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Chapter 1

by: haley milowitz

Chapter 1 BADM 3501

haley milowitz
GPA 3.5

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Chapter 1 Notes from Class
Financial Management and Markets (BADM 3501, Business administration)
Gergana Jostova
Class Notes
business, finance
25 ?




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This 3 page Class Notes was uploaded by haley milowitz on Saturday February 6, 2016. The Class Notes belongs to BADM 3501 at George Washington University taught by Gergana Jostova in Spring 2016. Since its upload, it has received 24 views. For similar materials see Financial Management and Markets (BADM 3501, Business administration) in Business at George Washington University.


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Date Created: 02/06/16
Financial Management – focuses on decisions relating to how much and what types of assets to acquire, how to raise the capital needed to purchase assets, and how to run the firm so as to maximize its value.  Study banks, stockbrokers, mutual funds, insurance companies, etc. Investments  Securities (stocks and bonds)  Portfolio theory – best way to structure portfolios of stocks and bonds  Market analysis – deals with the issue of whether stock and bond markets at any given time are too high or low or just right  Behavioral finance – investor psychology is examined in an effort to determine if stock prices have been bid up to unreasonable heights in a bubble or driven down Sarbanes-Oxley Act  A law passed by congress that requires the CEO and CFO to certify that their firm’s financial statements are accurate Proprietorships  Unincorporated business owned by one individual  3 advantages o Easy and inexpensive to form o Subject to few government regulations o Subject to lower income taxes than corporations  Limitations o Unlimited personal liability for the business’ debts, so they can lose more than the amount of money they invested in the company o The life of the business is limited to the life of the creator o Difficulty obtaining large sums of capital – usually used primarily for small businesses Partnerships  Legal arrangement between two or more people who decide to do business together  Can be established relatively easy and inexpensively  Taxed on an individual basis – avoid corporate income tax o If a partnership goes bankrupt and any partner is unable to meet his or her pro rata share of the firm’s liabilities, the remaining partners will be responsible for making good on the unsatisfied claims  Unlimited liability makes it difficult for partnerships to raise large amounts of capital Corporations  Legal entity created by a state, and it is separate and distinct from its owners and managers o Limits stockholders’ losses to the amount they invested in the firm. The corporation can lose al of its money, but its owners can lose only the funds they invested  Unlimited lives – easier to transfer shares of stock in a corporation than one’s interest in an unincorporated businesses  Easier to raise capital  Most corporations earnings are subject to double taxation – the corporation’s earnings are taxed and then when its after-tax earnings are paid out as dividends, those earnings are taxed again as personal income to the stockholders  S Corporations o Aid to small business, created by congress o Taxed as if they were proprietorships or partnerships – exempt from corporate income tax o Qualify – cannot have more than 100 stockholders  C Corporations o Larger corporations o Smaller ones elect S status and retain that status until they go public – become C corporations Limited Liability Companies and Limited Liability Partnerships  LLC is a popular type of organization that is a hybrid between a partnership and a corporations o Used by other businesses than LLP’s  LLP is similar to an LLC but LLP’s are used for professional firms in the fields of accounting, law, and architecture  Provide limited liability protection but they are taxed as partnerships  Investors in an LLC or LLP have votes in proportion to their ownership interest  Invented by lawyers so they have a complicated structure – necessary to hire a good lawyer when establishing an LLC or LLP Value maximized as a corporation for a larger business 1. Limited liability reduces the risks borne by investors and other thins held constant, the lower the firms risk the higher its value 2. A firm’s value is dependent on growth opportunities, which are dependent on its ability to attract capital. Corporations can attract capital more than other types of businesses - they are better able to take advantage of growth opportunities 3. The value of an asset also depends on its liquidity, which means the time and effort it takes to sell the asset for cash at a fair market value. Because the stock of a corporation is easier to transfer to a potential buyer than is an interest in a proprietorship or a partnership and because more investors are willing to invest in stocks than in partnerships (with their potential unlimited liability) a corporate investment is relatively liquid Intrinsic Value: estimate of a stocks true value based on accurate risk and return data. The intrinsic value can be estimated but not measured precisely.  Long run concept  Will maximize the average price over the long run but not necessarily the current price at each point in time Market Price: stock value based on perceived but possibly incorrect information as seen by the marginal investor Marginal Investor: an investor whose views determine the actual stock price Equilibrium: situation in which the actual market price equals the intrinsic value, so investors are indifferent between buying and selling a stock Short run focus consequences  Bump up current earnings, short term profits  Stock-based compensation – stockholders awarded executives stock options that could be used on a specified future date o On that date, the executive could receive stock, sell it, and earn a profit  Don’t want to penalize short term profits – would lower stock price that day  Some managers overstated profits, temporarily boosted stock price, exercised their options, sold inflated stock, and left the stock holders in the dark with the responsibility of paying o Enron Compensation Packages  Managers are rewarded on the basis of the stock’s performance over the long run, not the price on an option exercise date o Options should be phased in over a number of years so that managers have an incentive to keep the stock price high over time Corporate Raids  Individuals who target corporations for takeover because they are undervalued Hostile Takeover  The acquisition of a company over the opposition of its management Wealth Maximization  Primary goals for managers of publicly owned companies implies that decisions should be made to maximize the long-run value of the firm’s common stock


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