Financial Management of the Firm Exam 1 CHAPTER 1 I II Corporate Finance and the Financial Manager a Firm any business to an accountant it is any physical collection of assets used in the production of goods and services b The goal of financial management is to increase the market value of a company s equity Financial Management Decisions a Capital Budgeting the process of planning and managing a firm s long term investments i Ex Deciding whether or not to open up another store or considering the decision to develop and market a new software ii Concerned with evaluating the size timing and risk of future b Capital Structure the specific mixture of long term debt and equity the firm uses to finance its operations i Concerned with how much should the firm borrow and what are the least expensive sources of funds for the firm ii The mixture of debt and equity will affect the risk and value of cash flows the firm iii Ex choosing among lenders and loan types evaluating the expenses associated with borrowing the money deciding how and where to raise the money needed and establishing how much of the firm s operations will be financed by creditors or shareholders c Working Capital Management refers to the managements of short term assets such as inventory and short term liabilities such as money owed to suppliers i Concerned with how much inventory or cash should a firm keep on hand whether or not we should sell on credit define the terms for credit sales and how a firm will obtain short term financing if needed ii AKA liquidity management iii Ex will we borrow in the short term Pay cash If we borrow in the short term how and where should we do it iv Ex short term A R A P raw materials finished goods III Forms of Business Organization a Sole Proprietorship a business owned by one person i Easiest type of business to start ii Least regulated iii The business s income is the owner s income business income is taxed as personal income iv Perhaps a few employees v The owner has unlimited liability for his debts vi Limited to the owner s lifespan business dies with owner vii The amount of equity that can be raised is limited to the owner s personal wealth can lead to insufficient funds and stagnant growth b Partnership there are two or more owners i All the partners share gains and losses and share unlimited ii Partnership agreements must be made to establish how the liability partnership will work iii Single taxation c Corporation highest level of business organization i Equity ownership interest 1 Ex share stock or ownership certificates ii Capital a form of funding for a company 1 Can be financed by either equity or debt 2 Debt capital provided by lenders or creditors iii Double taxation getting taxed on your own income and having to pay corporate taxes as well IV iv Easiest in terms of transferring ownership The Agency Problem and Control of the Corporation a Agent anyone who runs a company but does not own it i Ex managers board of directors b Owners equity holders in a company i Ex stockholders c Agency Cost the cost of having the separation between agents and owners the potential costs management decision can have on shareholder income Refers to the costs of the conflict of interests between management and stockholders i Direct costs can be an expenditure that benefits management and costs stockholders or the expense that arises from the need to monitor management actions 1 Ex management purchasing a fancy company jet 2 Ex having to pay external auditors to verify the accuracy of manager s financial statements ii Indirect costs management suboptimal decision making to keep their jobs d Incentives in place for Managers to act in Stockholder interest i Managerial compensation tied to performance 1 Can be either cash or stock options ii Avoiding a take over by another firm e Sorbanes Oxley SOX Act passed to put in place a system that maintained internal controls and if fraud does happen those responsible can be held accountable i Passed because of the Enron Tyco and WorldCom scandals ii Requires that each company s annual report must have an assessment of their internal control structure and financial reporting and they must have an independent auditor review it iii Prohibits officers of corporations to take out loans from the corporation iv Officers of the corporation must explicitly declare that the information in the annual report is accurate and they must sign it f Control of the Firm i Stockholders control the firm 1 They elect a Board of Directors who are in charge of hiring and firing managers ii Ways in which unhappy stockholders can act 1 Proxy fight develops when a group solicits proxies in order to replace the existing board of directors and subsequently the managers 2 Acquisitions of ill managed firms iii Stakeholders someone other than a stockholder or a creditor who has a claim on the cash flows of the firm 1 Employees customers suppliers or the government V Financial Markets and the Corporation a Primary markets refers to the original sale of securities by governments and corporations i IPO initial public offering of a company s stocks the time when companies receive funding from equity markets ii Private Placement a negotiated sale between a corporation and a specific buyer b Secondary Markets refer to trades that occur between third partied such as brokers and individuals i Auction market middle man third party makes a commission on facilitating a trade ii Dealer market middle man third party takes temporary ownership of asset and makes money on the spread between what they bought it at and what they sold it for 1 Common in the bonds market and used car sales 2 Maintains an inventory c Trading in Corporate Securities i NYSE where the largest corporations sell their stocks 1 Has the most stringent listing requirements in the US ii NASDAQ tend to have smaller companies iii OTC another market for stocks that has no physical location and provides less international barriers CHAPTER 8 3 I Organization of the NYSE a Worlds first global exchange after merger with Euronext b Members NYSE has 1 366 they have stock in the NYSE i Have a license and subsequently the right the buy and sell stocks on the floor c Commission Brokers execute customer order to buy and sell stocks d Specialists acts as an assigned dealer for a small subset of securities i Aka market makers because they are obligated to maintain a fair market for their assigned securities ii Post bid prices and ask prices
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