1. Goals and Governance of the Corporation

Plant and machinery, office buildings, and vehicles are (BLANK) assets

tangible

Brand names and patents are (BLANK) assets

intangible

Corporations finance assets by

1. borrowing
2. reinvesting profits back into the firm
3. selling additional shares

Investment decisions do what?

spend money

Financing decisions do what?

raise money for investment

The financial goal of the corporation is

maximizing value

Financial managers add value whenever the (BLANK) can (BLANK) to earn a (BLANK) return than its (BLANK) can earn for themselves

corporation, invest, higher, shareholders

corporate governance helps to align the interests of

managers and shareholders

investment forms that provide funds and advice to young companies in return for a partial ownership share

venture capitalists

Decision to invest in tangible or intangible assets

capital budgeting or capital expenditure (CAPEX) decision

decision on the sources and amounts of financing

financing decision

assets used to produce goods and services

real assets

financial claims to the income generated by the firm’s real assets

financial assets

When a company needs to raise money it can either invite (BLANK) to put up cash in exchange for a share of (BLANK), or it can promise to pay back the (BLANK)

investors, ownership, investors’ cash plus a fixed rate of interest

Investors that receive shares of stock and become shareholders, part-owners of the corporation

equity investors

equity investors contribute

equity financing

investors that lend cash and get repaid cash plus a fixed rate of interest later

debt investors

debt investors are

lendors

the choice between debt and equity financing is often called the

capital structure decision

the firm’s sources of long-term financing

capital

A firm that is seeking to raise long-term financing is said to be

raising capital

When a firm invests in something to produce the firm’s goods and services, it acquires

real assets

The firm finances its investment in real assets by issuing (BLANK) to investors

financial assets

Shares of stock and bank loans are (BLANK) assets

financial

Financial assets that can be purchased and traded by investors in public markets are called

securities

Financial managers say that “value comes mainly from the (BLANK) side of the balance sheet”

investment

If Microsoft shares traded for $230 each and there were 7.56 billion shares outstanding then Microsoft’s market value, market capitalization, or market cap is

$1,739 billion

Financing decisions add (BLANK) value compared to good investment decisions

less

a. Capital budgeting
b. financing
c. Capital budgeting
d. Capital budgeting
e. Both

The investment decision =

purchase of real assets

The financing decision =

sale of financial assets

a. real
b. financial
c. real
d. financial
e. real
f. financial

A business organized as a separate legal entity owned by stockholders

corporation

the owners of a corporation are not personally liable for its obligations

limited liability

set out the purpose of the business and how it is to be financed, managed, and governed

articles of incorporation

A corporation’s owners are called

shareholders or stockholders

A corporation is legally distinct from the shareholders. Therefore, the shareholders have (BLANK) and cannot be held personally responsible for the corporation’s debts

limited liability

Shareholders can lose their entire investment in a corporation, but

no more

Incorporation means that the bank will be more cautious in lending to you because it will have no recourse to your

other assets

When a corporation is first established and the shares are not publicly traded the company is said to be

closely held

When new shares are issued to raise additional capital, corporations are called

public companies

Public shareholders elect a (BLANK) who appoint the top managers and monitor their performance

board of directors

Makes corporations able to, in principle, live forever as even if managers quit or are dismissed, the corporation survives

separation of ownership and control

The separation of corporate ownership and control can also have a downside as it can open the door for managers and directors to act in their

own interests

Income generated by businesses that are not incorporated is taxed just once as

personal income

An important tax drawback to corporations is that they are a separate legal entity and are taxed

separately

supervises all financial functions and sets overall financial strategy

chief financial officer (CFO)

is the most important financial voice of the corporation and explains earnings results and forecasts to investors and the media

chief financial officer (CFO)

Responsible for financing, cash management, and relationships with banks and other financial institutions.

treasurer

Responsible for budgeting, accounting, and taxes.

