
status and authority. Thus, managers have a strong
incentive to take actions designed to maximize stock
prices. In the words of one company president, “If you
want to keep your job, don’t let your stock sell at a
bargain price.”
 OVERVIEW OF FINANCIAL MANAGEMENT
(2) Stockholders (through managers) versus Creditors.
Creditors have a claim on part of the firm’s earnings stream
for payment of interest and principal on the debt, and they
have a claim on the firm’s assets in the event of bankruptcy.
However, stockholders have control (through the managers)
of decisions that affect the profitability and risk of the firm.
In view of these constraints, it follows that to best serve their
shareholders in the long run, managers must play fairly with
creditors. As agents of both shareholders and creditors,
managers must act in a manner that is fairly balanced
between the interests of the two classes of security holders.
 OVERVIEW OF FINANCIAL MANAGEMENT

WITHIN THE NEXT TEN (10)

MINUTES, PREPARE FOR A SHORT
POST-TEST.
REVIEW YOUR HAND-WRITTEN
NOTES; RE-READ YOUR ANSWERS
TO YOUR ASSIGNMENT.
BEGIN.
 OVERVIEW OF FINANCIAL MANAGEMENT
1. Which of the following statements is CORRECT?
a. One of the disadvantages of incorporating a business is
that the owners then become subject to liabilities in the event the
firm goes bankrupt.
b. Sole proprietorships are subject to more regulations than
corporations.
c. In any type of partnership, every partner has the same
rights, privileges, and liability exposure as every other partner.
d. Sole proprietorships and partnerships generally have a tax
advantage over many corporations, especially large ones.
e. Corporations of all types are subject to the corporate
income tax.
 OVERVIEW OF FINANCIAL MANAGEMENT
2. Which of the following statements is CORRECT?
a. It is generally more expensive to form a proprietorship than a
corporation because, with a proprietorship, extensive legal documents are
required.
b. Corporations face fewer regulations than sole proprietorships.
c. One disadvantage of operating a business as a sole
proprietorship is that the firm is subject to double taxation, at both the
firm level and the owner level.
d. One advantage of forming a corporation is that equity investors
are usually exposed to less liability than in a regular partnership.
e. If a regular partnership goes bankrupt, each partner is exposed
to liabilities only up to the amount of his or her investment in the business.
 OVERVIEW OF FINANCIAL MANAGEMENT
3. Cheers Inc. operates as a partnership. Now the partners have
decided to convert the business into a regular corporation. Which of
the following statements is CORRECT?
a. Assuming Cheers is profitable, less of its income will be
subject to federal income taxes.
b. Cheers will now be subject to fewer regulations.
c. Cheers’ shareholders (the ex-partners) will now be exposed
to less liability.
d. Cheers’ investors will be exposed to less liability, but they
will find it more difficult to transfer their ownership.
e. Cheers will find it more difficult to raise additional capital.
 OVERVIEW OF FINANCIAL MANAGEMENT
4. Which of the following could explain why a business might
choose to operate as a corporation rather than as a sole
proprietorship or a partnership?
a. Corporations generally find it relatively difficult to raise
large amounts of capital.
b. Less of a corporation’s income is generally subjected to
taxes than would be true if the firm were a partnership.
c. Corporate shareholders escape liability for the firm's debts,
but this factor may be offset by the tax disadvantages of the corporate
form of organization.
d. Corporate investors are exposed to unlimited liability.
e. Corporations generally face relatively few regulations.
 OVERVIEW OF FINANCIAL MANAGEMENT
5. Which of the following statements is CORRECT?
a. A hostile takeover is the main method of transferring ownership interest
in a corporation.
b. Unlimited liability and limited life are two key advantages of the
corporate form over other forms of business organization.
c. A corporation is a legal entity that is generally created by a state, and it
has a life and existence that is separate from the lives of its individual owners and
managers.
d. Limited liability of its stockholders is an advantage of the corporate form
of organization, but corporations have more trouble raising money in financial markets
because of the complexity of this form of organization.
e. Although its stockholders are insulated by limited legal liability, the legal
status of the corporation does not protect the firm’s managers in the same way, i.e.,
bondholders can sue its managers if the firm defaults on its debt, even if the default is
the result of poor economic conditions.
