Chapter 1 – Finance Study Guide
This study guide summarizes Chapter 1 with key definitions, explanations, exam-style questions, and
worked examples.
Key Concepts
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Financial assets vs real (tangible) assets
Capital budgeting, financing, and capital structure decisions
Time value of money (saving and borrowing)
Net Present Value (NPV)
Corporation ownership and control
Limited liability
Agency problem and agency costs
Goal of financial management
Important Definitions
Financial Asset: A claim on future cash flows (stocks, bonds, loans).
Real Asset: A tangible asset used to produce goods or services (buildings, machinery).
Capital Budgeting: Decision to invest in real assets.
Financing Decision: How a firm raises funds.
Capital Structure: Mix of debt and equity financing.
Limited Liability: Owners’ losses limited to their investment.
Agency Problem: Conflict between shareholders and managers.
Agency Costs: Monitoring and incentive alignment costs.
NPV: Present value of future cash flows minus initial cost.
Exam-Style Questions & Answers
What is the financial goal of a corporation?
Answer: Maximize the value of the firm for shareholders.
Explanation: This goal reflects long-term value, risk, and timing of cash flows.
Which is not a financial asset?
Answer: Buildings.
Explanation: Buildings are real assets, not financial claims.
Who owns a corporation?
Answer: Shareholders.
Explanation: Managers run the firm but do not own it.
What is limited liability?
Answer: Owners are not personally liable beyond their investment.
Explanation: This reduces investor risk.
Why do agency costs exist?
Answer: Separation of ownership and management.
Explanation: Managers may not always act in shareholders’ best interests.
Worked Examples
Saving: Save $70 today → $77 next year at 10%.
Borrowing: Borrow $20 today → repay $22 next year at 10%.
NPV: −50 + 80/1.10 = $22.73.