Chap 1 - Introduction To Corporate Finance Flashcards
Finance définition
Finance is how the money is used/raised by government, business or individuals.
3 key concepts
RISK - money in the future (uncertainty)
LIQUIDITY - convert into cash without loss
VALUATION - what an asset/project is worth today. Bring money into the present.
3 areas of finance
Corporate finance
Investment
Financial market & investment
2 financial certificates
CFA - Chartered Financial Analyst
FRM - Financial Risk Manager
3 financial decisions for the financial manager
Capital budgeting
=> what long term investments or projects should the business take on ?
Capital structure
=> how should we pay for our assets ? Debt or equity?
Working capital management
=> how do we manage the day to day finance if the firm ?
3 goals of the CFO (Chief Financial Officer)
- Make money
- Stay in business
- Increasing value
Debt investors définition
People that invest money in your deal for a fixed rate of return. (You agree to pay them a certain interest rate)
Equity investors definition
People that invest money in your deal for a percentage of the profits.
What can you use to finance a project ?
Debt investor or equity debt
2 strategies to have cash
=> delayed your payments
=> turn revenu into cash
2 Finance decisions
- Value of business
2. Trading strategy
Forms of business organizations
Sole proprietorship: single owner
Partnership: two or more owners
=> these are small companies
Corporation: limited liability company
=> big or public companies
Advantages and disadvantages of a corporation
ADVANTAGES
- limited liability
- unlimited life
- separation of ownership and management
- transfert of ownership is easy
- easier to raise capital
DISADVANTAGES
- difficult to start
- more regulated
- separation of ownership and management
‼️ Agency Problem
Advantages or disadvantages of a sole proprietorship
ADVANTAGES - easy to start - least regulated - single owner keeps the profits => Disadvantages of a corporation
DISADVANTAGES - limited to life of owner - equity capital limited to owner wealth - unlimited liability - difficult to sell ownership interests => Advantages of a corporation
Advantages and disadvantages of a partnership (look like single owner)
ADVANTAGES
- two or more owners
- more capital available
DISADVANTAGES
- unlimited liability
Ex: mariage, famille, divorce
What should be the goal of a corporation ?
Maximize the current value (=today’s value) of the company stock
This means we have to do everything to maximize the owner wealth but we have to take into consideration the market efficiency.
The Agency relationship
Principal (owner) hires an agent (manager) to represent his/her interests.
Stockholders (principals) hire managers (agents) to run the company.
Separation between owner and managers
=> COSTS
=> Decrease the value of the company
The Agency Problem
Conflict of interest between principal and agent
Management goals and Agency costs
Agency costs
DIRECT
- monitoring costs
INDIRECT
- managers’ personal utility (they only consider themselves and not the owner)
Ex: large corporate office
First class travel or private jet
INDIRECT COSTS ARE MORE SERIOUS
2 solutions for Agency costs
- Managerial compensation
Incentive can be used to align management and stockholders interests (stock options). Today’s value is 0 but in 10y it may be important.
Stock and stock options are used to pay managers to erase the Agency Problem.
Problem of this solution: by giving stock option the risk is increasing.
- Corporate control
The threat of a takeover may result in better management.
