Chapter 1

Question 1

Finance encompasses 3 areas

Answer 1

1. financial markets & institutions (flow of funds between users and suppliers of capitals)
2. investments (identify, acquire, and manage financial assets through stocks, bonds, etc)
3. financial management or business finance (**focus of class)

Question 2

goal of financial management

Answer 2

creation of economic value or wealth

Question 3

financial management

Answer 3

involves planning for, acquiring, and utilizing resources that maximize efficiency and value of firm

Question 4

financial management decision

Answer 4

-working capital management
-fixed capital management (capital budgeting)
-cost management-
capital structure management

Question 5

what is the purpose of a firm?

Answer 5

to create long-term wealth/value for shareholders (company wants to have enough leftover to satisfy shareholders and increase value)

Question 6

How do shareholders receive value?

Answer 6

dividends

stock price appreciation*** (main way)

Question 7

What should be primary goal of management?

Answer 7

shareholder wealth maximization –> maximize long-term price of common stock

Question 8

corporate governance system

Answer 8

• shareholders elect directors
• directors elect management
• management makes the decisions (working for shareholders)

-shareholders have little say in the company. they can vote on a board of directors but in reality, the decision is made by the company because its not a democratic system)

Question 9

agency conflict

Answer 9

managers who are “agents” for the shareholders, may not always act in the best interests of shareholders

Question 10

reasons behind the agency conflict

Answer 10

• agents have their own objectives which may conflict with those of shareholders
• may have a different perspective on risk

Question 11

incentives used to align management and shareholder interterests

Answer 11

• bonuses
• give management shares of the company stock

ex: we will let you pay $25 at any time for a share so that managers will work hard to increase the share price so they can make more money themselves

Question 12

factors that affect stock price

Answer 12

projected cash flows to shareholders

timing of the cash flow stream

riskiness of the cash flows

Question 13

stock price and value creation

Answer 13

value is created for shareholders when the cash inflow associated with an investment exceeds the cash outflow adjusted for timing and risk of the project

Question 14

annual report

Answer 14

-includes the balance sheet, income statement, statement of SE, and statement of cash flows

Question 15

Balance sheet

Answer 15

-provides a snapshot of a firm’s financial position at one point in time
-asset, liability, and equity accounts don’t represent current values (recorded at historical cost)
-some important liabilities are understated or left off
see PPT for a breakdown

Question 16

income statement

Answer 16

summarizes a firm’s revenues and expenses over a given period of time
-more like a video than a snapshot

Question 17

statement of stockholder’s equity

Answer 17

shows how much of the firm’s earnings were retained rather than paid out as dividends

Question 18

statement of cash flows

Answer 18

reports the impact of a firm’s activities on cash flows over a given period of time

• summarizes cash inflows and outflows for a specified period
• changes divided into three categories: 1. operating activity 2. investment activity (capital expenditures) 3. financing activity (cash from capital providers)

Question 19

“Cash, not income, is King”

Answer 19

the goal of financial management is to create economic wealth. in measuring wealth or value, we use cash flows, not accounting profits. with accrual accounting, net income is usually different than cash flow.

Question 20

income vs cash flow

Answer 20

income subtracts depreciation (a noncash expense) and ignores cash expenditures on fixed assests). In other words, income spreads the cost of assets over its useful life by making book keeping entries which is not a true representation of cash)

Question 21

revenue vs. cash flow

Answer 21

• if a person purchases $_ on credit, payment still has not been received
• even though our revenue goes up as a result of this, we haven’t actually received any cash (AR)

Question 22

Profit vs cash flow

Answer 22

• “profit” subtracts depreciation (a noncash expense)
• profit ignores cash expenditures on new capital
• profit records income and expense at the time of sales, not when cash exchanges occurs
• profit does not consider changes in working capital

Question 23

sources of funds

Answer 23

cash inflow
decrease in asset account
increase in liability or equity account

Question 24

uses of funds

Answer 24

cash outflow
increase in asset account
decrease in liability or equity account