controller

Below the CFO are usually a (BLANK) and a (BLANK)

treasurer, controller

main function is to obtain and manage the firm’s capital

treasurer

ensures that the money is used efficiently

controller

Treasurer: Fritz
Controller: Frieda

anyone responsible for an investment or financing decision

financial manager

A corporation’s roster of shareholders will usually include both (BLANK) and (BLANK) investors

risk-averse, risk-tolerant

No

The natural financial goal of the corporation is to maximize

market value

If the return offered by the investment project is higher than the rate of return that shareholders can get by investing on their own, then the shareholders would (BLANK) for the investment

vote

If cash is reinvested the opportunity cost is the

expected rate of return that shareholders could have obtained by investing in financial assets

If the investment project offers a lower return than shareholders can achieve on their own, the shareholders would vote to

cancel the project and take the cash instead

As long as a corporation's proposed investments offer (BLANK) rates of return than its shareholders can earn for themselves in the stock market (or in other financial markets, its shareholders will applaud the investments and the market value of the firm will increate

higher

The minimum acceptable rate of return on capital investment set by the investment opportunities available to shareholders in financial markets.

opportunity cost of capital

The minimum rate of return is called the

opportunity cost of capital

Another term for opportunity cost of capital

hurdle rate

Corporations increase value by accepting investment projects that earn more than the

opportunity cost of capital

A corporation should direct cash to investments that offer a (BLANK) than shareholders could earn for themselves

higher return

The opportunity cost of capital depends on the (BLANK) of the proposed investment project

risk

The safest investments, such as U.S. government debt, offer (BLANK) rates of return

low

Managers look to the financial markets to measure the opportunity cost of capital for the firm's

investment projects

They can observe the opportunity cost of capital for safe investments by looking up current interest rates on

safe debt securities

For risky investments, the opportunity cost of capital has to be

estimated

Opportunity cost of capital: 15%

No, 12% < 15%

Managers are agents for stockholders and are tempted to act in their own interests rather than maximizing value

agency problem

value lost from agency problems or from the cost of mitigating agency problems

agency cost

Sole proprietors face (BLANK) conflicts in financial management

no

In most large corporations the owners are usually outside investors, and so the managers by be tempted to act in their

own interests

Example of managers pursuing own interests in large corporations

may shy away from risky valuable investments due to job security

The temptation for value-destroying actions arises because the managers are not the shareholders, but (BLANK) of the shareholders

agents

Anyone with a financial interest in the corporation

stakeholder

Agency problems arise when managers and shareholders have different objectives
Managers may empire-build with excessive growth, risk-aversive, or take excessive salaries

Agency problems are controlled in practice in three ways

1. Internal controls and decision-making procedures

2. Compensation schemes that align managers' and shareholders' interest

3. Corporate governance systems

The compensation packages of top executives are almost always tied to the (BLANK) of their companies

financial performance

The more senior the manager the (BLANK) the base salary as a fraction of the total compensation package

smaller

Compensation packages are not all in cash, but partly in

shares

Some compensation schemes are not well designed; they reward managers even when value is

destroyed

gave U.S. shareholders the right to express their opinion on executive compensation through nonbinding "say on pay" votes at one-or-three-year intervals

Dodd-Frank financial reform law

the laws, regulations, institutions, and corporate practices that protect shareholders and other investors

corporate governance

good corporate governance requires laws and regulations that protect investors from self-dealing by insiders

legal requirements

CEOs and financial managers are required to act fairly and responsibly in the stockholders' interests

fiduciary duty

appoints top managers, including the CEO and CFO, and must approve important financial decisions

board of directors

The board of directors is elected by

shareholders

requires that more board of directors by independent, not affiliated with management

Sarbanes-Oxley Act of 2002 (SOX)

Boards of directors must meet in executive sessions with the (BLANK) not present

CEO

SOX also requires CEOs and CFOs to sign off personally on the corporation's

accounting procedures and results

investors who own 5%, 10%, or more of outstanding shares

blockholders

Disgruntled shareholders sell out and move on to other investments damaging the stock price and managers' compensation and reputation

wall street walk

The further the stop price falls, the easier it is for another company to buy up the majority of shares and

take over

The Wall Street Walk opens the door for

takeovers

sets U.S. accounting and reporting standards for public companies

Securities and Exchange Commission (SEC)