Corp.

Question 1

Q: What are the key features that differentiate organizational forms?

Answer 1

A: Key features include:

Legal separation from owners
Owner involvement in operations
Liability (limited or unlimited)
Tax treatment of profits/losses
Access to capital

Question 2

Q: What is a sole proprietorship?

Answer 2

A: A business owned and operated by an individual, where the owner has unlimited liability and profits are taxed as personal income.

Question 3

Q: How does a general partnership differ from a limited partnership?

Answer 3

A:

General Partnership: All partners have unlimited liability and share profits.
Limited Partnership: General partners manage the business with unlimited liability, while limited partners have liability limited to their investment and typically do not manage the business.

Question 4

Q: What distinguishes a corporation from other business structures?

Answer 4

A: A corporation is a separate legal entity with limited liability for shareholders, access to capital markets, and a separation between ownership and management.

Question 5

Q: What is double taxation, and how does it impact corporate shareholders?

Answer 5

A: Corporations pay taxes on profits, and shareholders are taxed again on dividends received. The effective tax rate depends on how much profit is distributed as dividends.

Question 6

Q: What are the key differences between public and private corporations?

Answer 6

A:

Public Corporations: Shares trade on exchanges, subject to regulations and financial disclosures.
Private Corporations: Shares are not publicly traded, have fewer regulatory requirements, and raise capital through private placements.

Question 7

Q: What is the key difference in claim priority between debtholders and equity holders?

Answer 7

A: Debtholders have a legal, contractual claim to interest and principal payments, while equity holders have a residual claim to net assets after all obligations are met.

Question 8

Q: Why is debt considered a less costly form of capital than equity?

Answer 8

A: Debt is less risky than equity because debtholders receive fixed payments and have priority in case of liquidation, leading to lower required returns.

Question 9

Q: How does leverage impact return on equity (ROE)?

Answer 9

A: Increased leverage can raise ROE if the return on assets exceeds the cost of debt, but it also increases financial risk.

Question 10

Q: What happens to equity and debt values when a company’s value changes?

Answer 10

A: Equity value fluctuates with the company’s value, while debt value remains fixed unless the company is worth less than its debt.

Question 11

Q: What is the main difference between shareholder theory and stakeholder theory in corporate governance?

Answer 11

A: Shareholder theory prioritizes maximizing shareholder value, while stakeholder theory considers the interests of multiple groups, including employees, lenders, and regulators.

Question 12

Q: Why do investors consider environmental, social, and governance (ESG) factors?

Answer 12

A: ESG factors impact financial performance through regulatory risks, reputation effects, and operational efficiency, affecting both equity and debt investors.

Question 13

Q: What is a principal-agent conflict?

Answer 13

A: A conflict that arises when an agent, hired to act in the principal’s interest, pursues their own interests instead, leading to potential misalignment.

Question 14

Q: What are agency costs?

Answer 14

A: Costs incurred due to principal-agent conflicts, including direct costs like monitoring agents and indirect costs like lost business opportunities.

Question 15

Q: How can conflicts of interest arise between shareholders and managers?

Answer 15

A: Managers may take lower risks than shareholders prefer, engage in empire-building, or entrench themselves rather than maximizing shareholder value.

Question 16

Q: What mechanisms help mitigate conflicts between shareholders and managers?

Answer 16

A: Corporate governance mechanisms like independent board oversight, executive compensation structures, shareholder activism, and proxy voting.

Question 17

Q: What are the risks of poor corporate governance?

Answer 17

A: Accounting fraud, weak oversight, regulatory violations, reputational damage, and misaligned management incentives leading to lower firm value.

Question 18

Q: What are the benefits of effective corporate governance?

Answer 18

A: Improved operational efficiency, reduced legal risks, better financial performance, and stronger alignment between management and shareholder interests.

Question 19

Question: What does the Cash Conversion Cycle (CCC) measure?

Answer 19

Answer: The CCC measures how efficiently a company converts its investments in inventory and other resources into cash inflows from sales. It represents the time taken to turn investments into cash.

Question 20

Question: How can a company reduce its Cash Conversion Cycle (CCC)?

Answer 20

Answer:

Reduce inventory levels (risk: supply chain disruptions).
Accelerate receivables collection (risk: lost sales).
Extend payables period (risk: supplier relationship issues).

Question 21

Question: What can increase a company’s liquidity risk?

Answer 21

Answer:

Drags on Liquidity: Excess inventory, slow receivables collection.
Pulls on Liquidity: Faster supplier payments, reduced credit availability.
Seasonality & Business Cycles: Can cause fluctuations in CCC an

Question 22

Q: What are the four types of capital investments?
A: The four types are:

Going concern projects – Maintain business operations or reduce costs.
Regulatory/compliance projects – Required by government or insurers, often safety/environmental-related.
Expansion projects – Grow the business by entering new markets or launching new products.
Other projects – Investments outside existing business lines, often high-risk and similar to startups.

Question 23

Q: What are the four steps in the capital allocation process?

