Detailed Notes from "Corporate Finance and the Financial Manager"
1. Corporate Finance & Financial Manager
• Corporate finance studies three main questions:
1. Long-term investments (Capital budgeting)
2. Long-term financing (Capital structure)
3. Daily financial activities (Working capital management)
Role of Financial Manager
• In large corporations, owners (stockholders) do not run daily operations.
• Financial manager acts on behalf of owners.
• Top finance roles: Vice President of Finance or Chief Financial Officer (CFO).
• Controller handles accounting, taxes, MIS.
• Treasurer manages cash, credit, financial planning, capital spending.
2. Financial Management Decisions
A. Capital Budgeting
• Planning and managing long-term investments.
• Goal: Choose investments where cash flows exceed costs.
• Considerations: Size, timing, risk of future cash flows.
• Examples: Walmart opening a new store, Microsoft developing new software.
B. Capital Structure
• Mixture of long-term debt and equity used to finance operations.
• Decisions:
o How much to borrow?
o Best debt-equity mix?
o Least expensive funding sources?
• Affects firm’s risk and value.
• Determines how cash flows are split between creditors and shareholders.
C. Working Capital Management
• Management of short-term assets and liabilities.
• Ensures firm has enough resources to operate daily.
• Questions:
o How much cash/inventory to hold?
o Credit policy?
o How to finance short-term needs?
3. Forms of Business Organization
A. Sole Proprietorship
• Owned by one person.
• Advantages: Easy to start, least regulated, owner keeps all profits.
• Disadvantages: Unlimited liability, limited life, difficult to transfer ownership, limited
capital.
• Taxation: Business income taxed as personal income (20% may be exempt under 2017
Tax Act).
B. Partnership
• Owned by two or more individuals/entities.
• Types:
o General partnership: All partners share gains/losses, unlimited liability.
o Limited partnership: Limited partners have liability limited to contribution.
• Disadvantages: Unlimited liability (general partners), limited life, difficult ownership
transfer.
• Taxation: Income passes to partners; 20% may be exempt under 2017 Tax Act.
C. Corporation
• Separate legal entity from owners.
• Advantages: Limited liability, unlimited life, easy transfer of ownership, easier to raise
capital.
• Disadvantages: Double taxation (corporate + personal dividend tax).
• Governed by articles of incorporation and bylaws.
• Ownership through shares; run by board of directors.
D. Limited Liability Company (LLC)
• Hybrid: taxed like a partnership, limited liability like a corporation.
• Must meet IRS criteria to avoid being taxed as a corporation.
4. Key Terms
• Capital Budgeting: Process of planning/managing long-term investments.
• Capital Structure: Mix of debt and equity used by a firm.
• Working Capital: Short-term assets and liabilities.
• Sole Proprietorship: Business owned by one person.
• Partnership: Business with two or more owners.
• Corporation: Legal entity separate from owners.
Broad Questions and Answers
Q1: What are the three main questions in corporate finance?
A:
1. What long-term investments should the firm undertake? (Capital budgeting)
2. How should the firm raise long-term financing? (Capital structure)
3. How should day-to-day financial activities be managed? (Working capital management)
Q2: What is the role of a financial manager in a corporation?
A: The financial manager is responsible for making decisions related to capital budgeting, capital
structure, and working capital management. They act in the interest of the shareholders and often
work under titles like CFO, VP of Finance, Treasurer, or Controller.
Q3: What are the key differences between a sole proprietorship and a corporation?
A:
• Liability: Sole proprietors have unlimited liability; corporation owners have limited
liability.
• Life: Proprietorship ends with owner’s death; corporation has perpetual life.
• Taxation: Proprietorship income is taxed once as personal income; corporation faces
double taxation.
• Capital raising: Proprietorships rely on owner’s wealth; corporations can issue stock and
borrow easily.
Q4: Why is the corporate form preferred for large businesses?
A: Corporations offer limited liability, perpetual existence, easier transfer of ownership, and
greater ability to raise large amounts of capital through equity and debt markets.
Q5: What is double taxation?
A: Double taxation occurs in corporations when profits are taxed at the corporate level and then
again at the shareholder level when dividends are paid out.
Q6: What is an LLC and how is it different from a corporation?
A: An LLC is a hybrid business form that provides limited liability like a corporation but is
taxed like a partnership (avoiding double taxation). It must meet IRS criteria to maintain this
status.
Multiple Choice Questions (MCQs)
1. What is capital budgeting?
A) Managing daily cash flows
B) Planning long-term investments
C) Deciding debt-equity mix
D) Handling tax payments
Answer: B
2. Which of the following is a responsibility of the Treasurer?
A) Cost accounting
B) Tax management
C) Cash management
D) Management information systems
Answer: C
3. What is a key disadvantage of a sole proprietorship?
A) Double taxation
B) Limited life
C) Difficulty in raising capital
D) Both B and C
Answer: D
4. In a general partnership, liability is:
A) Limited to investment
B) Unlimited for all partners
C) Limited for some partners
D) Nonexistent
Answer: B
5. What does capital structure refer to?
A) Mix of short-term assets and liabilities
B) Mix of long-term debt and equity
C) Management of daily operations
D) Planning of future investments
Answer: B
6. Which business form has perpetual life?
A) Sole Proprietorship
B) General Partnership
C) Corporation
D) Limited Partnership
Answer: C
7. Double taxation is a disadvantage of which business form?
A) LLC
B) Corporation
C) Sole Proprietorship
D) Partnership
Answer: B
8. Working capital management involves:
A) Long-term financing decisions
B) Day-to-day financial activities
C) Dividend policy
D) Issuing new shares
Answer: B
9. Who elects the board of directors in a corporation?
A) Managers
B) Creditors
C) Stockholders
D) Employees
Answer: C
10. An LLC is designed to:
A) Avoid all taxes
B) Combine limited liability with partnership taxation
C) Have unlimited liability
D) Exist only in the U.S.
Answer: B
11. Which is NOT a question in corporate finance?
A) What long-term investments to make?
B) How to manage daily finances?
C) What products to manufacture?
D) Where to get long-term financing?
Answer: C
12. The term “working capital” includes:
A) Buildings and machinery
B) Inventory and accounts payable
C) Long-term debt
D) Equity shares
Answer: B
13. In capital budgeting, financial managers evaluate:
A) Size, timing, and risk of cash flows
B) Dividend policies
C) Credit terms to customers
D) Short-term loans
Answer: A
14. Which business form is easiest to start?
A) Corporation
B) LLC
C) Sole Proprietorship
D) Partnership
Answer: C
15. What is a limited partner’s liability?
A) Unlimited
B) Limited to their investment
C) None
D) Shared equally
Answer: B
16. The CFO typically oversees:
A) Only the controller
B) Only the treasurer
C) Both treasurer and controller
D) Marketing department
Answer: C
17. Which form of business is a separate legal entity?
A) Sole Proprietorship
B) Partnership
C) Corporation
D) Both B and C
Answer: C
18. Which Act allowed up to 20% business income exemption for some entities?
A) Sarbanes-Oxley Act
B) Tax Cuts and Jobs Act of 2017
C) Dodd-Frank Act
D) Glass-Steagall Act
Answer: B
19. Ownership in a corporation is represented by:
A) Partnership agreement
B) Shares of stock
C) Personal assets
D) Bonds
Answer: B
20. The main goal of working capital management is to:
A) Maximize long-term investments
B) Ensure daily operational liquidity
C) Reduce corporate taxes
D) Issue new equity
Answer: B