Week 11 - Managerial Finance Flashcards

Question

What is a partnership?

Answer 1

owned by two or more owners can be limited liability (limited partnership) or unlimited liability (general partnership) ownership is combined with management responsibilities legal contract of partnership required examples: many legal and accounting firms

Answer 2

Advantages: Shared responsibility, more capital can be raised, and different skill sets can be brought to the table. Disadvantages: Unlimited liability (in general partnerships), potential for conflicts between partners, and shared profits.

Answer 3

owned by many shareholders limited liability (shareholders are only liable up to the amount of their investment in the company) ownership and control may be separate, shareholders elect a board of directors who appoint management the company is managed by a separate team, not the owners

Answer 4

Advantages: Limited liability, easier to raise capital (through stock issuance), and continuity of the business (it doesn't end if the owner/shareholder dies). Disadvantages: More complex to set up and maintain, subject to regulations and taxation at both the corporate and shareholder level (double taxation), and less control for individual owners.

Answer 5

investors are personally responsible for all business debts, even beyond the amount they invested

Answer 6

the most an inventor can lose is the amount they initially invested into the business their personal assets are protected from business debts

Answer 7

In the event that the business fails or accrues debts it cannot pay, the owners may have to use their personal assets (like their home, savings, etc.) to cover the liabilities.

Answer 8

If the business goes bankrupt or faces legal claims, shareholders or investors are only at risk for the value of their investment (e.g., the money they spent to purchase shares in a corporation).

Answer 9

Debt holders (creditors) are typically promised a fixed amount, £F, which is the face value of the debt (for example, the principal amount of a bond). If the value of the firm is less than the debt value (£F), debt holders receive whatever the firm is worth (X), since the firm cannot repay the full debt. If the value of the firm is greater than or equal to the debt value (£F), debt holders receive the full promised amount, which is £F algebraically as: Debt holder’s claim = min(£F, X) £F is the face value of the debt. X is the actual value of the firm.

Answer 10

Equity holders (shareholders) are entitled to the remaining value of the firm after debt holders have been paid If the value of the firm is less than the debt value (£F), there is no remaining value for equity holders, so they receive nothing. If the value of the firm is more than the debt value (£F), equity holders receive everything above the debt value, i.e., the remaining value after debt is paid off. algebraically as: Shareholder’s claim = max(0, X – £F) £F is the face value of the debt. X is the actual value of the firm.

Answer 11

x axis, Value of the firm (X) y axis, Payoff to debt holders line is upward sloping then is horizontal if the value of the firm is more than £F. debt holders get a maximum of £F

Answer 12

x axis, Value of the firm (X) y axis, Payoff to shareholders line is horizontal on the x axis a bit then is upward sloping if the value of the firm is less than £F, shareholders get nothing

Answer 13

1. Hire professional management to run the company (CEO, CFO..) 2. This management buys productive assets (property, equipment...) 3. They can buy these assets by borrowing money (debt), or by attracting shareholder's capital (equity) by selling shares essentially the corporation is a legal entity and is a separate 'person' away from owners (shareholders) 4. Debt holders provide the corporation with debt financing, lend money to the corporation in exchange for interest payments, talk directly to management about whether their debt is going to be repaid 5. Shareholders do not directly have control over management, they invest in the corporation by buying equity (shares of stock), they are last to get money out of the assets, dont have control over a corporation. They get voting rights and allowed to vote for the directors on the board 6. Board of directors, an oversight committee, look after the shareholders, can replace bad managers and the course of where the corporation is going

Answer 14

someone who provides funds, takes the business risk and doesnt have any claim to pre-specified payment like debt holders shareholders provide the funds necessary to finance the company by buying equity (shares) debt holders (creditors) provide funds by lending money to the corporation, usually in the form of bonds or loans

Answer 15

Shareholders take the business risk because their returns (if any) depend on the company’s performance. If the company does well, shareholders benefit through dividends and capital gains (increase in stock price). If the company performs poorly or goes bankrupt, shareholders may lose all or part of their investment. Debt holders face some risk, but they are not exposed to the upside of the business as shareholders are. They are entitled to a fixed payment (interest) and repayment of principal, regardless of the company’s performance, but they do face risk if the company defaults or goes bankrupt.

