Lecture 1: Introduction to Corporate Finance

Question 1

Explain The difference between Investment and financing decisions?

Answer 1

Simply put invetsment Decisions are where to spend the money while financing decisons are where to get the money from.

Question 2

What is the choice between debt and equity financing called?

Answer 2

The choice between debt and equity financing is called capital structure decision

Question 3

What does an investment decision equal?

Answer 3

Investment Decision = purchase of Real Assets (land, factory, machinery etc)

Question 4

What does a financing decision equal?

Answer 4

Financing Decision = sale of Financial Assets (stocks, bonds)

Question 5

What is a Sole Proprietorship?

Answer 5

Sole Proprietorship is
* One owner runs the business
* Straightforward organizational structure
* Owner has full (i.e. unlimited) liability for debts
* Lifespan of the business is limited to the life of the owner
*Relatively difficult to transfer ownership

Question 6

What is a Partnership?

Answer 6

Partnership:
- More than one owners
- Partners have full liability for debts
- Usually are larger than sole proprietorships
- Taxes are paid from the salary of each partner (personal taxes)

Question 7

What is a limited partnership?

Answer 7

Limited Partnership:
- Two kinds of owners:

General partners: Unlimited liability for debts, manage the business

Limited partners: Limited liability for debts, do not manage the business

Question 8

What is a corperation?

Answer 8

Corporation
- A business organized as a separate legal entity

• Governed based on the articles of incorporation
• Owned by shareholders or stockholders and controlled by the management

Question 9

What are the two types of corperation?

Answer 9

The Two Types of corporations arre:

1) Private Companies

2) Public Companies

Question 10

What are the advantages of a corperation?

Answer 10

The advantages of a corperation are:

1) The Owners (i.e. shareholders) have limited liability for the debts

2) It’s Easier to raise capital

3) Businesses have an Infinite lifespan

Question 11

What are the Disadvantages Of a corperation?

Answer 11

The disadvantages of a corperation are:

1) Double taxation: corperate profits are taxed first and the dividends given to shareholders are taxed as personla income

2) Seperation of ownership and management creates “Agency Problems”

Question 12

What is the goal of a corperation?

Answer 12

The goal of a corperation is to create and increase the value of the firm. “increasing shareholder value”

Question 13

why should a company not focus on just making profits?

Answer 13

A company shouldn’t just focus on making profits because a company may sacrifice long term profits and value for short term profits. for example they may excessively cut maintence, R&D or staff training.

Question 14

Why is focusing on Value the right goal?

Answer 14

Focusing on value is the right goal because it has a long term impact on the firm. creating value, creates profits but not the opposite.

Question 15

What are agency problems?

Answer 15

agency problems are when managers / agents make decisions taht serve their own personal interests and not the shareholders

Question 16

What are some examples of agency problems?

Answer 16

some exampels of agency problems are:

1) reduced effort

2) Avoiding risk taking
- reject risky projects and inevst in safer ones to secure their jobs

3) excessive perks like corperate jets, meeting in luxury resorts ect

Question 17

How do you mitigate agency problems?

Answer 17

You can mitigate agency problems by monitering managers actions reducing perks for example. You can also provide financial incentives to managers to allign managers incentives with stockholders incentives.

Question 18

What is the function of the board of directors?

Answer 18

The board of directors is elected by the shareholders to represent their interests, some of them miust be independent (outside of the company), when managers do not perform well they can lose their jobs

Question 19

What is the major function of financial markets and intermediaries?

Answer 19

The major function of financial markets and intermediaries is to connect corporations and investors

Question 20

what are some smaller functions of financial markets and intermediaries?

Answer 20

Transporting cash across time according to individual needs:
- Need money now? Borrow money now or sell shares
- Need money in the future? Deposit money now to earn interest and spend later

Risk transfer and Diversification:
- Transfer risk to insurance companies
- Diversifying risk by investing in the stock and bond market.

Question 21

What are finacial intermediaries? can you name some types of financial intermediaries?

Answer 21

Financial intermediaries are organizations that engage in financial transactions i.e., lending money, accepting deposits, investing in financial assets etc.

Types of Financial Intermediaries:

• Bank: An institution that provides liquidity by accepting deposits and lending money
  Insurance Company: An institution that sells insurance policies
• Mutual Fund: An investment company that pools the savings of many investors and invests in a portfolio of securities.
• Hedge Fund: A private investment pool, open to wealthy or institutional investors, that is only lightly regulated and therefore can pursue more speculative policies than mutual funds.
• Pension Fund: Fund set up by an employer to provide income to employees after retirement.