 OVERVIEW OF FINANCIAL MANAGEMENT
6. With which of the following statements would most people in business agree with?
a. A corporation’s short-run profits will almost always increase if the firm
takes actions that the government has determined are in the best interests of the
nation.
b. Firms and government agencies almost always agree with one another
regarding the restrictions that should be placed on hiring and firing employees.
c. Although people’s moral characters are probably developed before they
get into a business school, it is still useful for business schools to cover ethics,
including giving students an idea about the adverse consequences of unethical
behavior to themselves, their firms, and the nation.
d. It is not useful for a large corporation to develop a formal set of rules
defining ethical and unethical behavior. Such rules generally can't be applied in many
specific instances, so it is better to deal with ethical issues on a case-by-case basis.
e. “Whistle blowers,” because of the courage it takes to blow the whistle,
are generally promoted more rapidly than other employees.
 OVERVIEW OF FINANCIAL MANAGEMENT
7. Which of the following statements is CORRECT?
a. In a regular partnership, liability for other partners’ misdeeds is limited
to the amount of a particular partner’s investment in the business.
b. Partnerships have more difficulty attracting large amounts of capital than
corporations because of such factors as unlimited liability, the need to reorganize
when a partner dies, and the illiquidity (difficulty buying and selling) of partnership
interests.
c. A slow-growth company, with little need for new capital, would be more
likely to organize as a corporation than would a faster growing company.
d. In a limited partnership, the limited partners have voting control, while
the general partner has operating control over the business. Also, the limited partners
are individually responsible, on a pro rata basis, for the firm’s debts in the event of
bankruptcy.
e. A major disadvantage of all partnerships relative to all corporations is
the fact that federal income taxes must be paid by the partners rather than by the firm
itself.
 OVERVIEW OF FINANCIAL MANAGEMENT
8. The primary operating goal of a publicly-owned firm
interested in serving its stockholders should be to
a. Maximize the stock price per share over the long run,
which is the stock’s intrinsic value.
b. Maximize the firm's expected EPS.
c. Minimize the chances of losses.
d. Maximize the firm's expected total income.
e. Maximize the stock price on a specific target date.
 OVERVIEW OF FINANCIAL MANAGEMENT
9. Which of the following statements is CORRECT?
a. The proper goal of the financial manager should be to attempt to maximize the firm’s expected
cash flows, because this will add the most to the wealth of the individual shareholders.
b. The financial manager should seek that combination of assets, liabilities, and capital that will
generate the largest expected projected after-tax income over the relevant time horizon,
generally the coming year.
c. The riskiness inherent in a firm’s earnings per share (EPS) depends on the characteristics of the
projects the firm selects, and thus on the firm’s assets. However, EPS is not affected by the
manner in which those assets are financed.
d. Potential agency problems can arise between stockholders and managers, because managers
hired as agents to act on behalf of the owners may instead make decisions favorable to
themselves rather than the stockholders.
e. Large, publicly-owned firms like AT&T and GM are controlled by their management teams.
Ownership is generally widely dispersed; hence managers have great freedom in how they
manage the firm. Managers may operate in stockholders’ best interests, but they may also
operate in their own personal best interests. As long as managers stay within the law, there is no
way to either force or motivate them to act in the stockholders’ best interests.
