 What is the relationship between economics, finance, and accounting?

Ans. Finance came from economics and accounting. Economists developed the
notion that an asset’s value is based on the future cash flows the asset will
provide, and accountants provided information regarding the amount of those
cash flows. Finance people need knowledge for both.
 Who is the CFO, where does this individual fit into the corporate hierarchy, and what
are some of his or her responsibilities?
Ans. Chief financial officer is a senior vice president and the third ranking
officer. CFO is responsible for accounting, treasury, credit, legal, capital
budgeting, and investor relations, which involves communications with
stockholders and the press. The CFO is under the board of directors and the
CEO, but same level as COO.
 Does it make sense for not-profit organization such as hospitals and universities to
have CFO’s
Ans. Yes, because they are publicly owned and the CEO and CFO must both
certify to the SEC that reports released to stockholders and especially the annual
report, are accurate.
 What three areas of finance does this book cover? Are these areas independent, or are
they interrelated in the sense that someone working in one area should know
something about each of the other areas?
Ans. The three areas are Corporate Finance, Capital Markets and Investments.
They are interrelated with each other.
 What are the key differences between proprietorships, partnerships, and corporations?
Ans. Proprietorship is an unincorporated business owned by one owner,
partnerships is an unincorporated business own by two or more persons, and
corporations is a legal entity created by state, separate and distinct from its
owners and managers, having unlimited life, easy transfer ability of ownership,
and limited liability.
 How are LCCs and LLPs related to the other forms of organization?
Ans. LCCs is a new type of organization that is a hybrid between a partnership
and a corporation. LLP is similar to an LCC, but LLPs are used for professional
firms in the fields of accounting, law and architecture, while LLCs are used by
other business.
 What is an S corporation, and what is its advantage over a C corporation? Why don’t
firms such as IBM, GE, and Microsoft choose S corporation status?
Ans. S corporation is a special designation that allows small business that meet
qualifications to be taxed as if they were a proprietorship or a partnership rather
than a corporation. The advantage is that S corp. is taxed as proprietorship or
partnership and avoid double taxation like C corp.. Firm like IBM, GE, and
Microsoft can’t choose S corp. because they are too large and have thousands of
stockholders.
 What are some reasons the value of a business other than a small one is generally
maximized when it is organized as a corporation?
Ans. The first reason is they have limited liability that reduces the risks borne by
an investors, the lower the firm’s risks, the higher its value. Second, corporations
can attract capital more easily than other type of business, so, they are able to
take advantage of growth opportunities, and last, is the value of an asset also
depends on its liquidity, it means the time and effort it takes to sell the asset for
cash at a fair market value. More investors are willing to invest in stocks of a
corp. other than a small business.
 Suppose you are relatively wealthy and are looking for a potential investment. You do
not plan to be active in the business. Would you be more interested in investing in a
partnership or in a corporation? Why or why not?
Ans. Yes, because I’m sure I will be protected, it’s relatively liquid, and it attracts
more capital.
 What is management’s primary goal?
Ans. Shareholder wealth maximization is the management’s primary goal.
 What do investors expect to receive when they buy a share of stock? Do investor
know for sure how they will receive? Explain.
Ans. When the investor purchase a stock, you expect to receive dividends plus
capital gains. Not all stocks pay dividends immediately, but those corporations
that do, typically pay dividends quarterly.
 Based just on the name, which company would you expect to be riskier—General
Foods or South Seas Oil Exploration? Explain.
 Ans. South Seas Exploration, because General Foods is a food based company,
where food will always be demanded, whereas oil could be substituted by
new/other energy.
 When Boeing decides to invest $5 billion in a new jet airliner, are its managers certain
of the project’s effects on Boeing’s future profits and stock price? Explain.
Ans. Yes, they are because hope that investing the $5 billion will maximize
stockholder wealth, meaning the stocks’ value or price will increase.
 Who would be better able to judge the effect of a new airliner on Boeings profits—its
managers or its stockholders? Explain.
Ans. The managers would, because they would have more information than the
stockholders would on the project.
 Would all Boeing stockholders expect the same outcome from a given new project,
and how would those expectations affect the stock’s price? Explain.
Ans. No, because each project will have a different outcome.
 What’s the difference between stock’s current market price and its intrinsic value?
Ans. Stock’s current market price is actual market price seen by a marginal
investor and its intrinsic value is an estimate of the stock’s value.
