Corporate Finance Ch. 1-3

Capital Budgeting Decisions
Long Term Investments
ex: equipment land
Capital Structure Decision
Sources of financing
Working capital decision
short term asset and liability
Sole Proprietorships
-Unlimited owner Liability
-Difficult to raise funds
-Difficult to transfer ownership
-Limited and Unlimited Liability
-Difficult to raise funds
-Difficult to transfer Ownership
-Limited liability
-Easy to raise funds
-Easy to transfer ownership
General Goal of Finance
Maximize the market value of the existing owners equity
Corporate goal of finance
Maximize current value per share of the existing stock
Agency Relationship
whenever one party (“Principal”) hires another (Agent) to represent the interests of the principal
Agency Problem
Conflict of interest between the principal and the agent
Addressing Agency Problem:
Managerial Compensation
-Structure compensation to align management and stockholder goals
ex: stock options
Addressing Agency Problem:
Control of the Firm
-Proxy fights (by stockholders)- hard to do
-corporate takeovers (by other firms)
Financial Markets
Markets that bring together buyers and sellers of debt and equity securities
Types of Financial Markets
Primary and Secondary Markets
Primary Market
-Seller (the corporation) ex: Chickfila
-Buyer—>General Public (public offering)
—->Specific Party (Private placement)
Secondary Market
-Seller (Owner or creditor) ex: Individual selling Chickfila
-Buyer (another owner)
Over the Counter Markets
-No Physical Location
-dealers buy and sell for themselves, at own risk
Auction Market
-Physical location (wall street)
-Brokers match buyers and sellers
Balance Sheet
Shows firms accounting value on PARTICULAR DATE
Income Statement
Summarizes firms performance over a PERIOD OF TIME
Speed and ease which an asset can be converted to cash without significant loss
Financial Leverage
How a firm uses their debt
Book value
historical cost less accumulated depreciation
market value
value of an asset today
Net income=
Generally Accepted Accounting Principles (GAAP)
Shows revenue when it accrues and matches expenses to revenue
Operating Leverage
Extent of a firms fixed costs to total costs
Cash flow from Assets= Cash Flow to creditors+ Cash Flow from Stockholders
Short term Solvency
Measure the firms ability to pay its bills over short run
-Current, Quick and Cash Ratios
Long Term Solvency
Measure firms long run ability to meet obligations
-Total Debt, Debt-Equity Ratio, Eq. Mult., Times interest earned ratio, Cash Coverage Ratio
Asset Management (Turnover) Ratios
Measure the Firms efficiency in using assets for sales
-Inventory Turnover, Receivables Turnover, Total Asset Turnover
Profitability Ratios
Measure firms efficiency in using its assets and managing its operations
Market value
Measure performance using market price per share of stock
Price-Sales Ratio=
Market to Sales Ratio
Earnings per share=
Net Income/Shares Outstanding
Sales Per Share=
Sales/Shares Outstanding
Book value per share=
Total Current Equity/Shares Outstanding
ROE=Profit Margin*Total Asset Turnover*Equity Mult.
Growth in sales requires
growth in assets
Growth in assets requires
Internal Sources of financing
Internal (Retained Earnings)
External Sources
Debt=borrowing Money
Equity=Selling Stock
b=Retention Ratio=
(Net Income-Dividends) / Net Income
Current Assets-Current Liabilities
Liza is trying to decide whether her firm should acquire more debt or issue additional shares of stock. Which type of decision is Liza making?
Capital Structure
A decision to increase which one of the following accounts would be classified as a capital budgeting decision?
Les is the sole owner of Les’ Meat Market. The net profits of the Meat Market are taxed as personal income to Les. Which type of entity is Les’ Meat Market?
Sole Proprietorship
Which one of the following statements applies to a limited partnership?
All general partners have unlimited liability for the partnership’s debts
Increasing the current value of which one of the following best matches the goal of financial management
Stock Price
Which one of the following statements best matches the primary goal of financial management?
maximizing the value of a firm for its current owners while conducting business in a legal and ethical manner
Galatica has made an offer to purchase Free World, Inc. for $22 a share. The shareholders of Free World want to accept the offer but the managers of Free World are fighting against selling the firm for fear they will lose their jobs. This is an example of which one of the following?
Agency Problem
Which one of the following is the best example of an agency cost?
foregoing a profitable project because managers fear they may lose their jobs as a result
Toni’s Toy Store is a relatively new firm that has been very successful to date. The firm has been privately owned but as of this morning, the owners are issuing new shares of stock for sale to the general public. These shares are being sold in which type of market?
What is the primary function of an auction market?
Match buyers with sellers
Net New Borrowing=
Long term Debt(end)-LTD(Beg)
Net new Equity=
Common Stock (End)-Common Stock (Beg)