1.

What are the key differences between sole proprietorships,

partnerships, and corporations?
A sole proprietorship is an unincorporated business owned by one
individual.
A partnership exists whenever two or more persons associate to conduct a
noncorporate business. The major advantage of a partnership is its low cost
and ease of formation.
A corporation is a legal entity created by a state, and it is separate and
distinct from its owners and managers. This separateness gives the
corporation three major advantages:
1. Unlimited life
2. Easy transferability of ownership interest
3. Limited liability.

2. Why will the value of any business other than a very small one
probably be maximized if it is organized as a corporation?
Unlimited life, easy transferability of ownership interest, and limited liabilitymake
it much easier for corporations than for proprietorships or partnerships to raise
money in the capital markets.
3. Identify the two primary subordinates who report to the rms chief
nancial ofcer, and indicate the primary responsibilities of each.
Controller. Is typically responsible for the activities of the accounting and tax
departments.
The treasures. Direct responsibility for managing the rms cash and marketable
securities, for planning its capital structure, for selling stocks and bonds to raise
capital, for overseeing the corporate pension plan, and for managing risk.
4. What is managements primary goal?
Is stockholder wealth maximization, which translates into maximizing the price of
the rms common stock.
5. What actions could be taken to remove a management team if it
departs from the goal of maximizing shareholder wealth?
It is almost impossible to determine whether a particular management team is
trying to maximize shareholder wealth or is merely attempting to keep stockholders
satised while managers pursue other goals.
However, we do know that the managers of a rm operating in a competitive
market will be forced to undertake actions that are reasonably consistent with
shareholder wealth maximization.
6. What would happen if one rm attempted to exercise costly socially
responsible programs but its competitors did not follow suit?
If one company attempts to exercise social responsibility, it will have to raise prices
to cover the added costs. If other rms in its industry do not follow suit, their costs

and prices will be lower. The socially responsible rm will not be able to compete,
and it will be forced to abandon its efforts.
7. How does the goal of stock price maximization benet society at
large?
Therefore, most actions that help a rm increase the price of its stock also benet
society at large. This is why prot-motivated, free-enterprise economies have been
so much more successful than socialistic and communistic economic systems.
8. How would you dene business ethics?
As a companys attitude and conduct toward its employees, customers, community,
and stockholders.
9. Is being ethical good for prots in the long run? In the short run?
When conflicts arise between profits and ethics, sometimes the ethical
considerations are so strong that they clearly dominate. However, in many cases
the choice between ethics and profits is not clear cut.
10. What are agency costs, and who bears them?
the owner-manager may decide to lead a more relaxed lifestyle and not work as
strenuously to maximize shareholder wealth, because less of this wealth will
accrue to him or her, in essence, the fact that the owner-manager will neither gain
all the benets of the wealth created by his or her efforts nor bear all of the costs of
perquisites will increase the incentive to take actions that are not in the best
interests of other shareholders.
11. What are some mechanisms that encourage managers to act in the
best interests of stockholders? To not take advantage of bondholders?
Managerial compensation.
Direct intervention by shareholders.
The threat of ring
The threat of takeover.
12. Why should managers not take actions that are unfair to any of the
rms stakeholders?
13. Identify some factors beyond a rms control that inuence its stock
price.
External Constraints:
1. Antitrust Laws
2. Environmental Regulations
3. Product and Workplace Safety Regulations
4. Employment Practices Rules
5. Federal Reserve Policy
6. International Rules
7. And So Forth
1. Types of Products or Services Produced
2. Production Methods Used

3. Research and Development Efforts

4. Relative Use of Debt Financing
5. Dividend Policy
6. And So Forth
Expected Cash Flows
Timing of Cash Flows
Perceived Riskiness of Cash Flows
SELF-TEST PROBLEM
Define each of the following terms:
Sole proprietorship. The sole proprietorship is the simplest business form under
which one can operate a business. The sole proprietorship is not a legal entity. It
simply refers to a person who owns the business and is personally responsible for
its debts.
Partnership.
A
type
of business organization in
which
two
or
more individuals pool money, skills,
and
other resources,
and share profit and loss in accordance with terms of the partnership agreement.
Corporation. .Firm that meets certain legal requirements to be recognized as
having a legal existence, as an entity separate and distinct from its owners.
Limited partnership; Limited liability partnership.
Limited partnerships (LPs) and limited liability partnerships (LLPs) are
both businesses with more than one owner, but unlike general partnerships, limited
partnerships and limited liability partnerships offer some of their owners limited
personal liability for business debts.
In limited partnerships (LPs), at least one of the owners is considered a "general"
partner who makes business decisions and is personally liable for business debts.
But LPs also have at least one "limited" partner who invests money in the business
but has minimal control over daily business decisions and operations. The
advantage for these limited partners is that they are not personally liable for
business debts.
The limited liability partnership (LLP) is a similar business structure but it has no
general partners. All of the owners of an LLP have limited personal liability for
business debts.
Professional corporation. Is a corporation of professionals. In some states, some
professionals are permitted to form corporations under specific regulations, to allow
the professionals to have the benefit of a corporation while meeting ethical
requirements.
Stockholder wealth maximization. A process that increases the current net
value of business or shareholder capital gains, with the objective of bringing in the

