1.   What are the two key financial management decisions? For each type of decision, give an example of a business transaction that would be relevant.

Capital Budgeting e.g. deciding whether to expand a manufacturing plant; purchasing a new computer system

Capital Structure e.g. deciding whether to issue new equity and use the proceeds to retire outstanding debt

2.   What are the major disadvantages of the sole proprietorship and partnership forms of business organisation? What benefits are there to these types of business organisation as opposed to the corporate form? Why are some sole proprietors unwilling to change the form of business organisation to the corporate form?

DISADVANTAGES: unlimited liability, limited life, difficulty in transferring ownership, hard to raise capital funds.

ADVANTAGES: simpler, less regulation, the owners are also the managers, sometimes    personal tax rates are better than corporate tax rates. The reason why sole proprietors are often unwilling to change to a corporation is that it typically involves a loss of control (separation of ownership from management) and this brings with it agency type problems.

3.   What is the primary disadvantage of the corporate form of organisation? Name at least two of the advantages of corporate organisation.

The primary disadvantage of the corporate form is the double taxation to shareholders of distributed earnings and dividends.

Some advantages include limited liability, ease of transferability, ability to raise capital, unlimited life.

4.   Why do we assume that the goal of a corporation is to maximise shareholder wealth?

To  provide  advice  on  how  decisions  within  corporations  should  be  made  we  need  to understand what the owners or shareholders of the company desire from ownership, because if  this  group  is  not  satisfied,  then  the  firm  will  cease  to  exist  or,  at  least,  will  change substantially. For most shareholders, the purpose of owning shares is to increase their wealth because of ownership. They are willing to give up money at the time they purchase shares or when they forgo dividends that they could receive, in order to (hopefully) receive returns on their  money  in  the  future,  Thus,  firms  should  assess  alternatives  with  the  objective  of maximising the wealth of the shareholders. This maximises their purchasing power and allows them  to  choose  the  optimal  consumption  pattern.  In  saying  that  decisions  'should'  be undertaken with the objective of maximising shareholder wealth we are not claiming that this is the only function that firms perform.

Clearly, successful companies satisfy consumer wants, they provide employment, they

help bring about technological developments and they can provide benefits in terms of          sponsoring  cultural  or  sporting  events.  However, these  benefits  are  only  by  products.  If decisions are taken which do not satisfy the company shareholders, then those taking the     decisions are likely to be replaced. It is the shareholders who have ultimate control of the      company and who have the power to choose the management of the company.

Management are acting on the behalf of shareholders and should therefore take all decisions, including capital investment decisions, with their interests in mind.

5.   Who owns a corporation? Describe the process whereby the owners control the firm’s management. What is the main reason that an agency relationship exists in the corporate form of organisation? In this context, what kind of problems can arise? Name some other areas of activity in which an agency relationship exists.

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 ownership from control in the corporate form of               organisation is what causes agency problems to exist. Management may act in its own or  someone else's best interests, rather than those of the shareholders. If such events occur, they may contradict the goal of maximising the share price of the equity of the firm.

An agency relationship exists in any situation where one person employs another to act on their behalf, e.g. a person selling a house employs an estate agent, a person taking legal     action employs a solicitor, someone needing to fix their car employs a mechanic etc.

6.   What  is the  difference  between  primary and  secondary capital  markets? Why  is  the existence of secondary markets important?

The term primary market refers to the initial sale of securities (shares or bonds for example) where the transaction raises money for the corporation i.e. money goes from investors to the company in exchange for a security. An example of this is in an IPO – initial public offering.

The secondary market (for example the stock market/exchange) is the market where those  securities are bought and sold after the original sale. This exchange happens between investors. In the secondary market it is the seller of the security who receives funds, and not the corporation.

Although a corporation is only directly involved in a primary market transaction, the secondary markets are still critical to large corporations. The reason is that investors are    much more willing to purchase securities in a primary market transaction when they know that those securities can later be resold if desired. Thus secondary markets facilitate liquidity in the primary markets.