Answer 23

A:

Idea Generation – Identify project opportunities from internal and external sources.
Analyzing Project Proposals – Forecast cash flows and determine expected profitability.
Creating the Capital Budget – Prioritize projects based on strategic fit and available resources.
Monitoring & Post-Audit – Compare actual vs. projected results and refine forecasting methods.

Question 24

Q: What is Internal Rate of Return (IRR), and how is it used in investment decisions?

Answer 24

A: IRR is the discount rate that makes the NPV of a project equal to zero.

If IRR > required rate of return, accept the project.
If IRR < required rate of return, reject the project.
Advantages:
✔ Measures profitability as a percentage.
✔ Indicates margin of safety before a project becomes unprofitable.

Disadvantages:
✖ Assumes reinvestment at IRR, which may be unrealistic.
✖ Can produce multiple IRRs if cash flow patterns are unconventional.

Question 25

Q: What are the key differences between NPV and IRR?

Answer 25

A: NPV: Measures total value added to the firm. Preferred for decision-making. IRR: Measures return percentage but can be misleading due to reinvestment assumptions and multiple IRRs. NPV is generally the superior method because it directly reflects changes in shareholder value.

Question 26

Which of the following is most likely a going concern project? A) Opening a retail outlet in a new region. B) Acquiring and merging with a supplier to secure a source for a key component. C) Purchasing a new model of a factory machine that will decrease unit production costs.

Answer 26

Explanation Going concern projects are those to maintain the business or to increase the efficiency of existing operations. The other two projects are business growth investments that increase the size of the company. (Module 24.1, LOS 24.a)

Question 27

In the capital allocation process, a post-audit is used to: A) improve cash flow forecasts and stimulate management to improve operations and bring results into line with forecasts. Correct Answer B) improve cash flow forecasts and eliminate potentially profitable but risky projects. Incorrect Answer C) stimulate management to improve operations, bring results into line with forecasts, and eliminate potentially profitable but risky projects.

Answer 27

Explanation A post-audit identifies what went right and what went wrong. It is used to improve forecasting and operations. (Module 24.1, LOS 24.b)

Question 28

What should capital allocation decisions be based on?

Answer 28

Back: ✅ After-tax cash flows, not accounting income. 💡 Key Points: Accounting income includes accruals and ignores cash timing. Firm value is based on cash flows firms keep, not those paid in taxes. Depreciation & amortization create tax savings and should be included.

Question 29

Front: 📌 Which cash flows should be considered in capital budgeting?

Answer 29

Back: ✅ Incremental cash flows only 💡 Key Points: Ignore sunk costs (e.g., past consulting fees). Consider cannibalization (when a new product reduces existing sales). Positive externalities (new projects boosting other products) should be included.

Question 30

Front: 📌 Why is the timing of cash flows important?

Answer 30

Back: ✅ The time value of money 💡 Key Points: Money received earlier is worth more than money received later. Future cash flows should be discounted to reflect their present value.

Question 31

Front: 📌 What are common cognitive errors in capital budgeting?

Answer 31

Back: ❌ Poor forecasting (e.g., ignoring competitor responses). ❌ Not considering the cost of internal funds (should match cost of equity). ❌ Incorrectly accounting for inflation (nominal vs. real analysis mismatch).

Question 32

Front: 📌 What are behavioral biases that affect capital allocation?

Answer 32

Back: ❌ Pet projects may receive biased projections. ❌ Anchoring to past budgets prevents proper allocation. ❌ Focusing on EPS/ROE may lead to rejecting profitable long-term projects. ❌ Failing to generate alternative ideas can cause missed opportunities.

Question 33

Front: 📌 What are types of real options in capital investments?

Answer 33

Back: ✅ Timing options: Delay investment for better info. ✅ Abandonment options: Exit if future cash flows are negative. ✅ Expansion options: Scale up investment if profitable. ✅ Flexibility options: Adjust pricing or production methods. ✅ Fundamental options: Value depends on external factors (e.g., commodity prices).

Question 35

Front: 📌 What factors affect a company's capital structure?

Answer 35

Back: ✅ Internal Factors: Revenue stability & growth 📈 Predictability of cash flows 💰 Business risk (e.g., demand volatility) ⚠️ Asset liquidity & collateral availability 🏦 ✅ External Factors: Market & business cycle conditions 📊 Regulation & industry norms 📜 Cost & availability of debt financing 💵

Question 36

Front: 📌 How does a company’s business model affect its ability to take on debt?

Answer 36

Back: ✅ Companies with stable & recurring revenues can take on more debt. Noncyclical industries (e.g., utilities) support higher debt than cyclical industries. Low fixed costs (low operating leverage) → Higher debt capacity. Subscription models (Netflix) > Pay-per-use models (movie theaters) in debt capacity. More tangible assets = Easier to use as collateral for loans.

Question 37

Front: 📌 How does a company's life cycle stage impact its capital structure?

Answer 37

Back: ✅ Start-up Stage: High risk, low assets → Mostly equity financing. ✅ Growth Stage: Rising revenue → Conservative use of debt (secured by assets). ✅ Mature Stage: Stable cash flows → Can support more debt, including unsecured debt.