 OVERVIEW OF FINANCIAL MANAGEMENT
10. Which of the following statements is NOT CORRECT?
a. When a corporation’s shares are owned by a few individuals and
are not traded on public markets, we say that the firm is “closely, or privately,
held."
b. “Going public” establishes a firm's true intrinsic value, and it also
insures that a highly liquid market will always exist for the firm’s shares.
c. When stock in a closely held corporation is offered to the public for
the first time, the transaction is called “going public,” and the market for such
stock is called the new issue market.
d. Publicly owned companies have shares owned by investors who are
not associated with management, and public companies must register with and
report to a regulatory agency such as the SEC.
e. It is possible for a firm to go public and yet not raise any additional
new capital at the time.
 OVERVIEW OF FINANCIAL MANAGEMENT
11. Which of the following statements is most correct?
a. Compensating managers with stock can reduce the
agency problem between stockholders and managers.
b. Restrictions are included in credit agreements to
protect bondholders from the agency problem that exists
between bondholders and stockholders.
c. The threat of a takeover can reduce the agency
problem between bondholders and stockholders.
d. Statements a and b are correct.
e. All of the statements above are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT
12. Which of the following work to reduce agency conflicts
between stockholders and bondholders?
a. Including restrictive covenants in the company’s
bond contract.
b. Providing managers with a large number of stock
options.
c. The passage of laws that make it easier for
companies to resist hostile takeovers.
d. Statements b and c are correct.
e. All of the statements above are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT
13. Which of the following actions are likely to reduce agency
conflicts between stockholders and managers?
a. Paying managers a large fixed salary.
b. Increasing the threat of corporate takeover.
c. Placing restrictive covenants in debt agreements.
d. All of the statements above are correct.
e. Statements b and c are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT
14. Which of the following actions are likely to reduce the
agency problem between stockholders and managers?
a. Congress passes a law that severely restricts hostile
takeovers.
b. A manager receives a lower salary but receives
additional shares of the company’s stock.
c. The board of directors has become more vigilant in
its oversight of the company’s management.
d. Statements b and c are correct.
e. All of the statements above are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT

15. Which of the following mechanisms is used to

motivate managers to act in the interest of
shareholders?
a. Bond covenants.
b. The threat of a takeover.
c. Pressure from the board of directors.
d. Statements a and b are correct.
e. Statements b and c are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT
16. Which of the following is likely to encourage a firm’s
managers to make decisions that are in the best interest of
shareholders?
a. Executive compensation comes primarily in the
form of stock options.
b. The state legislature recently passed a law that makes
it more difficult to successfully complete a hostile takeover.
c. Institutional investors such as mutual funds and
pension funds hold large amounts of the firm’s stock.
d. Statements a and b are correct.
e. Statements a and c are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT
1. Which of the following statements is CORRECT?
a. One of the disadvantages of incorporating a business is
that the owners then become subject to liabilities in the event the
firm goes bankrupt.
b. Sole proprietorships are subject to more regulations than
corporations.
c. In any type of partnership, every partner has the same
rights, privileges, and liability exposure as every other partner.
d. Sole proprietorships and partnerships generally have a tax
advantage over many corporations, especially large ones.
e. Corporations of all types are subject to the corporate
income tax.
 OVERVIEW OF FINANCIAL MANAGEMENT
2. Which of the following statements is CORRECT?
a. It is generally more expensive to form a proprietorship than a
corporation because, with a proprietorship, extensive legal documents are
required.
b. Corporations face fewer regulations than sole proprietorships.
c. One disadvantage of operating a business as a sole
proprietorship is that the firm is subject to double taxation, at both the
firm level and the owner level.
d. One advantage of forming a corporation is that equity investors
are usually exposed to less liability than in a regular partnership.
e. If a regular partnership goes bankrupt, each partner is exposed
to liabilities only up to the amount of his or her investment in the business.
