Introduction To Finance- Chapter 1
Introduction To Finance- Chapter 1 Fin 301
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This 7 page Class Notes was uploaded by Rodriguez Notetaker on Wednesday January 6, 2016. The Class Notes belongs to Fin 301 at Drexel University taught by Dr. Tricia Robak in Fall 2016. Since its upload, it has received 22 views. For similar materials see Principles of Finance in Finance at Drexel University.
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Date Created: 01/06/16
Introduction to Finance 301: Chapter 1: Introduction to Corporate Finance 1.1 Corporate Finance and the Financial Management Corporate finance: is the study of ways to answer three questions (broadly definition) o What long-term investments should you take on? o Where will you get the long-term financing to pay for your investment? o How will you manage your everyday financial activities such as collecting from customers and paying suppliers? not the only questions made but most important The financial manager o An important feature corporations have is that the stockholders are not directly involved in the making business decisions. o The corporation employs these managers to represent the owners’ interest and make decisions on their behalf o Large corporations this manager is in charge of answering the three questions we raised o A sample simplified organizational chart: Financial management decisions: o Three types of decisions Capital Budgeting: Definition: the process of planning and managing a firm’s long-term investments The manager tries to identify investment opportunity that are worth more to the firm than they cost to acquire it Financial managers should worry not only on how much cash they receive but when they expect to receive it and how Time, risk and size of future cash flows is essence for this type of budgeting Capital Structure: Definition: is the specific mixture of long-term debt and equity the firm uses to finance its operations. Two concerns with this type of budgeting: o How much should the firm borrow? o What are the least expensive sources of funds for the firm? This budgeting helps determine the percentage of the firm’s cash flows that goes to creditors and stockholders The financial manager needs to decide how and where to raise the money o Expenses associated with long-term financing can be considerable, so different possibilities must be carefully evaluated. o Borrowing also money from a variety of lenders in a number of different and sometimes exotic ways. Choosing among lenders and among loan types is another job within being a financial manager Capital Management: Working capital management another word for it Definition: refers to a firm’s short-term assets o Inventory, short-term liabilities etc. Managing working capital is a day-to-day activity that ensures that the firm has sufficient resources to continue its operations and avoid costly interruptions. Some things to take in count for working capital o How much cash and inventory should be kept on hand o What amount should we sell on credit o How will we obtain any needed short-term financing 1.2 Forms of Business Organization Sole proprietorship: o Definition: is a business owned by one person o Benefits: Simplest type of business to start The least regulated form of organization Owner keeps all the profits Easiest to dissolve o Disadvantages: Owner has an unlimited liability for business debts Unlimited liability means refers to the legal obligations general partners and sole proprietors because they are liable for all business debts if the business can't pay its liabilities. No distinction between personal and business income All business income is taxed as personal income Life of this type of business is limited to the owner’s life span The equity is also limited to the amount of the owner’s wealth Meaning that the business is unable to exploit new opportunities because of insufficient capital Difficult to transfer because it means to sell entire business to a new owner Partnership o Definition: is similar than ^except that there are two or more owners (partners) o General Partnership: All the partners share in gains or losses Unlimited liability for all partnership debts The gains or losses is divided is described in the partnership agreement A partnership agreement can be written or oral o Limited partnership: One or more general partners will run the business with unlimited liability but there are some limited partners as well. Limited partners means that they are not actively participating in the business (he or she is limited in liability) o Advantages and disadvantages are both the same as sole proprietorship Corporation: o Definition: is the most important form (in terms of size) of business organization in the United States. Is a legal “person”, separate and distinct from its owners, and it has many of the rights, duties and privileges of an actual person. o Benefits: Can borrow money or own property by its own name Can own stock Easy to transfer to a new owner Perpetual life Limited liability Stockholders have the potential to lose money but only at most the certain amount the invest in. o Disadvantages: More complicated to start Forming involves in preparing articles of incorporation and a set of bylaws. Double taxation One for the corporation tax and the other one for the dividends you pay the stockholders A corporation by another name: o All corporations differ from country to country but the essential features of public ownership and limited liability remain. 1.3 The Goal of Financial Management. Financial goals: o Survive o Avoid financial distress and bankruptcy o Beat the competition o Maximize sales or market share o Minimize costs o Maximize profits o Maintain steady earning growth Each of these possibilities presents problems as a goal for the financial manager o These goals are easy to follow but not all actions are in the stockholders’ best interests. Profit maximizations is the most common cited goal May refer to long-run or average profits Goals listed above fall into two classes Related to profitability Involving sales, market share, and cost control all related Different ways of earning or increasing profits Involving bankruptcy avoidance, stability, and safety, relate in some ways to controlling risk Both groups are technically contradictory Because the goal of profit it involves some element of risk so it cant really maximize both safety and profit. Is a goal that encompasses both factors. The goal of financial management o Good decision increase the value of the stock and poor decisions decrease the value of the stock o The goal of financial management is to maximize the current value per share of the existing stock. o The total value of the stock in a corporation is simply equal to the value of the owners’ equity That the goal by maximize the market value of the existing owners’ equity o The financial manager best serves the owners of the business by identifying goods and services that add value to the firm because they are desired and valued in the free marketplace Sarbanes-Oxley o Purpose of protecting investors from corporate abuses o Officers of the corporation must review and sign the annual reports o They also have to declare the annual reports that are 100% truthful o Also that annual reports must list any deficiencies in internal controls 1.4 Not discussed 1.5 Financial Markets and the Corporation Cash flows between the firm and the financial markets o A financial markets function is to just bring buyers and sellers together o In financial markets it is debt and equity securities that are bought and sold o The markets do differ Its with the type of securities that are traded and how the traiding is conducted and who are the participants in the buying and selling transaction. Primary versus secondary markets o Primary markets Refers to the original sale of securities by governments and corporations The corporation is the seller Public offerings: involves selling securities to the general public Private placements: is a negotiated sale involving a specific buyer Debt and equity are often sold privately to large financial institutions such as a life insurance companies or mutual funds o Secondary Markets Refers to those in which these securities are bought and sold afther the original sale The transaction involves one owner or creditor selling to another It provides the means for transferring ownership of corporate securities. This is a critical market Because investors are more willing to purchase securities in a primary market transaction when they know that those securities can later be resold if desired. Equity are only issued if you are a corporarion ONLY Debt securities only issued by corporation or government ONLY Dealer versus Auction Markets o Two types of secondary markets: auction market and dealer markets o Dealers: buy and sell for themselves at their own risk OTC (over the counter) markets Most stock and long-term debt/debt securities take place here o Auction: An auction market or exchange has a physical location (Wall street for example) Dealers play a limited role while auctioners don’t Listing o Stocks that trade on an organized exchange are said to be listed on that exchange o New York Stock Exchange has the most stringent requirements of the exchange in the US
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