Chapter 01: The Goals and Functions of Financial Management

Chapter 1 The Goals and Functions of Financial Management

Discussion Questions
1-1. How did the recession of 200 !200" compare with other recessions since the Great #epression in terms of length$ %t was the longest 1-2. &hat effect did the recession of 200 !200" ha'e on go'ernment regulation$ %t was greatl( increased. 1-). &hat ad'antages does a sole proprietorship offer$ &hat is a ma*or draw+ac, of this t(pe of organi-ation$ . sole proprietorship offers the ad'antage of simplicit( of decision ma,ing and low organi-ational and operating costs. . ma*or draw+ac, is that there is unlimited lia+ilit( to the owner. 1-/. &hat form of partnership allows some of the in'estors to limit their lia+ilit($ 01plain +riefl(. . limited partnership allows some of the partners to limit their lia+ilit(. 2nder this arrangement3 one or more partners are designated general partners and ha'e unlimited lia+ilit( for the de+ts of the firm4 other partners are designated limited partners and are lia+le onl( for their initial contri+ution. The limited partners are normall( prohi+ited from +eing acti'e in the management of the firm. 1-5. %n a corporation3 what group has the ultimate responsi+ilit( for protecting and managing the stoc,holders6 interests$ The +oard of directors. 1-7. &hat document is necessar( to form a corporation$ The articles of incorporation.

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Chapter 01: The Goals and Functions of Financial Management

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&hat issue does agenc( theor( e1amine$ &h( is it important in a pu+lic corporation rather than in a pri'ate corporation$ .genc( theor( e1amines the relationship +etween the owners of the firm and the managers of the firm. %n pri'atel( owned firms3 management and the owners are usuall( the same people. Management operates the firm to satisf( its own goals3 needs3 financial re8uirements and the li,e. .s a compan( mo'es from pri'ate to pu+lic ownership3 management now represents all owners. This places management in the agenc( position of ma,ing decisions in the +est interest of all shareholders.

1-9.

&h( are institutional in'estors important in toda(6s +usiness world$ :ecause institutional in'estors such as pension funds and mutual funds own a large percentage of ma*or 2.;. companies3 the( are ha'ing more to sa( a+out the wa( pu+licl( owned companies are managed. .s a group3 the( ha'e the a+ilit( to 'ote large +loc,s of shares for the election of a +oard of directors3 which is suppose to run the compan( in an efficient3 competiti'e manner. The threat of +eing a+le to replace poor performing +oards of directors ma,es institutional in'estors 8uite influential. ;ince these institutions3 li,e pension funds and mutual funds3 represent indi'idual wor,ers and in'estors3 the( ha'e a responsi+ilit( to see that the firm is managed in an efficient and ethical wa(.

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&h( is profit ma1imi-ation3 +( itself3 an inappropriate goal$ &hat is meant +( the goal of ma1imi-ation of shareholder wealth$ The pro+lem with a profit ma1imi-ation goal is that it fails to ta,e account of ris,3 the timing of the +enefits is not considered3 and profit measurement is a 'er( ine1act process. The goal of shareholders wealth ma1imi-ation implies that the firm will attempt to achie'e the highest possi+le total 'aluation in the mar,etplace. %t is the one o'erriding o+*ecti'e of the firm and should influence e'er( decision.

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Chapter 01: The Goals and Functions of Financial Management

1-10.

&hen does insider trading occur$ &hat go'ernment agenc( is responsi+le for protecting against the unethical practice of insider trading$ %nsider trading occurs when an(one with non-pu+lic information +u(s or sells securities to ta,e ad'antage of that pri'ate information. The ;ecurities and 01change Commission is responsi+le for protecting mar,ets against insider trading. %n the past people ha'e gone to *ail for trading on non-pu+lic information. This has included compan( officers3 in'estment +an,ers3 printers who ha'e information +efore it is pu+lishers3 and e'en truc, dri'ers who deli'er +usiness maga-ines and read positi'e or negati'e articles a+out a compan( +efore the maga-ine is on the news stands and then place trades or ha'e friends place trades +ased on that information. The ;0C has prosecuted an(one who profits from inside information.

1-11.

%n terms of the life of the securities offered3 what is the difference +etween mone( and capital mar,ets$ Mone( mar,ets refer to those mar,ets dealing with short-term securities that ha'e a life of one (ear or less. Capital mar,ets refer to securities with a life of more than one (ear.

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&hat is the difference +etween a primar( and a secondar( mar,et$ . primar( mar,et refers to the use of the financial mar,ets to raise new funds for the corporation. .fter the securities are sold to the pu+lic <institutions and indi'iduals=3 the( trade in the secondar( mar,et +etween in'estors. %t is in the secondar( mar,et that prices are continuall( changing as in'estors +u( and sell securities +ased on the e1pectations of corporate prospects.

1-1).

.ssume (ou are loo,ing at man( companies with e8ual ris,4 which ones will ha'e the highest stoc, prices$ Gi'en companies with e8ual ris,3 those companies with e1pectations of high return will ha'e higher common stoc, prices relati'e to those companies with e1pectations of poor returns.

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Chapter 01: The Goals and Functions of Financial Management

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&hat changes can ta,e place under restructuring$ %n recent times3 what group of in'estors has often forced restructuring to ta,e place$ >estructuring can result in changes in the capital structure <lia+ilities and e8uit( on the +alance sheet=. %t can also result in the selling of low-profit-margin di'isions with the proceeds rein'ested in +etter in'estment opportunities3 and sometimes restructuring results in the remo'al of the current management team or large reductions in the wor, force. >estructuring has also included mergers and ac8uisitions. %nstitutional in'estors ha'e +een 'er( influential in forcing restructuring to ta,e place in recent (ears.

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