CHAPTER 2 B – 1
CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concept Questions
1. The three basic forms are sole proprietorships, partnerships, and corporations. Some disadvantages of
sole proprietorships and partnerships are: unlimited liability, limited life, difficulty in transferring
ownership, and hard to raise capital funds. Some advantages are: simpler, less regulation, the owners
because of the relative simplicity of starting these forms of businesses.
2. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly
traded or not).
3. 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
4. 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
5. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows,
6. An argument can be made either way. At the one extreme, we could argue that in a market economy,
all of these things are priced. There is thus an optimal level of, for example, unethical and/or illegal
product liability claims. What should the firm do?”
7. The goal will be the same, but the best course of action toward that goal may be different because of
CHAPTER 2 B – 2
8. The goal of management should be to maximize the share price for the current shareholders. If
management believes that it can improve the profitability of the firm so that the share price will exceed
the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers
in situations such as this.
9. We would expect agency problems to be less severe in other countries, primarily due to the relatively
small percentage of individual ownership. Fewer individual owners should reduce the number of
diverse opinions concerning corporate goals. The high percentage of institutional ownership might
the growing activism of these large shareholder groups may lead to a reduction in agency problems
for U.S. corporations and a more efficient market for corporate control.
10. How much is too much? Who is worth more, Larry Ellison or Tiger Woods? The simplest answer is
that there is a market for executives just as there is for all types of labor. Executive compensation is
the price that clears the market. The same is true for athletes and performers. Having said that, one
executive compensation will be designed to reward only differential performance, i.e., stock price
increases in excess of general market increases.