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1. Shareholder value

The primary goal of corporations

The owners of a corporation are the shareholders of the company . The primary goal of the corporate management team is to
maximize the shareholders’ wealth by maximizing the company’s stock price over the long run.

Points: 1/1

Explanation: Close Explanation

The owners of a corporation are the shareholders, or the people who own shares of stock in the company. Shareholders elect the board of

directors, who in turn create a management team to run the company and achieve corporate goals, including reducing cost and increasing
revenue. However, these goals collectively are meant to achieve one primary goal: maximize shareholder wealth. Management achieves this

goal by maximizing the company’s stock price over the long run.

Krit Corp. is a US manufacturing company based in the Midwest. As an investor, Wilson bought 100 shares of stock in Krit Corp. The stock price of Krit
Corp. is currently trading at $27.50 per share.

Wilson’s total wealth in Krit Corp. is:

$100.00

$363.64

$5,250.00

$2,750.00

Points: 1/1

Explanation: Close Explanation

Shareholder wealth is the total number of shares that a company has issued (also known as shares outstanding) times the market price of each

share.

Here, you have been asked to calculate the wealth that Wilson owns in the company. Wilson’s wealth will be the number of shares that Wilson
owns times the market price per share:

Wilson’s Wealth = Number of Shares that Wilson Owns * Market Price per Share

= 100 shares * $27.50

= $2,750.00

If the stock price of Krit Corp. decreases in the next two years, Wilson’s wealth in Krit Corp. will decrease .

Points: 1/1
Explanation: Close Explanation

The primary goal of company management is to maximize shareholder wealth, which implies that managers should make decisions that
maximize the long-run value of the company’s stock.

An investor’s wealth in the firm is equal to the number of shares that the investor owns times the stock price. If the stock price decreases, then
the investor’s wealth also decreases.

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2. Finance in an organization

Corporate finance is concerned with the different aspects of a business’s financial management. The chief financial officer (CFO) is the top financial
position in the organization and oversees several tasks.

The CFO is not responsible for which of the following departments? Check all that apply.

Capital budgeting

Production

Investments

Research and development

Marketing

Points: 0.8 / 1

Explanation: Close Explanation

Most corporations have an organizational structure in which the board of directors elect a chief executive officer (CEO). The chief operating
officer (COO) and the CFO report to the CEO. Various department heads report to the COO and the CFO.

The CFO is usually in charge of accounting, treasury, credit, legal, capital budgeting, investor relations, security analyst relations, and
investment decisions. The COO is in charge of the firm’s operations, which include marketing, production, human resources, administration, and
research and development.

The COO and CFO undertake other responsibilities, and every company has a distinctive organizational structure.

The US Securities and Change Commission (SEC), a US federal agency, is considered to be an investor’s advocate. Its purpose is to protect investors,

maintain market integrity, and facilitate capital formation. Under the Sarbanes–Oxley Act of 2002, the SEC requires CFOs to certify that the firm’s:

growth plans are on track

shareholders are protected

financial statements are audited

earnings numbers are accurate

Points: 1/1

Explanation: Close Explanation

As a reaction to several corporate and accounting scandals that resulted in the failure of companies such as Enron and WorldCom, Congress
passed the Sarbanes–Oxley Act of 2002. The act requires the US Securities and Change Commission (SEC) to implement rulings on all public
companies.

Although the other three aspects are important, the Sarbanes–Oxley Act of 2002 requires that financial statements be accurate and certified by
the CEO and the CFO.
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3. Corporate finance, capital markets, and investments

Finance professionals make decisions that fall into three distinctive areas: corporate finance, capital markets, and investments. Below is a set of
decisions made by finance professionals. Categorize the decisions according to the area of finance to which they belong.

Corporate Capital
Decision Finance Markets Investments

Richard, the chief executive officer (CEO) of ABC Corp., must make decisions that help achieve the

primary goal of the corporation: maximize shareholders’ wealth.

Brandon works for an investment bank and makes decisions about the sale of new common stock by

ABCL Inc.

