08 02 2012 20 28 00 Chapter 1 The Corporation The Four Types of Firms Sole Proprietorship o Business is owned and run by one person o Typically has few if any employees o Advantages Easy to create o Disadvantages Unlimited personal liability Partnership Limited life o Similar to a sole proprietorship but with more than one owner o All partners are personally liable for all of the firm s debts A lender can require any partner to repay all of the firm s outstanding debts o The partnership ends with the death or withdrawal of any single partner o Limited Partnership has two types of owners General Partners Have the same rights and liability as partners in a regular partnership Typically run the firm on a day to day basis o Limited Partners Have limited liability and cannot lose more than their initial investment Have no management authority and cannot legally be involved in the managerial decision making for the business Limited Liability Company LLC o All owners have limited liability but they can also run the business o Relatively new business form in the U S Corporation o A legal entity separate from its owners into contracts own assets and borrow money Has many of the legal powers individuals have such as the ability to enter o Formation The corporation is solely responsible for its own obligations Its owners are not liable for any obligation the corporation enters into Corporations must be legally formed The corporation files a charter with the state it wishes to incorporate in The state then charters the corporation formally giving its consent to the incorporation Due to its attractive legal environment for corporations Delaware is a popular choice for incorporation o Corporation Ownership Represented by shares of stock Owner of stock is called Shareholder Stockhoder Equity Holder Sum of all ownership value is called equity There is no limit to the number of shareholders and thus the amount of funds a company can raise by selling stock Owner is entitled to dividend payments Tax Implications Double Taxation o S Corporations SLIDE EXAMPLE Firm s profits are not subject to corporate income tax but instead are allocated directly to the shareholders Ownership Versus Control of Corporations Corporate Management Team o In a corporations ownership and direct control are typically separate o Board of Directors Elected by shareholders some times only enough candidates for the available position on a ballot Have ultimate decision making authority o Chief Executive Officer CEO Boar typically delegates day to day decision making to CEO o Shareholders agree that they are better off if management makes decisions that Goal of the Firm maximize the value of the shares Ethics and Incentives with Corporations o Agency Problems Managers may act in their own interest rather than in the best interest of One potential solution is to tie management s compensation to firm the shareholders performance o CEO Performance If a CEO is performing poorly shareholders can express their dissatisfaction by selling their shares This selling pressure will drive the stock price down Hostile Takeover o Low stock prices may entice a Corporate Raider to buy enough stock so they have enough control to replace current management The stock price will rise after the new management team fixes the company The Stock Market The stock market provides liquidity to shareholders Liquidity The ability to easily sell an asset for close to the price you can currently buy it for Public Company Stock is traded by the public on a stock exchange Private Company Stock may be traded privately When a corporation itself issues new shares of stock and sells them to investors Primary Markets they do so on the primary market Secondary Markets After the initial transaction in the primary market the shares continue to trade in a secondary market between investors Large Stock Markets New York Stock Exchange NYSE o Market Makers Specialists o Each stock has only one market maker NASDAQ o Does not meet in a physical location o May have many market makers for a single stock o Bid Price versus Ask Price o Bid Ask Spread Transaction cost Chapter 2 Introduction to Financial Statement Analysis Financial Statement Firm issued accounting reports with past performance information Filed with the SE o 10Q Quarterly o 10K Annual Must also send annual report with Financial Statements to shareholders Preparation of Financial Statements GAAP Generally Accepted Accounting Principles Auditor Neutral third party that checks a firm s financial statements Types of Financial Statements Balance Sheet o A snapshot in time of the firm s financial position o Balance sheet identity Assets Liabilities Stockholders Equity Assets what a company owns current assets cash or expected to be turned into cash in the next year Cash marketable securities a r inventories other current assets Liability What a company owes Current Liabilities Due to be paid within the next year Accounts payable Short term debt notes payable Other Current Liabilities Current Maturities of Long Term Debt Net Working Capital Current Assets Current Liabilities o Taxes Payable o Wages Payable Stockholders Equity The difference between the value of the firm s assets and liabilities Book Value of Equity BV of Assets BV of Liabilities could be negative Market Value of Equity market capitalization Market Price per share x of shares outstanding can t be negative o Balance Sheet Analysis Liquidation Value Value of the firm if all assets were sold and liabilities paid Market to Book Ratio Market to Book Ratio Market Value of Equity Book Value of Equity Value Stocks Low M B Ratios Growth Stocks High M B Ratios Debt Equity Ratio Measures a firms leverage Current Ratio Quick Ratio Enterprise Value Market Value Debt Cash Current Assets Current Liabilities Current Assets Inventories Current Liabilities Income Statement o TOTAL SALES COGS GROSS PROFIT Operating Expenses Selling General Adm R D dep amort OPERATING INCOME Other Income Expenses EARNINGS BEFORE INCOME TAXES EBIT Interest Income Interest Expense Pre Tax Income Taxes NET INCOME Earnings per Share o Profitability Ratios EPS Net Income 2 0 million Shares Outstanding 3 6 million shares 0 556 per share Gross Margin argMGross in Operating Margin Gross Profit Sales Operating argM in Income Operating Sales Net Profit Margin Net Profit Margin Net Income Total Sales o Working Capital Days Accounts Receivable Days Accounts Receivable Days Accounts Receivable Average