Introduction Flashcards
Real assets
Assets used to produce goods and services.
Real assets are physical assets that have an intrinsic worth due to their substance and properties. Real assets include precious metals, commodities, real estate, land, equipment, and natural resources
Financial Assets
Financial claims to the income generated by the firm’s real assets.
Financial Assets are highly liquid assets that are either in cash or can be fast converted to cash. They include investments such as stocks and bonds.
Why real asset?
Real assets offer the opportunity for diversification, inflation hedging, and competitive total return potential
machines and knowledge are real assets
Investment decision
- Purchase of real assets,
- how to best allocate capital to maximize their value.
An investment decision can be long-term, also known as capital budgeting.
Financing decision
- Sale of financial assets,
- Pay for investments and expenses. Companies can use existing capital, borrow, or sell equity.
- It involves the identification of various sources of finance and the quantum of finance to be raised from long-term and short-term sources.
Why separation important between financing and investing decisions?
- because we have to make a very important adjustment based on this principle.
- That adjustment is the fact that we do not subtract interest costs while calculating the cash flows that a project will generate.
Capital budgeting decision
A capital budgeting decision is both a financial commitment and an investment. By taking on a project, the business is making a financial commitment, but it is also investing in its longer-term direction that will likely have an influence on future projects the company considers.
Capital budgeting decision 2
- creates accountability and measurability.
- the capital budgeting process is a measurable way for businesses to determine the long-term economic and financial profitability of any investment project.
Capital budgeting decision 3
- The decision to invest in tangible or intangible assets
- Also called the investment decision
- Also called capital expenditure or CAPEX decisions
Financing Decisions
- Shareholders are equity investors.
2. Capital structure decision
Shareholders are equity investors.
Contribute equity financing
Capital structure decision
- The choice between debt and equity financing
2. Capital refers to a firm’s sources of long-term financing
Capital structure decision 2
Capital Structure, as the name suggests, means arranging capital from various sources, in order, to meet the need of long-term funds for the business.
The goal of the capital structure decision
is to determine the financial leverage that maximizes the value of the company (or minimizes the weighted average cost of capital).
Types of Corporations
- Public companies
- Private corporations
- Limited liability corporations (LLC)
Public companies
ownership is organized via shares of stock that are intended to be freely traded on a stock exchange or in over-the-counter markets.
Private companies
Private companies may issue stock and have shareholders, but their shares do not trade on public exchanges and are not issued through an initial public offering (IPO).
Limited liability corporations (LLC)
owners are not personally liable for the company’s debts or liabilities. Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship.
Types of business organizations
- Sole proprietorships
- Partnerships
- Corporations
- Limited liability options
A. Limited liability partnerships
B. Limited liability companies
C. Professional limited liability companies
Sole proprietorships
has just one owner who pays personal income tax on profits earned from the business
Partnerships
n a partnership business, all partners share liabilities and profits equally, while in others, partners may have limited liability.
Corporation
the corporation is a legal entity that is separate and distinct from its owners. 1 Corporation enjoy most of the rights and responsibilities that individuals possess
Limited liability
The owners of a corporation are not personally liable for its obligations.
Flow of Cash between Financial Markets and the Firm’s Operations
- Cash raised by selling financial assets to investors
- Cash invested in the firm’s operations and used to purchase real assets
- Cash generated by the firm’s operations
(a) Cash reinvested (b) Cash returned to investors
The flow of Cash between Financial Markets and the Firm’s Operations
- Firm Operation (real assets)
- Financial manager
- Financial markets (financial assets)
Stockholders want three things
- To maximize current wealth.
- To transform wealth into the most desirable time pattern of consumption.
- To manage risk characteristics of a chosen consumption plan.
The Financial Goal of the Corporation Continued
shareholder
stockholder
The investment trade-off
Profit maximization, Not a well-defined financial objective
- Which year’s profits?
Shareholders will not welcome higher short-term profits if long-term profits are damaged - Company may increase future profits by cutting year’s dividend, investing freed-up cash in the firm
Not in shareholders’ best interest if the company earns less than the opportunity cost of capital
Agency problem
represent the conflict of interest between management and owners
The investment trade-off
- Hurdle rate/cost of capital
Minimum acceptable rate of return on investment - Opportunity cost of capital
Investing in a project eliminates other opportunities to use invested cash
Agency cost
Value lost from agency problems or from the cost of mitigating agency problems
Corporate governance
The laws, regulations, institutions, and corporate practices that protect shareholders and other investors
