WEEK 1 - Introduction Flashcards
How do Corporations generate income via investments?
Invest in real assets (tangible,Intangible) via financing investment
(SEE FLOW CHART IN NOTES)
What are the 2 broad questions corporations must ask themselves for financial decisions?
- What investments should the firm make?
(Involves spending) - How should it pay for those investments?
(Involves raising money)
How do corporations pay for real assets?`
By selling claims:
- securities like bonds and shares
- Financial Assets like bonds and bank loans
What are the differing types of firms?
- Corporations: Large and Medium businesses owned by several people (Microsoft,Google etc.)
- Partnerships: Small Business owned and managed by group of people (with limited or unlimited liability)
- Sole Proprietorships: Small business owned and managed by single individual (likely to be unlimited liability)
What is a limited and unlimited liability?
- Limited: If firm goes bankrupt only thing you lose is your investment
- Unlimited: If firm goes bankrupt could lose house
What is the typical growth cycle of a corporation?
- Ownership divided by shares held by number of investors (shareholders)
- Initially shares owned by company’s managers and few backers (closely held company)
- As firm needs additional capital to grow, more share issued and become widely traded (public companies)
What are some elements of Corporations?
- Potential Investors may be single individuals or financial entities (pension/mutual fund, Insurance Companies)
- Investors have share on profits (via dividends) and cast vote on important decisions
- Corp attracts wide variety of investors, no of shares held widely varies among investors
- Corporation owned by shareholders but legally distinct from them
What are the characteristics of Corporations?
- Limited Liability: Stockholders not personally responsible for firm’s debts
- Distinct Entity: Corp considered distinct legal entity or legal person
- Separation of ownership (shareholders) and management:
- Shareholders vote to elect board of directors
- Board appoints top management
- This gives corporation ‘permanence’
What is Permanence?
Manager and or shareholders can change but corporation survives
What are the disadvantages of Corporations?
- Complex Structure: Loss in communication with shareholders which costly and time consuming
- Double Taxation Problem:
Tax on firm profits and shareholders dividends - Moral Hazard issues due to asymmetric info:
Managers may act at their best personal interests and not those of shareholders
What is the basic premise of the Financial Manager?
Stand between the firm’s operations and financial markets
SEE FLOW CHART
What is the role of the financial manager?
- Valuation and Investment Decisions (Manage firm’s operations)
- Financing Decisions
- Dividend Decisions
- Risk management and hedging
(SEE FLOW CHART)
What is the importance of financial institutions and financial markets?
- Provide choice between SR borrowing (from banks) and LR borrowing (issuing bonds) and issuing of shares
- Assist and provide advice in M&A
- Provide liquidity and risk-diversification that give security to potential investors to relinquish control of their savings for some period
- Provide financial managers with source of info on things (Market value,price of raw materials etc.)
What are the corporations financial objectives?
Shareholders want the Financial Manager to:
- Increase value of corp
- Increase stock price
- Maximise market value
- Increase shareholder wealth
How financial managers balance the investment trade off caused by the objective of maximising the market value?
Decision: Invest in project or pay out cash to shareholders
Answer: Invest if return of the investment is higher than the return of investing in the financial markets (for same lvl of risk)
Otherwise, shareholders prefer cash
