FIN 3403 Exam 1 Chapters 1 2 5 6 Chapter 1 Introduction to corporate finance What is corporate finance What long term investments should you take on Where will you get the long term financing to pay for your investment How will you manage your everyday financial activities The owners stockholders are usually not directly involved in making The corp employs managers to represent the owners interests Financial manager business decisions Financial Management decisions Capital budgeting o The first question concerns the firm s long term investments o Capital budgeting The process of planning and managing a firm s long o Evaluating the size timing and risk of future cash flows is the essence term investments of capital budgeting Capital structure o The second question for the manager concerns ways in which the firm obtains and manages the long term financing o A firms capital structure is the specific mixture of long term debt and equity the firm uses to finance its operation o Two concerns How much should the firm borrow What are the least expensive sources of funds Working capital management o Third question concerns working capital management a firms short term assets and short term liabilities on a daily basis o Questions about working capital How much cash and inventory How will we obtain any needed short term financing Should we sell on credit Forms of Business Organizations Sole proprietorship o A business owned by one person o Simplest least regulated form of organization o More proprietorships than any other type of organization o The owner keeps all the profits o Disadvantages Unlimited liability No distinction between personal and business income Unable to exploit new opportunities Partnership o Similar to proprietorship but there are two or more owners o In a general partnership all the partners share in gains or losses and have unlimited liability o In a limited partnership one or more general partners will run the business and have unlimited liability o Advantages Easy and inexpensive to form Unlimited liability for partnership debts All income tax is taxed as personal income o Central problem The ability to grow can be seriously limited by inability to raise Corporation cash for investment o A legal person separate and distinct from its owners and has many of the rights duties and privileges of an actual person o Must prepare articles of incorporation and a set of bylaws o Corp is a resident of the state o The stockholders and managers are usually separate groups o Advantages Ownership can be readily transferred and the life of the company is unlimited Borrows money in its own name Stockholders have limited liability o Disadvantages Double taxation at corporate level and personal level o A limited liability corporation LLC operates and is taxed like a partnership but retains limited liability for owners Essentially a hybrid of partnership and corp IRS will consider an LLC a corp thereby subjecting it to double taxation Goal of Financial Management To maximize the current value per share of the existing stock A more general way of stating the goal is Maximize the market value of the existing owners equity Sarbanes Oxley 2002 o sarbox is intended to protect investors from corp abuses o Sarbox makes company management responsible for the accuracy of the company s financial statements o Hundreds of firms have chosen to go dark meaning their shares are no longer traded on the major stock exchanges The agency problem and control of the corp Agency problems o The relationship between stockholders and management is called an agency relationship o An agency problem is a possibility of a conflict of interest between the principal and the agent Management goals o Agency costs refer to the costs of the conflict of interest between stockholders and management o Direct agency costs come in two forms A corp expenditure that benefits management but costs the stockholders actions An expense that arises from the need to monitor management o Management may tend to overemphasize organizational survival to o Incentive to increase share value for two reasons Managerial compensation is usually tied to financial protect job security Managerial compensation performance Promotions Control of the firms o An important mechanism by which unhappy stockholders can act to replace existing management is a proxy fight o A proxy is the authority to vote someone else s stock o Another way managers can be replaced is by takeover Stakeholders o Someone other than the stockholder or creditor who potentially has a claim on the cash flows of the firm Financial Markets and the Corp Cash flows to and from the firm o Cash flows to the firm from financial markets o The firm invests the cash in current and fixed assets o These assets generate cash o Some of this cash goes to pay corp taxes o After taxes are paid some of this cash flow in reinvested in the firm o The rest goes back to the financial markets as cash paid to creditors and shareholders Primary versus secondary market o Equities are issued solely by corps o Debt securities are issued by both governments and corps Primary markets o The corp is the seller and the transaction raises money for the corp o Two types Public offerings Registered with the securities and exchange commission Costs can be considerable Private placements Secondary markets Dealer versus auction markets o Provide the means for transferring ownership of corporate securities o Dealers buy and sell for themselves at their own risk o Dealer markets in stock and long term debt are called over the counter markets o An auction market has a physical location like wall street o Purpose of auction market is to match those who wish to sell with those who wish to buy Chapter 2 Financial Statements taxes and cash flows The balance sheet A snapshot of the firm that organizes and summarizes what a firm owns what it owes and the difference between the two Assests the left side Classified as either current or fixed o Fixed o Current Relatively long life Can be tangible or intangible A life of less than one year Liabilities and owner s equity the right side Classified as either current or long term o Current o Long term Have a life of less than one year ex account payable A debt that is not due in the coming year Bond and bondholders refer to long term debt and long term Shareholder s equity creditors o The difference between the total value of the assets and the liabilities Assets liabilities
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