Topic 2 - The Business-Finance Environment

Question 1

What is a Sole Proprietorship (x3)

Answer 1

1. A business owned by one person
2. The owner receives all the profits
3. The owner has unlimited liability

Question 2

What is a Partnership (x4)

Answer 2

1. A business owned by two or more people
2. Owners receive all profits
3. Unlimited liability
4. Partnership agreement (describes how profits and losses should be divided amongst partners)

Question 3

What is a Limited Corporation

Answer 3

1. A distinct legal entity that is separate from its owners
2. Ownership of a limited corporation is represented by shareholders
3. Shareholders have limited liability
4. Separation of shareholders and managers (large corporations)

Question 4

What happens in Single-tier board countries in terms of Separation of Ownership and Control of a corporation

Answer 4

The shareholders elect
the board of directors, who then select the managers

Question 5

What happens in two-tier board countries in terms of Separation of Ownership and Control of a corporation

Answer 5

A supervisory board (representatives of the major shareholders and employee groups) monitor the activities of an executive board who are responsible for managing the day-to-day operations of the corporation

Question 6

What Key Financial Decisions do the managers of the firm have to make (x3)

Answer 6

1.What long term investments should be undertaken?
2. How will those long-term investments be funded?
3. How should the firm’s short-term cash flow be managed?

Question 7

What is the difference between Financing decisions and Investing decisions

Answer 7

Financing decisions are those which focus on how a firm should raise money.
Investment
(or capital budgeting) decisions determine how the firm should invest the money it raises
from its funding activities.

Question 8

What is the role and overall goal of Financial management

Answer 8

Role - the bridge between a firm’s operations and the wider financial markets
Overall goal - to maximise the value of equity for the owners

Question 9

What is the Principal-Agent problem and when does it occur

Answer 9

When the principal hires the agent to manage their interests (the shareholders of the firm (principals) hire managers (agents) to run the corporation)
Managers may be tempted to act in their own interests, rather than trying to maximise the value of equity for the owners.

Question 10

What is an Agency cost

Answer 10

The value lost from the agency problem

Question 11

What are some mechanisms that shareholders of a firm might use to try and alleviate the Agency problem (x3)

Answer 11

1. Managerial compensation - managers may be given contracts in which their compensation is tied to the success of the corporation
2. Control of the firm - shareholders elect the board of directors who make decisions about hiring and firing
3. Corporate governance - laws, regulations, and corporate practices that protect shareholders