Chris works for a financial advising firm. He must create a financial plan and come up with a list of

securities in which his client can invest. Chris must make decisions regarding the investments that he
should recommend to his clients to include in their portfolio.

Points: 0.33 / 1

Explanation: Close Explanation

Corporate finance focuses on financial decisions that corporations need to make to run the firm. The objective of these decisions is to achieve
the primary goal of the corporation: maximize shareholder wealth. Here, Richard, as the CEO of ABC Corp., must make decisions with the chief
financial officer (CFO) to help maximize the firm’s value and manage its financial risk. This belongs in the area of corporate finance.

The capital market includes the stock market and the bond market. These markets come under the supervision of financial regulators such as
the Securities and Exchange Commission (SEC). Capital markets include entities—such as banks, investment banks, stockbrokers, mutual funds,

insurance companies, governmental organizations such as the Federal Reserve Bank, and individuals—that deal with capital for different
purposes. Investment banks are a part of the capital markets. Capital markets consist of the primary market in which new stocks and bonds are
sold and the secondary market in which stocks and bonds are bought and sold among investors. Brandon is dealing with the sale of new

common stock by ABCL Inc. and thus falls under capital markets.

Security analysis, portfolio theory, market analysis, and behavioral finance fall under the area of investments. Market analysis for investments

includes decisions that depend on the state of stock and bond markets. Here, Chris must do research and analyze securities to choose
investments that will help his client achieve his or her investment objective.

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4. Forms of business organizations

Businesses can be classified into the following forms: sole proprietorship, partnership, corporation, limited liability company (LLC), and limited liability
partnership (LLP).

Different forms of businesses have different characteristics. Which of the following characteristics would apply to a limited liability company and a

limited liability partnership? Check all that apply.

Owners have limited liability and right to vote

Have corporate ownership structure

Taxed as a partnership

LLPs are not suitable for professional firms such as accounting, law, and architecture

Limited financial liability

Owned by single individual

Points: 0.83 / 1

Explanation: Close Explanation

A limited liability company (LLC) or a limited liability partnership (LLP), as the name suggests, is similar to a partnership, but owners
have limited personal liability for the debts and actions of the company. An LLP is similar to an LLC. These firms combine the features of a
partnership and a corporation. Owners of an LLC are called members, and they cannot be held personally liable for the company’s debts. As in

a partnership, income is distributed proportionately among the members, and they are taxed at individual levels, thus avoiding the issue of
double taxation. LLPs are used for professional firms such as accounting, law, and architecture, while LLCs are used by other businesses.

You come across different kinds of businesses every day. The following table describes some businesses. Using the description of each business,
classify it as a sole proprietorship, a partnership, a corporation, or a limited liability company/limited liability partnership.

Business Scenario Type of Business

Jacob founded and operated a wedding planning agency, which specialized in celebrity Sole Proprietorship
weddings. When he died, his business was dissolved because there was no plan for control

after his death.

Wilson started a business, based in a different state, with his uncle. Due to the business’s Partnership

underperformance, they had to close the business. Wilson, however, ended up losing his
house due to a litigation claim.

DDX Co. is a shipping company. David owned 1,000 shares of DDX stock. He found better Corporation

opportunities and sold his entire stake in DDX to another investor.

Selena and Mario run a law firm in Chicago. The firm has debt of $100,000, but Selena LLC/LLP
and Mario will not be held personally liable for the law firm’s debt.

Points: 0.5 / 1

Explanation: Close Explanation

Jacob’s wedding planning business is an example of a sole proprietorship. The life of the business was limited to the proprietor’s life.
Wilson’s company is an example of a partnership in which Wilson and his uncle made a legal arrangement to run the company. In a partnership,
the owners are subject to unlimited personal liability, which allows claims over the partners’ personal assets.

DDX Co. is a corporation, and David was one of the shareholders (owners) in the company. His stake in the company was equal to the value of

1,000 shares of DDX stock. Ownership in corporations can be transferred, so David transferred his ownership by selling his shares of DDX stock.

Selena and Mario’s law firm is an example of a limited liability partnership (LLP). LLPs, similar to LLCs, protect the owners so that they are not

personally liable for the company’s debts.