highest
possible return.
The
wealth
maximization strategy generally
involves making sound financial investment
decisions which
take
into consideration any risk factors that would compromise or outweigh the
anticipated benefits.
Social responsibility. Social responsibility entails developing businesses with a
positive relationship to the society which they operate in.
Business ethics. The study of proper business policies and practices regarding
potentially controversial issues, such as corporate governance, insider trading,
bribery, discrimination, corporate social responsibility and fiduciary responsibilities.
Normal profits. When economic profit is equal to zero; this occurs when the
difference between total revenue and total cost (explicit and implicit costs) equals
zero. Normal profit is different than accounting profit because opportunity cost is
taken into consideration.
Normal rate of return. The gain or loss on an investment over a specified period,
expressed as a percentage increase over the initial investment cost. Gains on
investments are considered to be any income received from the security plus
realized capital gains.
Agency problema. A conflict of interest inherent in any relationship where one
party is expected to act in another's best interests. The problem is that the agent
who is supposed to make the decisions that would best serve the principal is
naturally motivated by self-interest, and the agent's own best interests may differ
from the principal's best interests.
Performance shares. In the case of stock compensation, shares of company
stock given to managers only if certain company wide performance criteria are met,
such as earnings per share targets.
Executive Stock Options. A stock option granted to specified employees of a
company. ESOs carry the right, but not the obligation, to buy a certain amount of
shares in the company at a predetermined price. An employee stock option is
slightly different from a regular exchange-traded option because it is not generally
traded on an exchange, and there is no put component.
Hostile takeover. The acquisition of one company (called the target company) by
another (called the acquirer) that is accomplished not by coming to an agreement
with the target company's management, but by going directly to the company's
shareholders or fighting to replace management in order to get the acquisition
approved.
Profit maximization. A process that companies undergo to determine the
best output and price levels in order to maximize its return. The company will
usually adjust influential factors such as production costs, sale prices, and

output levels as a way of reaching its profit goal. There are two main profit
maximization
methods
used,
and
they
are Marginal CostMarginal Revenue Method and Total Cost-Total Revenue Method.
Earnings per share. Earning per share, also called net income per share, is
a market prospect ratio that measures the amount of net income earned per share
of stock outstanding. In other words, this is the amount of money each share of
stock would receive if all of the profits were distributed to the outstanding shares at
the end of the year
Dividend policy decisin. The policy a company uses to decide how much it will
pay out to shareholders in dividends.
INTEGRATED CASE
Financial Management Overview
Kato Summers opened Take A Dive 17 years ago; the store is located in Malibu,
California, and sells surfing-related equipment. Today, Take a Dive has 50
employees including Kato and his daughter Amber, who works part time in the
store to help pay for her college education. Katos business has boomed in recent
years, and he is looking for new ways to take advantage of his increasing business
opportunities. Although Katos formal business training is limited, Amber will soon
graduate with a degree in finance. Kato has offered her the opportunity to join the
business as a full-fledged partner. Amber is interested, but she is also considering
other career opportunities in finance. Right now, Amber is leaning toward staying
with the family business, partly because she thinks it faces a number of interesting
challenges and opportunities. Amber is particularly interested in further expanding
the business and then incorporating it. Kato is intrigued by her ideas, but he is also
concerned that her plans might change the way in which he does business. In
particular, Kato has a strong commitment to social activism, and he has always
tried to strike a balance between work and pleasure. He is worried that these goals
will be compromised if the company incorporates and brings in outside
shareholders.
Amber and Kato plan to take a long weekend off to sit down and think about all of
these issues. Amber, who is highly organized, has outlined a series of questions for
them to address:
a. What kinds of career opportunities are open to finance majors?
b. What are the primary responsibilities of a corporate fi- nancial staff?
The primary responsibilities for a financial team vary depending on the size
of the business and how specialized the positions within the financial
department are. Understanding the different responsibilities of finance
professionals will help you determine whether you want to work as a big fish
in a small financial pond, or take the opposite tack with your career as a
specialist.
Small Versus Large Business Finance Staff

Bookkeeping
Compliance
Budgeting
Cash Flow Management
Financial Analysis
c. What are the most important financial management issues today?
Barter Exchanges
Benchmarking
Budget Exercises
Capital Budget
Data Security
Free Credits
d. (1) What are the alternative forms of business organization? (2)
What are their advantages and disadvantages?
General Partnerships, Limited Partnerships (LP) and Limited Liability Partnerships
(LLP)
A partnership is a structure appropriate to use if you are not going to be the sole
owner
of
your
new
business.
In a general partnership, all partners are personally liable for business debts, any
partner can be held totally responsible for the business and any partner can make
decisions
that
affect
the
whole
business.
In a limited partnership, one partner is responsible for decision-making and can be
held personally liable for business debts. The other partner merely invests in the
business. Although the general structure of limited partnerships can vary, each
individual is liable only to the extent of their invested capital.
LLPs are most commonly used by professionals such as doctors and lawyers. The
LLP structure protects each partner's personal assets and each partner from debts
or liability incurred by the other partners. Different states have varying regulations
regarding these establishments of which business owners must take note.
Partnerships must file information returns with the IRS, but they do not file separate
tax returns. For tax purposes, the partnership's profits or losses pass through to its
owners, so a partnership's income is taxed at the individual level. LPs and LLPs
are also state entities and must file paperwork and pay fees similar to those
involved in establishing an LLC.
Regardless of the way a business is structured, its owners will have the same
overarching goals when it comes to the company's financial management.

e. What is the primary goal of the corporation? (1) Do firms have any
responsibilities to society at large? (2) Is stock price maximization good or
bad for society? (3) Should firms behave ethically?
f. What is an agency relationship? (1) What agency relationships exist within
a corporation? (2) What mechanisms exist to influence managers to act in
shareholders best interests? (3) Should shareholders (through managers)
take actions that are detrimental to bondholders?
g. Is maximizing stock price the same thing as maximizing profit?
h. What factors affect stock prices? i. What factors affect the level and
riskiness of cash flows?