Chapter 1 Corporate Finance and the Financial Manager 1

Chapter 1
Corporate Finance and the Financial Manager

 Answers to Concept Check Questions

What are the advantages and disadvantages of organizing a business as a corporation?

AdvantagesDisadvantages

Corporation responsible for obligations not responsible for obligations of owners

More expensive to set updouble taxation

More borrowing power/fundingarticles of incorporation

What is the limited liability partnership (LLP)? How does it differ from a limited partnership?

A LLP is similar to a general partnership in that the partners can be active in the management of the firm, and they do have a degree of unlimited liability. The limitation on a partner’s liability is only in cases related to actions of negligence of other partners or those supervised by other partners. I n all other respects, including a particular partner’s own negligence or the negligence of those supervised by the particular partner, that partner has unlimited personal liability. Limited partners, however, have limited liability —that is, their liability is limited to their investment. Their private property cannot be seized to pay off the firm’s outstanding debts

What is an income trust? Which type of trust will get preferential tax treatment after 2011?

Canada Revenue Agency allows an exemption from double taxation for certain flow-through entities where all income produced by the business flows to the investors and virtually no earnings are retained within the business. These entities are called income trusts and they come in three forms. A business income trust an energy trust and a real estate investment trust (REIT). Income trusts formed before November 2006 are not taxed at the business level until 2011. REITs will continue to have no tax at the business level beyond 2011, but the other forms of income trusts will not.

What are the main types of decisions that a financial manager makes?

The financial manager has three main tasks:

make investment decisions – capital budgeting investment opportunities,
make financial decisions – balance between debt and equity and the capital structure,
management of the short term cash needs – cash planning for the firm.

What is the goal of the financial manager?

Although there many potential goals for the financial manager, the financial manager is the caretaker of the money (capital) the shareholders have invested in the company and the bottom line is the long term maximization of shareholder wealth

How do shareholders control a corporation?

Shareholders control the corporation through their voting rights; however directors and executive are rarely replaced though a grass roots shareholder uprising.If shareholders are unhappy with a CEO’s performance, they could, in principle, pressure the board to oust the CEO. Instead, dissatisfied investors often choose to sell their shares. Of course, somebody must be willing to buy the shares from the dissatisfied shareholders. If enough shareholders are dissatisfied, the only way to entice investors to buy (or hold) the shares is to offer them a low price. Similarly, investors who see a well-managed corporation will want to purchase shares, which drives the stock price up. Thus, the stock price of the corporation is a barometer for corporate leaders that continuously gives them feedback on the shareholders’ opinion of their performance.

What types of jobs would a financial manager have in a corporation?

There are various positions within a corporation that a financial manage may hold. The financial manager could hold the position of Chief Financial Officer, Controller, Treasurer, Budgeting, Risk Management or Credit Management.

What ethical issues could confront a financial manager?

Managers, despite being hired as the agents of shareholders, put their own self-interest ahead of the interests of those shareholders (also called the principals). Managers face the ethical dilemma of whether to do what is in their own best interests or adhere to their responsibility to put the interests of shareholders first, For example, managers’ compensation contracts are designed to ensure that m ost decisions in the shareholders’ interests are also in the managers’ interests; shareholders often tie the compensation of top managers to the corporation’s profits or perhaps to its stock price. For example, biotech firms take big risks on drugs that fight cancer, AIDS, and other widespread diseases. The market for a successful drug is huge, but the risk of failure is high. Investors who put only some of their money in biotech may be comfortable with this risk, but a manager who has all of his or her compensation tied to the success of such a drug might opt to develop a less risky drug that has a smaller market.

What advantages does a stock market provide to corporate investors?

Markets provide liquidity for a company’s shares and determine the marketprice for those shares. An

investor in a public company values the ability to turn his investment into cash easily and quickly by simply selling his shares on one of these markets. The analysis and trading by participants in these markets provide an evaluation of financial managers’ decisions that not only determine the stock price, but also provide feedback to the managers on their decisions.

What is the importance of a stock market to a financial manager?

The analysis and trading by participants in these markets provide an evaluation of financial managers’ decisions that not only determine the stock price, but also provide feedback to the managers on their decisions.

What is the basic financial cycle?

In the financial cycle, (1) people invest and save their money, (2) that money, through loans and stock, flows to companies that use it to fund growth through new products, generating profits and wages, and (3) the money then flows back to the savers and investors. All financial institutions play a role at some point in this cycle of connecting money with ideas and returning the profits back to the investors.

What are the three main roles financial institutions play?

Financial institutions have a role beyond moving funds from those who have extra funds (savers) to those who need funds (borrowers and firms): they also move funds through time.