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5. Intrinsic values and stock prices

The intrinsic value of a company’s stock, also known as its fundamental value, refers to the stock’s “true” value based on accurate risk and return
data. The value perceived by stock market investors determines the market price of a stock.

A stock trading at a price below its intrinsic value is considered to be undervalued. A stock trading at a price above its intrinsic value is considered to

be overvalued.

The goal of the managers of a publicly owned company should be to maximize the firm’s intrinsic value .

Points: 1/1

Explanation: Close Explanation

A stock’s intrinsic value is an estimate of the stock’s “true” value based on accurate risk and return data. Maximizing a firm’s intrinsic value
will maximize the average stock price over the long run, but not necessarily the current market price at each point in time. The primary goal for

managers of publicly owned companies is to maximize the long-run value of the firm’s common stock. The best way for managers to achieve
this goal is to focus on maximizing the firm’s intrinsic value.

An analyst with a leading investment bank tracks the stock of Mandalays Inc. According to her estimations, the value of Mandalays Inc.’s stock should

be $69.54 per share, but Mandalays Inc.’s stock is trading at $55.78 per share on the New York Stock Exchange (NYSE). Considering the analyst’s
expectations, the stock is currently:

overvalued

undervalued

in equilibrium

Points: 1/1

Explanation: Close Explanation

A stock trading at a price below its intrinsic value is considered to be undervalued. A stock trading at a price above its intrinsic value is
considered overvalued.

Here, stock of Mandalays Inc. is trading at $55.78 per share, which is less than the intrinsic value of $69.54 per share, as determined by the

analyst. Thus, according to this analyst’s estimates, the stock of Mandalays Inc. is considered to be undervalued.

The following graph shows a stock’s actual market price and intrinsic value over time. The intrinsic value comes from another research analyst. Use
the dropdown menus to label the periods in which the stock was undervalued or overvalued.
 Actual Stock Price
30

Intrinsic Value
29

28
Stock Price and Intrinsic Value ($)

A
27

26

25

24

B
23

22

21

20
2013 2014 2015 2016 2017 2018
Years

A Overvalued

B Undervalued

Points: 1/1

Explanation: Close Explanation

According to the graph, the analyst estimated the intrinsic value of the stock to be more than the market price of the stock between 2014 and

2016. Thus, the stock was considered to be undervalued during that time period. However, according to this analyst, the market stock price
exceeded the intrinsic value of the stock after 2016. From then until the end of 2019, the stock was overvalued.

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6. Stockholder and manager conflicts

Executive compensation packages often tie performance to bonus and incentive awards, supplemental retirement packages, perquisites, and
severance pay, in order to encourage the management team to align their performance with organizational goals.

Executives are often compensated above and beyond their salary and benefits. Which of the following perquisites would not encourage managers to

maximize long-run shareholder wealth?

Stock options

A percentage of the company's profits

The use of a private jet

Points: 1/1

Explanation: Close Explanation

Compensation packages should motivate the executives to maximize long-run shareholder wealth. If management is rewarded based on the

profit levels of the firm, either directly or through stock options, they will strive to achieve high profit levels so that they should earn more.
Profit maximization will not only help increase shareholders' wealth but also the firm's value.

The use of a private jet is nice but it doesn’t offer the executive any specific incentive to maximize shareholder wealth.

Vision Tech is a software company based out of San Francisco. Its stockholders are mostly individual investors and there is relatively little institutional
ownership. If several pension and mutual funds were to take large positions in Vision Tech’s stock, would direct shareholder intervention be more or
less likely to motivate the firm’s management?

More likely

Less likely

Points: 1/1

Explanation: Close Explanation

Direct shareholder intervention is strongest when investors are concentrated and organized. Institutional investors, such as pension and mutual

funds, concentrate and organize investors, so they are better able to take action and directly intervene in the company’s affairs. When a
company's investors are predominantly individual investors, they find it difficult to voice their concerns to management, and there is less chance

that management will heed those concerns.

