Study Guide for Midterm 1 (Exam 1)

Flashcards based on the Midterm 1 study guide, covering key concepts from Chapters 1, 2, and 3, including business organization, firm objectives, financial markets, and financial statements.

What are the main forms of business organization?

Proprietorships, Partnerships, and Corporations.

What is the primary objective for firm managers?

To maximize shareholder wealth.

What is an agency problem in the context of a firm?

A potential conflict of interest that can arise between stockholders and managers, or between stockholders and bondholders.

How can firms mitigate potential conflicts between stockholders and managers?

By providing managers with incentives like stock options, direct intervention by shareholders, or the threat of a hostile takeover.

What is a key tax difference between corporations and proprietorships/partnerships?

Corporations are subject to double taxation (corporate income tax and personal income tax on dividends), while proprietorships and partnerships typically only have income taxed at the individual level.

What are the three main ways capital is allocated and formed in the economy?

Direct transfer, indirect transfer through an investment bank, and indirect transfer through a financial intermediary.

What is the primary market versus the secondary market?

The primary market is where new securities are issued, while the secondary market is where existing securities are traded among investors.

How do money markets differ from capital markets?

Money markets deal in short-term debt instruments (less than one year), while capital markets deal in long-term debt and equity instruments (more than one year).

Explain the difference between an auction market and a dealers market.

In an auction market (e.g., NYSE), buyers and sellers confront each other to determine prices. In a dealers market (e.g., Nasdaq), dealers hold inventories of securities and facilitate trading.

What is an Initial Public Offering (IPO)?

The first time a company offers shares of its stock to the public.

Distinguish between an investment bank and a commercial bank.

Investment banks help companies raise capital and advise on mergers/acquisitions, while commercial banks accept deposits and make loans.

What are the four core financial statements included in an annual report?

The Income Statement, Balance Sheet, Statement of Cash Flows, and Statement of Stockholders' Equity.

What kind of information can be found on a company's Balance Sheet?

A snapshot of the company's assets (e.g., current assets like cash, inventory), liabilities (e.g., current liabilities like accounts payable), and equity at a specific point in time.

What kind of information can be found on a company's Income Statement?

A summary of the company's revenues, expenses, and profits (e.g., EBIT, Net Income) over a period of time.

What is a key limitation of financial statements?

They are often based on historical costs rather than current market values and can be affected by accounting choices or seasonal factors.

How does an increase in an asset typically affect a firm's cash position?

An increase in an asset (e.g., purchasing equipment) is typically a cash outflow, decreasing the firm's cash position.

How does an increase in a liability or equity typically affect a firm's cash position?

An increase in a liability (e.g., taking a new loan) or equity (e.g., issuing new stock) is typically a cash inflow, increasing the firm's cash position.

What is the formula for calculating Net Working Capital?

Current Assets - Current Liabilities.

What is Free Cash Flow (FCF) and why is it important?

FCF is the cash a company can generate after accounting for cash outflows to support operations and maintain its capital assets. It's important because it represents the cash available to all investors (stockholders and debtholders) after the firm has met all operating needs and paid for additions to net plant and equipment.

Distinguish between current assets and fixed assets on a Balance Sheet.

Current assets are assets expected to be converted to cash within one year (e.g., cash, accounts receivable, inventory). Fixed assets are assets with a useful life of more than one year (e.g., property, plant, and equipment).

What is the difference between book value and market value?

Book value is the value of an asset or liability recorded on the company's balance sheet (historical cost minus accumulated depreciation). Market value is the price at which an asset or liability can be bought or sold in the open market.

What role do underwriters play in an IPO?

Underwriters (typically investment banks) help companies issue new securities by advising on price, marketing the securities to investors, and facilitating the sale to raise capital.

What are some examples of financial intermediaries?

Commercial banks, investment banks, credit unions, insurance companies, mutual funds, and pension funds.