Answer 16

Shareholders have a direct financial stake in the corporation as owners. They benefit from the corporation’s success (through dividends and capital gains) but are last in line to get paid if the company faces financial difficulty. Debt holders (creditors) also have a financial stake because they provide loans to the company. They are entitled to receive their principal plus interest. While they don't benefit from the upside (like shareholders), they are more secure because they are paid before shareholders in the event of liquidation. those who do not provide finance - employees, customers, supplies, government (dont own shares)

Answer 17

1. Board of Directors 2. Chairman of the Board and Chief Executive Officer (CEO) 3. President and Chief Operations Officer (COO) 3a. Vice President Marketing 3b. Vice President Finance (CFO) i. Treasurer ii. Controller 3c. Vice President Production

Answer 18

institutes rules and policies thats set by the board of directors

Answer 19

responsible for the day-to-day activity of the company and the person reports back to the CEO

Answer 20

responsible for managing financial risk for a company has two teams that this person manages, treasurer and controller

Answer 21

this person takes care of the accounting function, so record keeping

Answer 22

manages cash, financial planning and capital expenditure

Answer 23

financial management decisions including capital budgeting, capital structure, working capital management and forms of business organisation including sole proprietorship, partnership and corporation

Answer 24

1. Capital budgeting 2. Capital structure 3. Working capital management

Answer 25

Capital budgeting is the process of planning and evaluating the long-term investments that a corporation will make. How to Spend Money: It involves deciding how to spend money to maximise the company’s value. The focus is on evaluating investment opportunities and deciding which projects or assets will provide the best return over time.

Answer 26

Capital structure refers to the way a company finances its operations and investments, primarily through a mix of debt (borrowed funds) and equity (ownership funds). How to Raise Money: One of the primary decisions in financial management is determining the optimal mix of debt and equity. The goal is to balance risk and return while minimising the cost of capital.

Answer 27

Working capital management involves managing the company’s short-term assets and liabilities, ensuring that the company has enough liquidity to meet its short-term obligations and operational needs. How to Manage Day-to-Day Cash Flow: Effective working capital management ensures that the company can maintain optimal liquidity and avoid financial difficulties

Answer 28

the value of the firm can be compared to a pie (represents everything the company owns, including its assets and its ability to generate future cash flows. This value is the total worth of the firm, and it is what shareholders, debt holders, and other stakeholders are interested in) the capital structure decision can be viewed as how best to slice up the pie (divide this pie among the different sources of capital—mainly debt and equity) the goal of the manager is to increase the size of the pie (total value of the firm, through investment, financial decisions, business operations) if how you slice the pie affects the size of the pie (whether to use more debt or more equity to finance the company affects the firm’s cost of capital and its overall risk profile)

Answer 29

to maximise shareholder value This goal focuses on increasing the current value per share of the company’s stock, which ultimately reflects the market value of the existing owners' equity achieved through: profit maximisation, cost minimisation, increased market share, effective capital allocation, risk management, long term planning...

Answer 30

the financial managers should act in the best interests of the stockholders

Answer 31

someone (principal) hires another (agent) to represent his or her interests, eg shareholders and management (i.e., maximizing the stock price or the market value of the company’s equity). However, there is the potential for a conflict of interest between the managers and the shareholders, known as the agency problem

Answer 32

agents' (manager) interest might be different from the principals' (shareholders) goal - 'conflict of interest' This happens because the agent may pursue their own personal goals or interests, rather than focusing solely on maximising shareholder wealth

Answer 33

to have a luxurious office or private jet to spend more time with their families (might not work hard to maximise shareholders value) to build an empire (making a firm as large as possible by raising funds and investing them, even into money-losing businesses)

Answer 34

Eg Own an old car you want to sell Possible price £1000-£2000 Hire a friend to sell it for you, offer £100 to help you, does she have the incentive to try hard and sell it for £2000 probably not how to solve this agency problem: closely monitoring Change your offer to 10% of the sales price