Question 38

Front: 📌 How do macroeconomic factors influence the cost of capital?

Answer 38

Back: ✅ Top-down factors affecting WACC: Inflation 📈 → Increases interest rates & cost of debt. GDP growth 📊 → Impacts investor risk appetite. Monetary policy 💰 → Central bank rates affect corporate borrowing costs. Exchange rates 🌍 → Can impact multinational firms’ cost of capital. Credit spreads 📉 → Higher spreads = higher debt costs.

Question 39

A company is most likely to be financed only by equity during its: A) start-up stage. B) growth stage. C) mature stage.

Answer 39

Explanation During the start-up stage, a firm is unlikely to have positive earnings and cash flows or significant assets that can be pledged as debt collateral, so firms in this stage are typically financed by equity only. (Module 25.1, LOS 25.b)

Question 40

What is the weighted-average cost of capital (WACC)?

Answer 40

Back: WACC is the blended cost of a company's debt and equity, reflecting the return required by investors and lenders.

Question 41

Why is the cost of debt typically lower than the cost of equity?

Answer 41

Back: Debt holders have priority claims over equity holders, and interest expenses on debt are often tax-deductible.

Question 42

What are the key factors that affect a company's capital structure?

Answer 42

Back: Factors include revenue stability, cash flow predictability, business risk, asset liquidity, and debt financing costs.

Question 43

How does industry type influence a company’s capital structure?

Answer 43

Back: Noncyclical industries with stable revenues can take on more debt, while cyclical industries with volatile earnings tend to rely more on equity.

Question 44

What role do tangible assets play in debt financing?

Answer 44

Back: Tangible assets serve as collateral, making debt financing easier and reducing borrowing costs.

Question 45

How do start-up companies typically finance their operations?

Answer 45

Back: Start-ups rely mostly on equity due to high business risk, lack of collateral, and uncertain cash flows.

Question 46

How do business cycles impact the cost of capital?

Answer 46

Back: During downturns, credit spreads widen, making debt more expensive, while in strong economies, borrowing costs decrease.

Question 47

What are some macroeconomic factors that influence a company's cost of capital?

Answer 47

Back: Inflation, GDP growth, monetary policy, and exchange rates all affect interest rates and credit spreads.

Question 48

A company's optimal capital structure: A) maximizes firm value and minimizes the weighted-average cost of capital. B) minimizes the interest rate on debt and maximizes expected earnings per share. C) maximizes expected earnings per share and maximizes the price per share of common stock.

Answer 48

Explanation The optimal capital structure minimizes the firm's WACC and maximizes the firm's value (stock price). (Module 25.2, LOS 25.c)

Question 49

Which of the following statements regarding Modigliani and Miller's Proposition II with no taxes is most accurate? A) A firm’s cost of debt financing increases as a firm’s financial leverage increases. B) A firm’s weighted-average cost of capital is not affected by its choice of capital structure. C) A firm’s cost of equity financing increases as the proportion equity in a firm’s capital structure is increased.

Answer 49

Explanation MM's Proposition II (with no taxes) states that capital structure is irrelevant because the decrease in a firm's WACC from additional debt financing is just offset by the increase in WACC from a decrease in equity financing. The cost of debt is held constant, and the cost of equity financing increases as the proportion of debt in the capital structure is increased. (Module 25.2, LOS 25.c)

Question 50

What is a business model?

Answer 50

Back: A business model explains how a firm provides a product or service, finds customers, delivers the product or service, and makes a profit.

Question 51

What are the key components of a business model?

Answer 51

Back: A business model answers five key questions: Who? Identifies potential customers. What? Defines the product or service and its differentiation. How? Describes key assets and suppliers. Where? Explains sales channels and delivery methods. How much? Determines pricing strategy.

Question 52

What are some common pricing strategies?

Answer 52

Back: Price takers: Commodity producers (e.g., oil). Price makers: Companies with differentiated products (e.g., patented drugs). Price discrimination: Different pricing for different customers (e.g., tiered or dynamic pricing). Bundling: Selling complementary products together. Freemium: Basic service is free, with paid premium features.

Question 53

What are common business model variations?

Answer 53

Back: B2B (Business-to-Business): Selling to companies. B2C (Business-to-Consumer): Selling directly to consumers. Subscription: Recurring revenue model (e.g., Netflix). Licensing & Franchising: Using a brand or product for a fee (e.g., biotech licensing a drug). Hidden Revenue: Free products supported by ads (e.g., Google Search).

Question 54

What is the value chain in a business model?

Answer 54

Back: A firm's value chain refers to how it creates value through its operations, including: Inbound logistics Operations Outbound logistics Marketing Sales & service

Question 55

What are network effects and crowdsourcing?

Answer 55

Back: Network effects: A business becomes more valuable as more users join (e.g., eBay, Facebook). Crowdsourcing: Users contribute to the business (e.g., Wikipedia, Waze).