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Lecture Summary


  1. Why is stockholder wealth maximization considered a better goal for the firm than profit maximization?
  2. The goal of profit maximization is too simplistic because it assumes away the problems of uncertainty of returns and the timing of returns. The goal of maximization of shareholders' wealth, or the market value of the firm's common stock, is the appropriate goal because the effects of all financial decisions are considered. The goal of shareholder wealth maximization is a long-run goal, while profit maximization is a short-run goal.

  3. What are the three forms of business organizations?
    The three forms of business organization are sole proprietorships, partnerships, and corporations.

  4. What are the advantages and disadvantages of each business structure?
  5. The advantages of a sole proprietorship are that it is easily initiated and the owner retains title to the firm's assets and is entitled to all the profits from the business. The disadvantages are that the sole proprietor has unlimited liability and the business is terminated when the owner discontinues the business or upon the owner’s death. The advantages and disadvantages of the partnership are similar to those of the sole proprietorship. Although general partners have unlimited liability, limited partners' liability may be restricted to the amount of capital invested in the partnership. The advantages of a corporation are limited liability, easy transferability of shares, and the fact that life of the corporation is not dependent upon the status of the investors. The disadvantages include the cost of forming a corporation and double taxation of income. Large and growing firms choose the corporate form because of the relative ease it affords in raising capital.

  6. If you were the CFO of a large corporation, how would you calculate your corporation's income tax liability?
  7. You would determine your earnings before taxes and then use the corporate income tax tables to compute your tax liability. It is important to note that corporate tax rates are marginal tax rates.

  8. What are the ten axioms of financial management?
    • Axiom 1: The risk-return trade-off—we won’t take on additional risk unless we expect to be compensated with additional return
    • Axiom 2: The time value of money—a dollar received today is worth more than a dollar received in the future
    • Axiom 3: Cash—not profits—is king
    • Axiom 4: Incremental cash flows—it’s only what changes that counts
    • Axiom 5: The curse of competitive markets—why it’s hard to find exceptionally profitable projects
    • Axiom 6: Efficient capital markets—the markets are quick and the prices are right
    • Axiom 7: The agency problem—managers won’t work for the owners unless it’s in their best interest
    • Axiom 8: Taxes bias business decisions
    • Axiom 9: All risk is not equal—some risk can be diversified away, and some cannot
    • Axiom 10: Ethical behavior is doing the right thing, and ethical dilemmas are everywhere in finance

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