 Do stocks have known and ‘’provable’’ intrinsic values, or might different people
reach different conclusions about intrinsic values? Explain.
Ans. No, intrinsic values are estimates and different data and different data have
different views.
 Should managers estimate intrinsic values or leave that to outside security analysts?
Explain.
Ans. Managers have the best information about a firm’s future prospects, so
their estimates are better than outside investors. However, their estimates can be
wrong.
 If a firm could maximize either its current market price or its intrinsic value, what
would stockholders want managers to do? Explain.
Ans. Stockholders would want firms to maximize the intrinsic value not he
current market value.
 Should a firm’s managers help investors improve their estimates of the firm’s intrinsic
value? Explain.
 Ans. Yes, they should provide information to investors to help them make better
estimates of the firm’s intrinsic value, to help keep stock prices closer to
equilibrium.
 What four trends affect business management in general and financial management in
particular?
Ans. The four trends are first, the points discussed in the preceding section have
led to profound changes in business practices, second trend is the increased of
globalization of business, third trend is having a profound effect on financial
management is ever improving information technology (IT) and last trend
relates to corporate governance, or the way the top managers operate and
interface with stockholders.
 How would you define business ethics?
Ans. Business ethics can be thought as company’s attitude and conduct toward its
employees, customers, community, and stockholders. It requires law and codes
one must follow to act ethically.
 Can a firm’s executive compensation plan lead to unethical behavior? Explain.
Ans. Yes, because of misleading accounting practices that led to overstated
profits.
 Unethical acts are generally committed by unethical people. What are some things
companies can do to help ensure that their employees act ethically?
Ans. Estimating intrinsic values is what security analysis is all about and is what
distinguishes successful from unsuccessful. We can estimate intrinsic values, but
we can’t be sure that we are right. A firm’s future prospects, so manager’s
estimates intrinsic values are generally better than those of outside investors.
 What are three techniques stockholders can use to motivate managers to maximize
their stock’s long-run price?
Ans. First technique is reasonable compensation packages- this attracts and
retains managers, but they should go beyond the needed, second is firing of
managers who didn’t perform well, and last is threat of hostile takeovers.
 Should managers focus directly on the stock’s actual market price or its intrinsic
value, or are both important? Explain.
Ans. Both are important because managers should communicate effectively with
stockholders to keep the actual price close to the intrinsic value. It’s bad for
 stockholders and managers when the intrinsic value is high but the actual price
is low. In that situation, a raider may swoop in, buy the company at a bargain
price, and fire the managers.
 Why might conflict arise between stockholders and bondholders?
Ans. Conflict may arise between stockholders and bondholders because,
bondholders generally receive fixed payment regardless of how well the company
does, while stockholders do better when the company do better. In addition,
shareholders have voting rights at general meetings, while bondholders do not.
 Define each of the following terms:
a. Sarbanes-Oxley Act- a law passed by Congress that requires the CEO and
CFO to certify that their firm’s financial statements are accurate.
b. Proprietorship- is an unincorporated business owned by one individual.
Partnership – is an unincorporated business owned by two or more persons.
Corporation – a legal entity created by a state, separate and distinct from its
owners and managers, having unlimited life, easy transferability of
ownership and limited liability.
c. S Corporations- is a special designation that allows small business that meet
qualifications to be taxed as if they were a proprietorship or a partnership
rather than a corporation.
Limited Liability Companies- a relatively new type of organization that is a
hybrid between a partnership and a corporation.
Limited Liability Partnerships- similar to an LLC but used for professional
firms in the fields of accounting, law and architecture. It has limited liability
like corporations but is taxed like partnership.
d. Stockholder wealth maximization- the managers of publicly owned companies
implies that decisions should be made to maximize the long-run value of the
firm’s common stock.
e. Intrinsic value- an estimate of the stock’s ‘’true’’ value based on accurate risk
and return data. It cannot be measure precisely.
Market price- is the actual market price based on perceived but possibly
incorrect information seen by a marginal investor.
f. Equilibrium- the situation in which the actual market price equals the
intrinsic value, so investors are indifferent between buying and selling a
stock.
Marginal investor- an investor whose views determine the actual stock price.
g. Business ethics- a company’s attitude and conduct towards its employees,
customers, community and stockholders.
h. Corporate raider- an individual who target a corporation for takeover because
it is undervalued
Hostile takeover- the acquisition of a company over the opposition of its
management.