UT FIN 357 - Chapter 1. Introduction to Corporate Finance (30 pages)

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Chapter 1. Introduction to Corporate Finance



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Chapter 1. Introduction to Corporate Finance

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Pages:
30
School:
University of Texas at Austin
Course:
Fin 357 - Business Finance
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The Corporation Chapter 1 Finance 357 J David Miller 2017 Premium Denim is Profitable 2 Source Wall Street Journal The Company How do we acquire the money we need to run our business 10 million Balance Sheet Current Liabilities Current Assets Net Working Capital Fixed Assets Total Value of Asset 3 Long term Debt Shareholders Equity Total Value of the Firm to Investors Capital Structure Capital Structure The proportion of financing that comes from debt and equity Example 1 50 debt and 50 equity 5 million in long term bonds and 5 million in Stock Example 2 80 debt and 20 equity 7 5 million in long term bonds 0 5 million in short term debt and 2 million in Stock 4 Terminology Persons or Institutions that buy company Debt are known as Creditors Debtholders or Bondholders Persons or Institutions that buy company Equity are known as Shareholders Firm Value B S Think Value Bondholders Shareholders 5 Capital Budgeting Capital Budgeting Process of making and managing expenditures on long lived assets Balance Sheet Current Liabilities Current Assets Net Working Capital Fixed Assets Total Value of Asset 6 Long term Debt Shareholders Equity Total Value of the Firm to Investors Net Working Capital The third important area of finance is the management of Net Working Capital Net Working Capital is the firm s current assets minus the firm s current liabilities Short term cash flow problems often occur because the timing mismatch between current assets and current liabilities 7 Generic Organization Chart Board of Directors Chief Executive Officer CEO Chief Operations Officer COO Chief Financial Officer CFO Chief Technology Officer CTO Treasurer Cash Manager Capital Expenditures 8 Controller Credit Manager Financial Planning Financial Accounting Manager Cost Accounting Manager Legal Structure What legal structure should we use Sole Proprietorship Partnership General Partnership Limited Partnership Corporation Limited Liability Corporation C Corp S Corp 9 The Sole Proprietorship Pros A business owned by one person Pros Cheapest form of business No formal charter is required and few government regulations must be satisfied No corporate taxes All profits are taxed as individual income 10 The Sole Proprietorship Cons Cons Unlimited Liability Unlimited Liability for business debts and obligations No distinction between personal and business assets Limited Life Sole Proprietorship is limited by life of sole proprietor Limited Equity Only Sole Proprietors money can be invested in business as equity 11 The Partnership Types General Partnership Each partner liable for all debts of the partnership Partnership agreement specifies how work and profits will be divided Partnership agreement may be written or oral contract Limited Partnerships Liability of some partners is limited to the amount of cash contributed to the partnership One partner must act as the general partner Limited Partners do not participate in managing the business 12 The Partnership Pros Pros Inexpensive to form Business filings and some documents may be necessary Income taxed as personal income Income to both General and Limited Partners is taxed a personal income General partners control management Simple majority vote of general partners is only required on important matters 13 The Partnership Cons Cons General Partners have Unlimited Liability If one General Partner cannot pay liabilities other General Partners must make up the difference Limited life Partnership is usually terminated when a General Partner dies Not true if Limited Partner dies Difficult to transfer ownership Partnerships usually dissolve and reform Difficult to raise large amounts of cash Equity contributions usually limited to partner s investment 14 The Corporation Corporation a distinct legal entity with a name and many legal powers of a natural person Can acquire property Can sue and be sued Citizen of the state in which it is formed Pays taxes separately from its owners Founders establish Articles of Incorporation and Bylaws 15 The Corporation Articles of Incorporation Include Name Intended Life Business Purpose Number of shares issued Statement of limitation and rights of shareholders Number of members of Board of Directors Bylaws Rules to be used by corporation to regulate its own existence 16 The Corporation Pros Pros Easy transfer of ownership Ownership is represented by shares of stock which can easily be transferred to new owners Unlimited Life Corporation is separate from its owners and can continue after their deaths Limited Liability Shareholders are only liable for the amount they invested in the corporation Enhanced ability to raise cash Unlimited life limited liability of owners and ease of ownership transfer make raising cash much easier 17 The Corporation Cons Cons Double Taxation Federal Taxes State Taxes Local Taxes Corporations are first taxed on profits that is earns Dividends and other payouts to shareholders are then taxed a second time as personal income of the shareholders 18 The Corporation Around the World The corporate form of business has different names around the world 19 Limited Liability Corporations LLCs are a relatively new form of business They are a hybrid of a partnership and a corporation They operate and are taxed like a partnership but have limited liability like a corporation 20 Structure Comparison Summary Formation Liability Life Taxation Fund Raising 21 Corporation Partnership Sole Proprietorship Complex Simple Very Simple Limited Unlimited Unlimited Unlimited Limited Limited Double Single Single Easy Difficult Difficult Financial Securities Securities Types Debt Securities Contractual obligations to repay corporate borrowing Equity Securities Share of common stock and preferred stock that represent non contractual claims to the residual cash flow of the firm 22 Importance of Cash Flows Financial cash flows are extremely important to the life of a company While accounting cash flows are useful they don t always match the actual cash flows of a company In Finance we use accounting information but sometimes make adjustments to better reflect the actual flows of cash 23 Accounting Value vs Financial Value Midland Company refines and trades gold In October Midland acquires 2 500 ounces of gold for 900 000 in cash In early December Midland sells the gold for 1 000 000 At year end Midland has not been able to collect from the customer 24 Midland Company Accounting View Income Statement Year Ended December 31 Midland Company


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