BU FE 101 - Corporate Finance and the Financial Manager

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Zara MahmoodRobertsFE101Corporate Finance and the Financial ManagerWHY STUDY FINANCE?Our career paths have become less predictable and more dynamic- With each new opportunity we must weigh all the costs and benefitsValuation Principle – shows how to make the costs and benefits of a decision comparable so that we can weigh them properlyTHE FOUR TYPES OF FIRMSThere are four major types of firms: sole proprietorships, partnerships, limited liability companies, and corporationsSole ProprietorshipsSole Proprietorship – a business owned and run by one person- Very small with few or no employees- 71% of US business is sole proprietorships but only generates 5% of the revenue1. Straightforward to set up2. Only one owner in firm  investors hold no ownership stake3. Owner has unlimited personal liability for firm’s debts4. Life is limited to life of owner  difficult to transfer ownership- Disadvantages outweigh the advantages- Many convert the business into another form after it growsPartnershipsPartnerships – A business owned and run by more than one owner1. All partners are liable for firm’s debt2. Partnership ends in death or withdrawal of any single partner3. Can avoid liquidation if partnership agreement provides alternatives like a buyoutSome firms such as medical practices, law firms run as partnerships- Personal liability increases confidence of the firm’s clientsLimited Partnership – A partnership with two kinds of owners, general partners andlimited partners- Liability of a limited partner is limited to their investment- Withdrawal of limited partner does not dissolve the partnershipo Value of interest is transferable, not interest itself- Has no management authority and cannot be involved in managerial decisionLimited Liability – When an investor’s liability is limited to her investmentLimited Liability CompaniesLimited Liability Company (LLC) – A limited partnership without a general partner- All owners have limited liabilityZara MahmoodRobertsFE101o Can also run the business as managing membersCorporationsCorporation – A legally defined, artificial being, separate from its owners- Many of the legal power that people haveo Enter into contracts, acquire assets, incur obligations, protection against the seizure of its property- Owners are not liable for any obligations the corporation enters intoFormation of a Corporation- Must be legally formed through consent by state by chartering ito More costly to set upOwnership of a Corporation- No limit on number of ownerso Each owner owns only a fraction of the corporationStock – The ownership or equity of a corporation divided into sharesEquity – The collection of all the outstanding shares of a corporationShareholder – An owner of a share of stock or equity in a corporationDividend Payments – Payments made at the discretion of the corporation to its equity holders- Proportional to the amount of stock they ownNo limitation on who can own stock- Allows free and anonymous trade in the shares of the corporationo Can raise substantial amounts of capitalTax Implications for Corporate EntitiesAn important difference among the types of corporate organizational forms in the way they are taxed- Corporation is separate legal entity, profits are taxed separate from ownersDouble Taxation – Corporation pays taxes on profits, shareholders pay their personal income tax from divvied profitsS CorporationsCorporation structure organizations are the only ones double taxed- S corporations are exempt from double taxation- Subchapter S tax regulations  firms profits and losses are not subject to corporate taxes but are allocated directly to shareholders based on their ownership shareo Shareholders pay income taxon these profitsC CorporationsGovernment has strict limitations on S taxtreatment- Shareholders must be US citizens andresidents- Can be no more than 100Zara MahmoodRobertsFE101Many corporations are C corporations, subject to corporate tax- Only taxed when you receive income as a dividendTHE FINANCIAL MANAGERSome companies have many owners so it does not make sense for them to have direct control of the firm- Financial manager can make financial decisions for the business for the stockholderso Makes investment decisionso Makes financing decisionso Manages short-term cash needsMaking Investment DecisionsFinancial manager must weight costs and benefits of each investment- Does it quality as good uses of the money stockholders have invested?- Shape what the firm does and whether it will add value for its ownersMaking Financing DecisionsOnce decision is made, manager must decide how to pay for them- Large investments may require corporation to raise additional moneyo Selling more shares of stock or taking bondsManaging Short-Term Cash NeedsManger must ensure that the firm has enough cash on hand to meet its obligations everyday- Managing working capital  can mean the difference between success and failure- A company burns through a lot of cash before the sales of the product generate incomeo Financial manager makes sure that access to cash doesn’t hinder firm’s successThe Goal of the Financial ManagerDecisions by financial manager are made to maximize the wealth of the owners/stockholders- Caretaker of stockholder money, makes decisions in their interests- When owners agree on corporation goals, the goals are implementedTHE FINANCIAL MANAGER’S PLACE IN THE CORPORATIONBoard of directors and the management team, headed by the CEO, possess direct control of the corporationZara MahmoodRobertsFE101The Corporate Management TeamBoard of Directors – A group of people elected by shareholders who have the ultimate decision-making authority in the corporation- Each share of stock gives a shareholder one vote in the election of the board of directorso Investors with more shares have more influenceo Outstanding shareholders can be on the board or appoint boardChief Executive Officer – Charged with running the corporation by instituting the rules and policies set by the BOD- CEO can often be chairman of the board- CFO reports directly to the CEOEthics and Incentives in CorporationsAgency ProblemsThere is a separation of ownership and control in a corporation- Managers have little incentive to work in the interest of shareholderso Working against their own self-interestAgency Problem – When managers, despite being hired as the agents of shareholders, put their own self-interest ahead of the interests of those


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BU FE 101 - Corporate Finance and the Financial Manager

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