ch01sm

ch01sm - Chapter 1 The Financial Manager and the Firm...

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1 Chapter 1 The Financial Manager and the Firm Critical Thinking Questions 1.1 Describe the cash flows between a firm and its stakeholders. Cash flows are generated by a firm’s productive assets that were purchased through either issuing debt or raising equity. These assets generate revenues through the sale of goods and services. A portion of this revenue is then used to pay wages and salaries to employees, pay suppliers, pay taxes, and pay interest on the borrowed money. The leftover money, residual cash, is then either reinvested back in the business or is paid out to stockholders in the form of dividends. 1.2 What are the three fundamental decisions financial management team is concerned with, and how do they affect the firm’s balance sheet? The primary financial management decisions every company faces are capital budgeting decisions, financing decisions, and working capital management decisions. Capital budgeting addresses the question of which productive assets to buy; thus, it affects the asset side of the balance sheet. Financing decisions focus on raising the money the firm needs to buy productive assets. This is typically accomplished by selling long-term debt and equity. Finally, working capital decisions involve how firms manage their current
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2 assets and liabilities. The focus here is seeing that a firm has enough money to pay its bills and that any spare money is invested to earn interest. 1.3 What is the difference between stockholders and stakeholders? Stockholders, also referred to as shareholders, are the owners of the company. A stakeholder, on the other hand, is anyone with a claim on the assets of the firm, including, but not limited to, shareholders. Stakeholders are the firm’s employees, suppliers, creditors, and the government. 1.4 Suppose that a group of accountants want to start their own accounting company. What organizational form of business would they choose, and why? Most lawyers, accountants, and doctors form what are known as limited liability partnerships. These formations combine the tax advantages of partnerships with the limited liability of corporations. 1.5 What does double taxation in the corporate setting mean? According to the tax law, owners of corporate stock are subject to taxation twice. A company’s income is taxed initially at the corporate level, and then the shareholders and investors are taxed on the dividends they receive from the company.
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3 1.6 Explain why profit maximization is not the best goal for a company. What is an appropriate goal? Although profit maximization appears to be the logical goal for any company, it has many drawbacks. First, profit can be defined in a number of different ways, and variations in net income for similar firms can vary widely. Second, accounting profits do not exactly equal cash flows. Third, profit maximization does not account for timing and ignores risk associated with cash flows. An appropriate goal for financial managers who do not have these objections is to maximize the value of the firm’s current stock price. In
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This note was uploaded on 05/06/2011 for the course FIN 300 taught by Professor Olander during the Spring '08 term at ASU.

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ch01sm - Chapter 1 The Financial Manager and the Firm...

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