INTRODUCTION TO CORPORATE FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. Capital budgeting (deciding on whether to expand a manufacturing plant), capital structure (deciding
whether to issue new equity and use the proceeds to retire outstanding debt), and working capital
management (modifying the firm’s credit collection policy with its customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise
capital funds. Some advantages: simpler, less regulation, the owners are also the managers, sometimes
personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed
earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to
raise capital, unlimited life, and so forth.
4. The treasurer’s office and the controller’s office are the two primary organizational groups that report
directly to the chief financial officer. The controller’s office handles cost and financial accounting, tax
management, and management information systems, while the treasurer’s office is responsible for
cash and credit management, capital budgeting, and financial planning. Therefore, the study of
corporate finance is concentrated within the treasury group’s functions.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly-
traded or not).
6. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders
elect the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership from control in the corporate form of organization is what causes agency problems to exist.
Management may act in its own or someone else’s best interests, rather than those of the shareholders.
If such events occur, they may contradict the goal of maximizing the share price of the equity of the
7. A primary market transaction.
8. In auction markets like the Toronto Stock Exchange, brokers and agents meet at a central location (the
exchange) to match buyers and sellers of assets. Physical locations for stock markets are disappearing
as trading becomes more electronic. Dealer markets like Nasdaq consist of dealers operating at
dispersed locales who buy and sell assets themselves, communicating with other dealers either
electronically or literally over-the-counter. Dealer markets are less transparent than auction markets
where trades are reported publicly almost immediately.
9. Such organizations frequently pursue social or political missions, so many different goals are
conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and
services are offered at the lowest possible cost to society. A better approach might be to observe that
even a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximize
the value of the equity.
10. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows,
both short-term and long-term. If this is correct, then the statement is false.