Chapter 1 Flashcards
3 types of Financial Decisions
Capital Budgeting = process of planning and managing firm’s long-term investments. Capital Structure = mixture of debt and equity maintained by firm Working Capital Management = firm’s short term assets and liabilities
Capital Budgeting
Capital Budgeting = Planning and managing firm’s long-term investments. -More cash flow than the asset costs to acquire. -Size, timing, risk of future cash flow
Capital Structure
Capital Structure = Mixture of long-term debt and equity maintained by firm 1) How much needed? What’s the best mix? Because this affects risk and value of firm. 2) Where do I get it for least expense?
Working Capital Management
Working Capital Management = short-term assets, day-to-day activities, sufficient resources to continue operations -How much cash/inventory to keep? -Sell on credit? Short-term financing? Or instead, purchase on credit?
Financial Management
VP Finance/CFO = top financial officer at firm Treasurer = cash, credit, financial planning, capital expenditures (we focus here) Controller = cost, financial accounting, tax payments, management informationn
Forms of Business
Each form has +/- related to ability to raise cash, taxes, etc. 1) Sole Proprietorship 2) Partnership 3) Corporation -Bigger the firm the more advantageous to incorporate
Sole Proprietorship
Sole Proprietorship = owned by one person
- PROS = Simplest, least regulated, all profits retained, single taxation
- CONS = Unlimited liability, limited capital, difficult to sell/transfer, personal $ = business $
Partnership
Partnership = formed by 2+ individuals or entities
General Partnership = all partners share gains/loss and all have unlimited liability to firm’s debts, not just a share
Limited Partnership = general partners run the firm with unlimited liability, limited parnters don’t participate liable only for amount contributed
- PROS = low barriers to entry, limited partner’s interest can be sold, single taxation
- CONS = ownership non-transferrable (ends with 1 partner leaving) can’t sell, income tax is personal to partner, hard to raise capital
Corporation
Corporation = created as a distinct legal entity, separate and distinct from owners, composed of 1+ individuals or entities
Needed to start: *Articles of Incorporation/Charter *(basic) and *Bylaws *(rules about regulation/proceedings)
-Separation of ownership and management
3 type: C-Corporation (large), S-Corporation, Limited-Liability Corporation (LLC). The last 2 are hybrid. There is no personal liability, not hard to establish but they cannot be too large.
- PROS = Easily transferrable, limited-liability ownership, unlimited life of busienss, easier to raise funds
- CONS = Barriers-to-entry, double taxation, separation of owners/management
-Value of ownership can be 0 but not negative
Goal of Financial Management
- To maximize the current value per share of existing stock (for corporation)
- To maximize the value of existing owner’s equity (for private companies)
From the stockholder’s point of view, what is a good financial management decision?
Good decisions ↑ stock value, bad decisions ↓ stock value
Agency Problem
Agency Problem = possibility of conflict of interest between stockholders and management of firm. Where agent is management, principal is stockholder.
Agency Cost = cost of conflict of interest between stockholders and management. Where management passes up opportunity, this is an *indirect *cost to shareholders. Where management spends money, or needs to be monitored, this is a *direct *cost.
Management Goal = Less risk, job security, independence and corporate self-sufficiency
Stockholder Goal = Increase value of equity, wealth. Risk affinity.
Fix: Management Compensation (pay tied to financial performance, better job prospects), Corporate Control (takeover leads to layoffs so management is wary)
Financial Market (Cash Flows)
Brings buyers and sellers together, product is debt and equity
Purpose: Raise funds and evaluate the assets they issue
- Issuance brings cash into firm
- Firm invests cash
- Gains from investments come back as cash
- Firm pays taxes to government on gains
- Firm pays investors/creditors
- Rest of cashflow is reinvested in firm
Primary vs. Secondary Market
Primary market = Original selling of securities, corporation is seller and transaction raises cash for the firm, initial offering to public. There are 2 ways: Public Offerings (SEC regulated) and Private Placements
Secondary Market = Owners/creditors selling to others, this quality makes initial buyers less reluctant to buy. There are 2 ways: Dealer (buy/sell for self, 1 person) vs *Auction *(physical location for middleman/matchmaker)
