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Unformatted text preview: Chapter 1 An Overview of Financial Management ANSWERS TO END-OF-CHAPTER QUESTIONS 1-1 a. A proprietorship, or sole proprietorship, is a business owned by one individual. A partnership exists when two or more persons associate to conduct a business. In contrast, a corporation is a legal entity created by a state. The corporation is separate and distinct from its owners and managers. b. In a limited partnership, limited partners liabilities, investment returns and control are limited, while general partners have unlimited liability and control. A limited liability partnership (LLP), sometimes called a limited liability company (LLC), combines the limited liability advantage of a corporation with the tax advantages of a partnership. A professional corporation (PC), known in some states as a professional association (PA), has most of the benefits of incorporation but the participants are not relieved of professional (malpractice) liability. c. Stockholder wealth maximization is the appropriate goal for management decisions. The risk and timing associated with expected earnings per share and cash flows are considered in order to maximize the price of the firm's common stock. d. Social responsibility is the concept that businesses should be partly responsible for, and thus bear the costs of, the welfare of society at large. Business ethics can be thought of as a company's attitude and conduct toward its employees, customers, community, and stockholders. A firm's commitment to business ethics can be measured by the tendency of the firm and its employees to adhere to laws and regulations relating to such factors as product safety and quality, fair employment practices, and the like. e. Normal profits are those profits close to the average for all firms within an industry. Similarly, a normal rate of return is a return on investment that is close to the return earned by an average firm in the industry. Firms with normal profits cannot easily increase their social responsibility costs unless the entire industry does so. f. An agency problem arises whenever a manager of a firm owns less than 100 percent of the firms common stock, creating a potential conflict of interest called an agency conflict. The fact that the manager will neither gain all the benefits of the wealth created by his or her efforts nor bear all of the costs of perquisite consumption will increase the incentive to take actions that are not in the best interests of the nonmanager shareholders. g. Economic Value Added (EVA) is a method used to measure a firms true profitability. EVA is found by taking the firms after-tax operating profit and subtracting the annual cost of all the capital a firm uses. If the firm generates a positive EVA, its management has created value for its shareholders. If the EVA is negative, management has destroyed shareholder value....
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This note was uploaded on 12/10/2010 for the course FIN 161 taught by Professor Ahmed during the Spring '10 term at Albany College of Pharmacy and Health Sciences.
- Spring '10
- Corporate Finance