BUS 320 Study Guide - Spring 2018, Comprehensive Midterm Notes - Time, Interest Rate, Inflation
BUS 320
MIDTERM EXAM
STUDY GUIDE
Fall 2018
Chapter 1 - An Overview of Financial Management
Forms of Business Organizations
• Proprietorships and Partnerships
o Advantages
▪ Ease of formation
▪ Subject to few regulations
▪ No corporate income taxes
o Disadvantages
▪ Difficult to raise capital
▪ Unlimited liability
▪ Limited life
o Often set up through LLCs/LLPs
• Corporation
o Advantages
▪ Unlimited life
▪ Easy transfer of ownership
▪ Limited liability
▪ Ease of raising capital
o Disadvantages
▪ Double taxation
▪ Cost of setup and report filing
Stock Prices and Intrinsic Value
• In equilibrium, a stock’s price should equal its true or intrinsic value
• Intrinsic value is a long-run concept
• To the extent that investor perceptions are incorrect, a stock’s price in the short run may deviate
from its intrinsic value
• Ideally, managers should avoid actions that reduce intrinsic value, even if those decisions
increase the stock price in the short run
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Stockholder-Manager Conflicts
• Managers are naturally inclined to act in their own best interests (which are not always the same
as the interest of the stockholders)
• But the following factors affect managerial behavior:
o Managerial compensation packages
o Direct intervention by shareholders
o Threat of firing
o Threat of takeover
Stockholder-Debtholder Conflicts
• Stockholders are more likely to prefer riskier projects because they receive more of the upside if
the project succeeds. By contrast, bondholders receive fixed payments and are more interested in
limiting risk
• Bondholders are particularly concerned about the use of additional debt
• Bondholders attempt to protect themselves by including covenants in bond agreements that limit
the use of additional debt and constrain managers’ actions
Balancing Shareholder Interest and Society Interests
• The primary financial goal of management is shareholder wealth maximization which translates
to maximizing stock price
o Value of any asset is present value of cash flow stream to owners
o Most significant decisions are evaluated in terms of their financial consequences
o Stock prices change over time as conditions change and as investors obtain new
information about a company’s prospects
• Managers recognize that being socially responsible is not inconsistent with maximizing
shareholder value
Chapter 2 – Financial Markets and Institutions
How is capital transferred between savers and borrowers? (3) Direct transfers, Investment banks, and
Financial Intermediaries
The Capital Allocation Process
• In a well-functioning economy, capital flows efficiently from those who supply capital to those
who demand it
• Suppliers of capital: Individuals and institutions with “excess funds”. These groups are saving
money and looking for a rate of return on their investment
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