Chap 1 - Introduction To Corporate Finance

Question 1

Finance définition

Answer 1

Finance is how the money is used/raised by government, business or individuals.

Question 2

3 key concepts

Answer 2

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.

Question 3

3 areas of finance

Answer 3

Corporate finance
Investment
Financial market & investment

Question 4

2 financial certificates

Answer 4

CFA - Chartered Financial Analyst

FRM - Financial Risk Manager

Question 5

3 financial decisions for the financial manager

Answer 5

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 ?

Question 6

3 goals of the CFO (Chief Financial Officer)

Answer 6

1. Make money
2. Stay in business
3. Increasing value

Question 7

Debt investors définition

Answer 7

People that invest money in your deal for a fixed rate of return. (You agree to pay them a certain interest rate)

Question 8

Equity investors definition

Answer 8

People that invest money in your deal for a percentage of the profits.

Question 9

What can you use to finance a project ?

Answer 9

Debt investor or equity debt

Question 10

2 strategies to have cash

Answer 10

=> delayed your payments

=> turn revenu into cash

Question 11

2 Finance decisions

Answer 11

1. Value of business

2. Trading strategy

Question 12

Forms of business organizations

Answer 12

Sole proprietorship: single owner
Partnership: two or more owners

=> these are small companies

Corporation: limited liability company

=> big or public companies

Question 13

Advantages and disadvantages of a corporation

Answer 13

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

Question 14

Advantages or disadvantages of a sole proprietorship

Answer 14

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

Question 15

Advantages and disadvantages of a partnership (look like single owner)

Answer 15

ADVANTAGES

• two or more owners
• more capital available

DISADVANTAGES
- unlimited liability

Ex: mariage, famille, divorce

Question 16

What should be the goal of a corporation ?

Answer 16

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.

Question 17

The Agency relationship

Answer 17

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

Question 18

The Agency Problem

Answer 18

Conflict of interest between principal and agent

Management goals and Agency costs

Question 19

Agency costs

Answer 19

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

Question 20

2 solutions for Agency costs

Answer 20

1. 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.

2. Corporate control
   The threat of a takeover may result in better management.