Chapter 1-Corporate Finance and the Financial Manager

Capital Budgeting
The process of planning and managing a firm’s long-term investments (opportunities worth more than cost).
Capital Structure (aka Financial Structure)
The specific mixture of long-term debt and equity the firm uses to finance its operations.
1.How much firm should borrow (what mix of debt/equity is best)?
2.Least expensive sources of funds for the firm.
Working Capital
A firm’s short-term assets and liabilities. Examples: inventory, STA, STL (money owed to suppliers).
3 areas of corporate financial management:
1. Capital management
2. Capital structure
3. Capital management
Q. What is the capital budgeting decision?
The financial manager tries to identify the investment opportunities that are worth more to the firm than they cost to acquire.
Q. What do you call the specific mixture of long-term debt and equity that a firm chooses to use?
Capital Structure
Q. Into what category of financial management does cash management fall?
Working Capital Management
3 different legal forms of business organizations?
1. Sole proprietorship
2. Partnership
3. Corporation
Sole Proprietorship
A business owned by a single individual.
Advantages of a Sole proprietorship (3):
1. Easy inexpensive to form
2. Least Regulated
3. Owner keeps all profits
Disadvantages of a Sole proprietorship (6):
1. Owner has unlimited liability for debts
2. Amount of equity is amt of owner’s wealth
3. Creditors can access personal assets
4. Business income is considered personal income
5. Life of co. is limited to owner’s life
6. Difficult to transfer
A business formed by two or more individuals or entities.
In a general partnership, ALL partners (2):
1. Share in gains and losses.
2. Have unlimited liability for all partnership debts.
Partnership Agreement
A written or oral agreement which can be formal or informal and describes the way partnership gains (and losses) are divided.
Limited Partnership
One or more General Partners runs the business AND have unlimited liability.
General Partners
One or more partners who actively participate in the business.
Limited Partners
Partner(s) who do not actively participate in the business but have invested money into it. Liability for business debt is limited to the amount invested.
Advantages of a Partnership (2):
1. Easy and inexpensive to form
2. Informal oral or written agreement
Disadvantages of a Partnership (6):
1. GP’s have unlimited liability for partnership debt
2. Partnership terminates when a GP wishes to sell or dies.
3. Income is taxed as personal income.
4. Amount of equity raised is limited to the partner’s combined wealth.
5. GP Partnership is not easily transferrable.
6. A LP can be sold without dissolving but must have an interested buyer.
3 Primary Disadvantages of a Sole Props and Partnerships as forms of business organizations are (3):
1. Owners have unlimited liability for business debt
2. Limited life of the business
3. Difficulty of transferring ownership
A business created as a distinct legal entity composed of one or more individuals or entities. Most complicated to form but the most important.
Characteristics of a Corporation (7):
1. A corporation is a legal person
2. Which is separate and distinct from its owners
3. It has many rights, duties, and privileges owner
4. Can borrow money and own property
5. Can sue and be sued, can enter into contracts
6. A corporation can be a GP or LP
7. Can own stock in another company
Forming a corporation involves preparing (2):
1. Articles of Incorporation
2. Bylaws
Articles of Incorporation include (4):
1. Name
2. Intended life
3. Business purpose
4. Number of shares that can be issued
Who elects the Board?
The Stockholders
Who selects the managers?
The Board
The managers essentially work for?
The Stockholders
Rules describing how the corporation regulates its existence. They can be simple or extensive. Bylaws can be amended from time to time by the stockholders.
Advantages of a Corporation (5):
1. Ease of transferring ownership
2. Limited liability for business debts
3. Unlimited life of the business
4. Need new equity? Sell more stock
5. Raise capital to fund growth and product development
Disadvantages of a Corporation
1. Double taxation- paid coming in (earnings), paid when going out (dividends).
Limited Liability Company (LLC)
The goal of the entity is to operate and be taxed like a partnership but retain *limited liability* for owners. It’s a hybrid of *partnership and corporation*.
Other names for corporation (3):
1. Joint Stock Companies
2. Public Limited Companies
3. Limited Liability Companies
What is the goal of Financial Management?
To maximize the current value per share of the existing stock. (CH1.3)
When do stockholder’s get paid?
Last (CH1.3)
How do financial managers maximize the value of stock?
They identify investments and financial arrangements that favorably impact the value of the stock. (CH1.3)
Corporate Finance
The study of the relationship between business decisions and the value of the stock in the business. (CH1.3)
The total value of the stock in a corporation is equal to?
The value of the owner’s equity. (CH1.3)
Sarbanes-Oxley Act 2002 requires public corporations:
1. No personal loans to company officers
2. Annual report must have an assessment of company’s:
a. internal controls structure
b. financial reporting
c. Independent auditor to evaluate assessment
3. Officers must review and sign annual report
4. Declare no false statements in the report
5. Declare responsibility for internal controls
6. Report shall list deficiencies in internal controls
7. Management responsible for accuracy of financial statements (CH1.3)
Agency Relationship
The relationship between stockholders and management.
Agency Problem
The possibility of conflict of interest between stockholders and management.
Agency Costs
The *costs* of the conflict of interest between stockholders and management.
2 Agency costs:
1. Direct
2. Indirect
Indirect Agency Costs
A lost opportunity due to the conflict of interest
Direct Agency Costs come in two forms;
1. Corporate expenditure – benefits management
2. Expense – paying outside auditors to monitor
Proxy Fight
Someone other than the stockholder or creditor who potentially has a claim on cash flows of the firm. Example: Employees, customers, suppliers, even govt.
Financial markets function as both ________ and _________ markets for debt and equity securities.
primary and secondary markets
Primary Markets refer to:
The original sale of the securities by governments and corporations. Can be resold.
Secondary Markets refer to:
These securities are bought and sold after the original sale.
Equities are issued by:
Debt Securities:
Both corporations and governments
In a primary market, the seller is the _________ and the transaction raises money for the __________.
Two types of primary transactions:
-public offerings and
-private placement
True or False: Public offerings of debt and equity must be registered with the Securities and Exchange Commission (SEC).
Secondary Markets involves:
A transaction which involves one owner or creditor selling to another.
Two kinds of Secondary Markets:
1. Auction markets
2. Dealer markets
Buy and sell securities for themselves
Brokers and Agents
Match security buyers to sellers
Over-the-counter (OTC) Markets
Dealer markets in stocks and long-term debt. Literally used to be sold “over the counter.”
Auction Markets (aka exchange markets)
-has a physical location (e.g. Wall Street)
-most of the buying and selling is done by the dealer
The primary purpose of an auction market?
-is to match buyers with sellers.
The equity shares of most of the large firms in the U.S. trade in organized _________ markets.
“listed on the exchange”
Stocks that are traded on an organized exchange.