Answer 35

managerial compensation and corporate control

Answer 36

incentives can be used to align management and stockholder interests incentives need to be carefully structured to ensure that they achieve their goal (use of stock options, bonuses and promotions)

Answer 37

internal control: replace bad managers, performance reviews of managerial effectiveness external control: threat of a takeover may result in better management, firms with poor management may be taken over

Answer 38

1. the corporation will issue financial securities onto the market to raise funds, and the investors will give cash to the corporation (money flows to the company from the investors) this money will be used to invest in productive assets (manufacturing, technology) 2. these productive assets should generate cash, cash flow from assets will flow out of the company 3. this cash flow is used to pay taxes to the government, pay stakeholders, salaries. alot of this gets reinvested back into the company. also can include debt payments 4. goal is to try get the dividends and debt payments over long period of time to be larger than the cost to the investors initially

Answer 39

markets where debt and equity securities are bought and sold

Answer 40

1. London Stock Exchange (LSE) 2. New York Stock Exchange (NYSE)

Answer 41

where securities are issued for the first time, raising finance through capital markets (ie equity, bonds) and the money goes directly to the company or government that issued the securities. The issuer then uses the funds for its intended purpose (e.g., investment in capital projects or business expansion).

Answer 42

The primary market serves as a means for companies to raise funds by offering new securities (stocks or bonds) to investors. This money raised is used by the company to fund operations, expand, invest in new projects, or reduce debt.

Answer 43

Initial Public Offerings (IPOs): A company may issue shares to the public for the first time via an IPO. The company sells shares to investors, and the funds raised go directly to the company. Bond Issuances: Companies or governments may also issue bonds to raise money. Investors purchase the bonds, and the issuer agrees to pay interest and return the principal at maturity.

Answer 44

once securities have been issued in the primary market, they can be traded traded between investors and the money goes to the 'owner' of securities. The company that issued the securities doesn't receive any proceeds from these transactions. The exchange of money occurs solely between investors.

Answer 45

The secondary market allows investors to buy and sell securities after they have been issued. This provides liquidity to investors, as they can sell their holdings if they need cash or want to adjust their portfolio.

Answer 46

Stock Exchanges: The London Stock Exchange (LSE) and New York Stock Exchange (NYSE) are examples of secondary markets where investors buy and sell stocks and bonds. Over-the-Counter (OTC): Some securities are traded in decentralised markets, called over-the-counter markets, where dealers negotiate directly.

Answer 47

. Stocks and bonds Firms-------------->Investors Money securities <------------| A------>B| {Primary market} <------- money {secondary market}

Answer 48

companies, governments and individuals to increase their investment choices

Answer 49

invest in financial assets so they can defer consumption and earn a return to compensate them for doing so

Answer 50

raise capital by issuing securities, enabling them to invest in productive assets, fund operations.. since they have better access to the capital

Answer 51

information about the returns that are required for various levels of risk

Answer 52

future cash flows

Answer 53

1. maturity 2. frequency of expected payments 3. uncertainty of cash flows and/or final price 4. ordering of repayment in case of bankruptcy

Answer 54

short term maturity (usually less than 1 year) issues by government, financial institutions or corporations often used to meet short-term funding needs or manage short term liquidity

Answer 55

maturity usually longer than 1 year, issues by governments or corporations eg US treasury bonds (government bonds) or corporate bonds issued by companies like Apple or Microsoft

Answer 56

Government Bonds: These are typically long-term instruments with fixed interest (coupon) payments, paid periodically (e.g., semi-annually or annually). They are relatively low-risk, especially if issued by stable governments.

Answer 57

Corporate Bonds: Issued by companies. Bondholders are entitled to cash payments (coupons) before equity holders in case of liquidation. Corporate bonds are riskier than government bonds but often provide higher returns.

Answer 58

no maturity variable payments: Shareholders may receive dividends, which are not guaranteed and can vary based on the company's performance and decisions made by its board of directors. Last to be paid in bankruptcy: In the event of liquidation, equity holders are the last to be paid after debt holders and other creditors have been satisfied. Therefore, equity securities are considered riskier than debt securities. Example: Shares of Apple, Tesla, or other public companies.