Mod 4

Question 1

Nexus of Contracts

Answer 1

The view that a firm creates a web of contracts with its owners, lenders, customers, employees, suppliers, and other counterparties as it pursues value creation

Question 2

Residual Claimant

Answer 2

Owner who has the lowest priority claim on the cash flow of the firm

Question 3

Sole Proprietorship

Answer 3

A business owned by a single individual

Question 4

Sole Proprietorship Advantages

Answer 4

Easy to start

Little reguation

Owner makes all of the decisions

Owner gets all the profit

Business income taxed as personal income

Question 5

Sole Proprietorship Disadvantages

Answer 5

Unlimited liability

Don’t benefit from specialization

Difficult to transfer ownership

Mortality of owner

Limited access to capital

Question 6

Unlimited Liability

Answer 6

Creditors can look beyond the business assets to the proprietor’s personal assets for payment

Question 7

Illiquidity

Answer 7

Inability to sell an asset quickly at its fair market value

Question 8

Problem of Asymmetric Information

Answer 8

Transaction where the buyer and seller have different information sets.

When one party has superior info and the other inferior, it can be difficult and costly to arrive at mutually agreeable terms

Question 9

Coincidence of Skills

Answer 9

Must find someone who has the necessary skills to operate the business

Question 10

Partnership

Answer 10

A business formed by 2 or more individuals or entities

Question 11

General Partnership

Answer 11

All partners share in the gains and losses

All have unlimited liability for all partnership debts

Question 12

Limited Partnership

Answer 12

A special type of partnership with 2 types of partners

Question 13

General Partner

Answer 13

General partners contribute money and make business decisions. They face unlimited liability

Question 14

Limited Partner

Answer 14

Limited partners provide capital to the business but don’t participate in day-to-day decisions. They have limited liability

Question 15

Partnership Agreement

Answer 15

A contract that outlines the rules under which a partnership operates.

Includes provisions for the distribution of profits, obligations of partners, procedures for selling ownership interest, and mechanisms for conflict resolution

Question 16

Partnership Advantages

Answer 16

Profits taxed at personal rate

Gains from specialization

Increased access to capital

Question 17

Partnership Disadvantages

Answer 17

Unlimited liability

Difficult to transfer ownership

Question 18

Bylaws

Answer 18

Rules and procedures that govern the operation of the business

Question 19

Board of Directors

Answer 19

The elected representatives of the shareholders who have a fiduciary obligation to act in the interest of the stockholders

Question 20

Stockholders

Answer 20

Owners of a corporation

Question 21

Limited Liability

Answer 21

When the maximum loss an owner can realize is their investment in the business

Question 22

Liquidity

Answer 22

Increased liquidity

Question 23

Corporation Advantages

Answer 23

Limited liability
Ability to raise lots of capital
Unlimited life
Increased liquidity
Specialization

Question 24

Double Taxation

Answer 24

Profits pay corporate income tax and dividends to shareholders are taxed at the personal level

Question 25

Agency Relationship

Answer 25

The principal hires an agent to act in their best interest

Question 26

Public Company

Answer 26

Company whose shares trade on at least 1 stock exchange

Question 27

S Corporation

Answer 27

Corporation with 100 or fewer owners Taxed at the personal rate

Question 28

C Corporation

Answer 28

Corporation with more than 100 owners Pay corporate income tax and dividend distributions are taxed at the personal level

Question 29

Corporation Disadvantages

Answer 29

Double taxation Increased regulation Agency costs

Question 30

Goal of the firm

Answer 30

Maximize value for the firm

Question 31

Value

Answer 31

What a business is worth

Question 32

How to Create Value

Answer 32

Make good long term investments Finance investments in an optimal way Well run day-to-day operations

Question 33

Agent

Answer 33

Party in an agency relationship hired to act in the principals best interest

Question 34

Principal

Answer 34

The party in an agency relationship who hires an agent to act in their best interest

Question 35

Agent Principal Problem

Answer 35

Possibility of a conflict of interest between the principal and the agent

Question 36

Mitigate Agent Principal Problem

Answer 36

Executive compensation Take over threat and market for executive talent Regulation

Question 37

Sarbanes Oxley Act (SOX)

Answer 37

US law designed to improve the reliability of financial statements of public companies and increase the penalties to company executives for fraudulent financials

Question 38

Stakeholder

Answer 38

Someone other than a stockholder who potentially has a claim on the cash flows of the firm

Question 39

Debt

Answer 39

Funding of a business enterprise that comes from lenders

Question 40

Dividend

Answer 40

When a corporation disgorges its profits to stockholders

Question 41

Buyback

Answer 41

When a corporation uses profits to buy its shares in secondary markets

Question 42

Capital Budgeting

Answer 42

Process of planning and managing a firm’s long term investments

Question 43

Capital Structure

Answer 43

Mixture of debt and equity maintained by a firm

Question 44

Equity

Answer 44

Funding of a business enterprise that comes from owners

Question 45

Primary Market

Answer 45

Capital market where an economic agent issues new securities in return for cash Original sale of securities by governments and corporations

Question 46

Secondary Market

Answer 46

Capital market where existing securities trade between parties but the cash does not flow back to the issuer of the security

Question 47

Contract

Answer 47

A binding written or oral agreement between 2 or more parties

Question 48

Corporation

Answer 48

A business created as a distinct legal entity from the owners, stockholders, or shareholders. The corporation is liable for the claims of creditors, not owners, providing the shareholders limited liability

Question 49

Initial Public Offering

Answer 49

When shares of a corporation become available to the public at large for the first time

Question 50

Market Capitalization

Answer 50

Market value of a corporation Price per share x # of shares outstanding

Question 51

Monitoring

Answer 51

Principals spend time, money, and effort to watch the activities of their agents in order to alleviate agency problems

Question 52

Securities and Exchange Commission

Answer 52

A federal gov body whose mandate is to protect investors and promote fair well-functioning markets

Question 53

Shares of Stock

Answer 53

Standardized ownership claims on a corporation which convey certain rights to the shareholders, such as voting on the board of directors and sharing in dividends

Question 54

Volume

Answer 54

Number of secondary market trades take place over a period of time