 OVERVIEW OF FINANCIAL MANAGEMENT
3. Cheers Inc. operates as a partnership. Now the partners have
decided to convert the business into a regular corporation. Which of
the following statements is CORRECT?
a. Assuming Cheers is profitable, less of its income will be
subject to federal income taxes.
b. Cheers will now be subject to fewer regulations.
c. Cheers’ shareholders (the ex-partners) will now be exposed
to less liability.
d. Cheers’ investors will be exposed to less liability, but they
will find it more difficult to transfer their ownership.
e. Cheers will find it more difficult to raise additional capital.
 OVERVIEW OF FINANCIAL MANAGEMENT
4. Which of the following could explain why a business might
choose to operate as a corporation rather than as a sole
proprietorship or a partnership?
a. Corporations generally find it relatively difficult to raise
large amounts of capital.
b. Less of a corporation’s income is generally subjected to
taxes than would be true if the firm were a partnership.
c. Corporate shareholders escape liability for the firm's debts,
but this factor may be offset by the tax disadvantages of the corporate
form of organization.
d. Corporate investors are exposed to unlimited liability.
e. Corporations generally face relatively few regulations.
 OVERVIEW OF FINANCIAL MANAGEMENT
5. Which of the following statements is CORRECT?
a. A hostile takeover is the main method of transferring ownership interest
in a corporation.
b. Unlimited liability and limited life are two key advantages of the
corporate form over other forms of business organization.
c. A corporation is a legal entity that is generally created by a state, and it
has a life and existence that is separate from the lives of its individual owners and
managers.
d. Limited liability of its stockholders is an advantage of the corporate form
of organization, but corporations have more trouble raising money in financial markets
because of the complexity of this form of organization.
e. Although its stockholders are insulated by limited legal liability, the legal
status of the corporation does not protect the firm’s managers in the same way, i.e.,
bondholders can sue its managers if the firm defaults on its debt, even if the default is
the result of poor economic conditions.
 OVERVIEW OF FINANCIAL MANAGEMENT
6. With which of the following statements would most people in business agree with?
a. A corporation’s short-run profits will almost always increase if the firm
takes actions that the government has determined are in the best interests of the
nation.
b. Firms and government agencies almost always agree with one another
regarding the restrictions that should be placed on hiring and firing employees.
c. Although people’s moral characters are probably developed before they
get into a business school, it is still useful for business schools to cover ethics,
including giving students an idea about the adverse consequences of unethical
behavior to themselves, their firms, and the nation.
d. It is not useful for a large corporation to develop a formal set of rules
defining ethical and unethical behavior. Such rules generally can't be applied in many
specific instances, so it is better to deal with ethical issues on a case-by-case basis.
e. “Whistle blowers,” because of the courage it takes to blow the whistle,
are generally promoted more rapidly than other employees.
 OVERVIEW OF FINANCIAL MANAGEMENT
7. Which of the following statements is CORRECT?
a. In a regular partnership, liability for other partners’ misdeeds is limited
to the amount of a particular partner’s investment in the business.
b. Partnerships have more difficulty attracting large amounts of capital than
corporations because of such factors as unlimited liability, the need to reorganize
when a partner dies, and the illiquidity (difficulty buying and selling) of partnership
interests.
c. A slow-growth company, with little need for new capital, would be more
likely to organize as a corporation than would a faster growing company.
d. In a limited partnership, the limited partners have voting control, while
the general partner has operating control over the business. Also, the limited partners
are individually responsible, on a pro rata basis, for the firm’s debts in the event of
bankruptcy.
e. A major disadvantage of all partnerships relative to all corporations is
the fact that federal income taxes must be paid by the partners rather than by the firm
itself.
 OVERVIEW OF FINANCIAL MANAGEMENT
8. The primary operating goal of a publicly-owned firm
interested in serving its stockholders should be to
a. Maximize the stock price per share over the long run,
which is the stock’s intrinsic value.
b. Maximize the firm's expected EPS.
c. Minimize the chances of losses.
d. Maximize the firm's expected total income.
e. Maximize the stock price on a specific target date.
