Exam 1 Flashcards
Advantages of sole proprietorship (4)
- Easiest to start
- Least regulated
- Single owner keeps all the profit
- Taxed once as personal income**
Disadvantages of sole proprietorship (4)
- Limited to life of owner**
- Equity capital limited to owner’s personal wealth
- Unlimited liability
- Difficult to sell ownership interest
Advantages of Partnership (4)
- Two or more owners
- More capital available
- Relatively easy to start
- Income taxed once as personal income
Disadvantages of partnership (3)
- Unlimited liability
- Partnership dissolves
- Difficult to transfer ownership
Advantages of corporation (4)
- Limited liability**
- Unlimited life
- Transfer of ownership is easy
- Easier to raise capital
Disadvantages of corporation (2)
- More paperwork
- Double taxation**
What is the goal of financial management?
The goal of financial management is to maximize the current market value of the existing stock.
Ownership stake in a company
Stock
A share in the ownership of the company
A share of stock
% of outstanding stock you own =
% of the company you own
Number of shares issued by a company that are actually owned by someone
Outstanding stock
Stock is also referred to as __
Equity
3 Features of Common Stock:
- Voting rights
- Proxy voting
- Classes of stock
First shot at new stock issue to maintain proportional ownership if desired
Preemptive right
Other rights of common stock:
- Share proportionally in dividends paid
- Share proportionally in remaining assets after liquidation
- Preemptive right
Current liabilities (short-term debt) (3):
- Accounts payable
- Loans outstanding
- Current portion of long-term debt (payable in the next 12 months)
Long-term liabilities =
Bonds outstanding
A contract between a borrower and investor
Bond
T/F
Interest payments made by the company are tax deductible.
True
T/F
Bond holders have an ownership stake in the company.
False
They are just lenders and not owners.
T/F
Bonds can be traded between investors the same way as stocks.
True
Capacity to pay is extremely strong
Aaa and AAA bonds
Capacity to pay is very strong
Aa and AA bonds
Capacity to pay is strong, but more susceptible to changes in circumstances
A and A bonds
Capacity to pay is adequate, adverse conditions will have more impact on the firm’s ability to pay
Baa and BBB bonds
Capacity to pay will degenerate
Ba and B
BB and B
Income bonds with no interest being paid or default with principal and interest in arrears
C and D bonds
Differences between debt and equity (5)
Debt:
- Not an ownership interest
- Creditors do not have voting rights
- Interest is considered a cost of doing business and is tax deductible
- Creditors have legal recourse if interest or principal payments are missed
- Excess debt can lead to financial distress and bankruptcy
Equity:
- Ownership interest
- Common stockholders vote for the board of directors and other issues
- Dividends are not considered a cost of doing business and are not tax deductible
- Dividents are not a liability of the firm, and stockholders have no legal recourse if dividends are not paid
- An all equity firm can not go bankrupt merely due to debt since it has no debt
The ease and quickness with which assets can be converted to cash quickly and without a significant loss in value
Liquidity
Pro and Con of liquidity:
- The more liquid a firm’s assets, the less likely the firm is to experience problems meeting short-term obligations
- Liquid assets frequently have lower rates of return than fixed assets
The balance sheet provides the ___ value of the assets, liabilities, and equity
Book
The price at which the assets, liabilities, or equity can actually be bought or sold
Market value
How do you find the marginal tax rate?
Current taxable income + $1 = bracket they fall in
How do you find the marginal tax rate?
Current taxable income + $1 = bracket they fall in
The interest is earned on interest as well as principal
Compound interest
Present value formula =
PV = FV / (1+r)^t
The longer you have to wait to get the cash flow, the ___
worse it is
The higher the interest rate the _____
lower the present value
The most you should pay is __
present value
Infinite series of equal payments
Perpetuity
Debt security, usually an interest-only loan
Bond
Face value (per value) =
typically $1,000
Stated interest payment made on the bond
Coupon payment (pmt)
Stated in the indenture (contract). Equals: Annual coupon payments / face value of the bond
Coupon rate
Specified date on which the principal amount of the bond will be repaid
Maturity
A bond that sells for more than its face value
Premium bond
A bond that sells for less than its face value
Discount bond
If a bond sells at face value, its Yield to Maturity is ____
equal to its coupon rate
Premium bond YTM is ____ than the coupon rate
lower
Discount bond YTM is ____ than the coupon rate
higher
Discount bond YTM is ____ than the coupon rate
higher
- The firm will pay a constant dividend forever
- This is like preferred stock
- The price is computed using the perpetuity formula
Constant dividend - or zero growth model
- The firm will increase the dividend by a constant percent every period
- The price is computed using the growing perpetuity model
Constant dividend growth - Gordon growth model
