ch,1 Flashcards
What is Corporate finance
the answer to these questions:
1. What long-term investments should the firm take on?
- Where will we get the long-term financing to pay for the investment?
- How will we manage the everyday financial activities of the firm?
What is capital budgeting?
the process of planning and managing the firm’s long-term investments
Capital structure
the specific mixture of short-term debt, long-term debt, and equity the firm uses to finance its operations.
- How should we pay for our assets? where do you get money from? through stock or through bond. Should we use debt or equity?
What is working capital management?
the difference between a firm’s short-term assets and its short-term liabilities
- everyday liquidity, cash flow, every day finances
treasurer
oversees cash management, capital expenditures and financial planning
Controller
oversees taxes, cost accounting, financial accounting and data processing
The 3 forms of business
- sole proprietorship
- partnership
- corporation
Sole proprietorship advantages and disadvantages
Advantages:
Easiest to start
Least regulated
Single owner keeps all the profits
Taxed once as personal income
Disadvantages:
Unlimited liability
Limited to life of owner
Equity capital limited to owner’s personal wealth
Difficult to sell ownership interest
Partnership advantages and disadvantages
Advantages:
- Two or more owners
- More human and financial capital available
- Relatively easy to start
Income taxed once as personal income
Disadvantages:
Unlimited liability
- General partnership
- Limited partnership
Partnership dissolves when one partner dies or wishes to sell
Difficult to transfer ownership
Possible disagreements between partners
Corporation advantages and disadvantages
Advantages:
Limited liability
Unlimited life
Separation of ownership and management
Transfer of ownership is easy
Easier to raise capital
Disadvantages:
Separation of ownership and management
Double taxation (income is taxed at the corporate rate and then dividends are taxed at the personal rate)
Income trust advantages and disadvantages
Advantages
Not subject to corporate income tax and income is typically taxed in hands of unit holders.
Investors view income trusts as more tax efficient.
Disadvantages:
Income trusts are not corporations and so, do not have the same advantages as one
You pay only personal income taxes and enjoy benefits of corporation. But they changed the law, and now you have to pay double-tax. So it’s not as important.
Co-operative advanatges and disadvantages
Advantages:
Equally owned by its members
Helps its members compete more effectively while creating social capital
Disadvantages:
Potentially difficult to reach decisions based on premise of equal ownership by members
What are the 3 equivalent goals of financial management?
- Maximize shareholder wealth
- Maximize share price
- maximize firm value
What is the agency problem and the agency costs
Stockholders (principals) hire managers (agents) to run the company.
Agency Problem:
Conflicts of interest can exist between the principal and the agent.
Agency Costs:
Direct agency costs: misusage of firm’s assets, monitoring cost
Indirect agency costs: forgone opportunity costs
Explain managerial compensation
Incentives: . For example, tying bonuses to profits might encourage management to pursue short-run profits and forego projects that require a large initial outlay. Stock options may work, but there may be an optimal level of insider ownership. Beyond that level, management may be in too much control and may not act in the best interest of all stockholders
ex: if you fail to achieve the goal, you will be fired.
ex: you will get stocks.
Problem: Ex: if I can boost my stock in 2 years, I can get paid a lot, and leave. So this is not good for the long time behaviour of the company.
Social responsibility and ethical investing
- investors are demanding that corporations behave responsibly
- how a corporation treats the community in which it operates, their customers, corporate governance, their employees, the environment and human rights.
What are some controversial business activities
include alcohol, gaming, genetic engineering, nuclear power, pornography, tobacco and weapons.
Why would managers avoid takeover?
Poorly managed firms are more attractive as acquisitions than well-managed firms, bc a greater turnaround potential exits. Avoiding a takeover by another firm gives management another incentive to act in the shareholders’ interest.
Explain figure cash flows between the firm and the financial markets (1.4)
1.5 slides
money markets refers to
short-term debts and liquid securities
capital markets
refers to long-term debts and shares of a firm
Primary vs secondary markets
- Primary market refers to the original sale by the issuer
- Secondary market refers to where securities are sold and bought after the original sale
The risk-return trade-off
There is a reward for bearing risk
The greater the potential reward, the greater the risk
simple interest earn interest on ________
principal only
Compound interest earn interest on __________
principal and reinvested interest