Vision Tech’s stock price is currently trading at $39 per share. The consensus among analysts is that the intrinsic value of Vision Tech’s stock is $33
per share. Is Vision Tech more or less likely to receive a hostile takeover bid?

Less likely

More likely

Points: 1/1
Explanation: Close Explanation

A hostile takeover is likely when a firm’s stock price is trading below its intrinsic value. If this continues for a long time, outside investor groups
start believing that the existing management of the firm is underperforming and new management can boost the firm’s long-run stock
prospects. If the stock price is greater than the intrinsic value, the stock is considered to be overvalued, and investors would not want to spend

more money than the underlying asset is worth.

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7. Agency conflicts between managers and shareholders

Remember, an agency relationship can degenerate into an agency conflict when an agent acts in a manner that is not in the best interest of his or her

principal. In large corporations, these conflicts most frequently involve the enrichment of the firm’s executives or managers (in the form of money and

perquisites or power and prestige) at the expense of the company’s shareholders. This usurping and reallocation of shareholder wealth is most likely to
occur when shareholders do not have sufficient information about the decisions and actions being made by the firm’s management.

Consider the following scenario and determine whether an agency conflict exists:

Last week, an investigative reporter for a major metropolitan newspaper discovered that the doctors conducting clinical trials of a new

cancer treatment drug are also the principal shareholders in Cancer Solutions Inc. (CSI). CSI is the company developing and attempting
to market the drug. Upon being interviewed by federal authorities, the doctors acknowledged their conflict of interest but reported that
they were sold the shares at a 75% discount by CSI’s chief financial officer. The CFO was concerned that CSI might not be able to meet

its annual performance objectives and in turn pay his anticipated multimillion-dollar bonus.

Does an agency conflict exist between CSI’s CFO and the company’s shareholders?

No; professionals, such as doctors and professional money managers, would not participate in unethical activities.

No; in general, shareholders are satisfied with company officers engaging in any type of legal or illegal activity to ensure the chances of
them receiving greater dividend payments.

Yes; the shares should not have been sold at a 75% discount, which is price discrimination.

Yes; CSI’s CFO engaged in unethical conduct to manipulate the firm’s short-term earnings and improve the likelihood of receiving his
annual bonus.

Points: 1/1

Explanation: Close Explanation

The case of CSI exhibits both a conflict of interest and an agency conflict. A substantial conflict of interest exists between the doctors conducting
the clinical trials and the company—in which the doctors are also principal shareholders—developing the drug. The agency conflict exists
between the drug company’s CFO and the firm’s shareholders. Engaging in unethical behavior to manipulate the firm’s short-term earnings and
improve the likelihood of receiving an annual bonus may expose the firm’s end customers (cancer patients) to potential physical harm. It also

subjects the company and its shareholders to otherwise unnecessary legal expenses and fines and severely harms the firm’s reputation.

For the past 40 years, companies have attempted to attract, retain, and encourage managers by developing attractive compensation packages. These
compensation packages have also been intended to reduce potential agency conflicts between these managers and the firm’s shareholders.

In the best interest of shareholders, compensation packages should be structured in a way such that managers have an incentive to maximize the

long-term value of the company’s common stock price.

Points: 1/1

Explanation: Close Explanation

A compensation package that includes only a salary and does not include a feature (for example, stock options) that links the executive’s wealth
to the price of the firm’s stock will not motivate the executive to pay focused attention to the long-term wealth of the firm’s shareholders or to
increase the firm’s share price.

True or False: A small number of institutional investors are often able and motivated to bring direct shareholder pressure on a firm’s management in
an effort to reduce potential agency conflicts.

False

True

Points: 1/1

Explanation: Close Explanation

This statement is true. Institutional investors (such as pension funds and mutual funds) are almost always better able and significantly more

motivated to monitor management’s actions than are individual investors. Because they are investing and are responsible for the funds of their
depositors, they have a strong desire to ensure that the firm’s share price and the value of their investment are maximized.

It is also easier to coordinate the actions and objectives of a small number of large (in terms of the number of shares owned), experienced,
geographically concentrated institutional investors than those of a large number of small, usually inexperienced, geographically dispersed

individual investors.

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