 OVERVIEW OF FINANCIAL MANAGEMENT
9. Which of the following statements is CORRECT?
a. The proper goal of the financial manager should be to attempt to maximize the firm’s expected
cash flows, because this will add the most to the wealth of the individual shareholders.
b. The financial manager should seek that combination of assets, liabilities, and capital that will
generate the largest expected projected after-tax income over the relevant time horizon,
generally the coming year.
c. The riskiness inherent in a firm’s earnings per share (EPS) depends on the characteristics of the
projects the firm selects, and thus on the firm’s assets. However, EPS is not affected by the
manner in which those assets are financed.
d. Potential agency problems can arise between stockholders and managers, because managers
hired as agents to act on behalf of the owners may instead make decisions favorable to
themselves rather than the stockholders.
e. Large, publicly-owned firms like AT&T and GM are controlled by their management teams.
Ownership is generally widely dispersed; hence managers have great freedom in how they
manage the firm. Managers may operate in stockholders’ best interests, but they may also
operate in their own personal best interests. As long as managers stay within the law, there is no
way to either force or motivate them to act in the stockholders’ best interests.
 OVERVIEW OF FINANCIAL MANAGEMENT
10. Which of the following statements is NOT CORRECT?
a. When a corporation’s shares are owned by a few individuals and
are not traded on public markets, we say that the firm is “closely, or privately,
held."
b. “Going public” establishes a firm's true intrinsic value, and it also
insures that a highly liquid market will always exist for the firm’s shares.
c. When stock in a closely held corporation is offered to the public for
the first time, the transaction is called “going public,” and the market for such
stock is called the new issue market.
d. Publicly owned companies have shares owned by investors who are
not associated with management, and public companies must register with and
report to a regulatory agency such as the SEC.
e. It is possible for a firm to go public and yet not raise any additional
new capital at the time.
 OVERVIEW OF FINANCIAL MANAGEMENT
11. Which of the following statements is most correct?
a. Compensating managers with stock can reduce the
agency problem between stockholders and managers.
b. Restrictions are included in credit agreements to
protect bondholders from the agency problem that exists
between bondholders and stockholders.
c. The threat of a takeover can reduce the agency
problem between bondholders and stockholders.
d. Statements a and b are correct.
e. All of the statements above are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT
12. Which of the following work to reduce agency conflicts
between stockholders and bondholders?
a. Including restrictive covenants in the company’s
bond contract.
b. Providing managers with a large number of stock
options.
c. The passage of laws that make it easier for
companies to resist hostile takeovers.
d. Statements b and c are correct.
e. All of the statements above are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT
13. Which of the following actions are likely to reduce agency
conflicts between stockholders and managers?
a. Paying managers a large fixed salary.
b. Increasing the threat of corporate takeover.
c. Placing restrictive covenants in debt agreements.
d. All of the statements above are correct.
e. Statements b and c are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT
14. Which of the following actions are likely to reduce the
agency problem between stockholders and managers?
a. Congress passes a law that severely restricts hostile
takeovers.
b. A manager receives a lower salary but receives
additional shares of the company’s stock.
c. The board of directors has become more vigilant in
its oversight of the company’s management.
d. Statements b and c are correct.
e. All of the statements above are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT

15. Which of the following mechanisms is used to

motivate managers to act in the interest of
shareholders?
a. Bond covenants.
b. The threat of a takeover.
c. Pressure from the board of directors.
d. Statements a and b are correct.
e. Statements b and c are correct.
 OVERVIEW OF FINANCIAL MANAGEMENT
16. Which of the following is likely to encourage a firm’s
managers to make decisions that are in the best interest of
shareholders?
a. Executive compensation comes primarily in the
form of stock options.
b. The state legislature recently passed a law that makes
it more difficult to successfully complete a hostile takeover.
c. Institutional investors such as mutual funds and
pension funds hold large amounts of the firm’s stock.
d. Statements a and b are correct.
e. Statements a and c are correct.