Fin320 Chapter 1

Front 1

Four basic areas of finance

Back 1

1. Corporate finance

2. Investments

3. Financial institutions

4. International finance

Front 2

Investments

Back 2

Deal with financial assets such as stocks and bonds

Front 3

3 career opportunities in investments

Back 3

1. Stockbroker

2. Portfolio Manager: manage money for investors

3. Security Analysis: researches individual investments and makes a determination as to whether the price is right

Front 4

Financial institutions

Back 4

Banks and insurance companies

Front 5

International finance

Back 5

Careers in international finance generally involve international aspects of either corporate finance, investments, or financial institutions

Front 6

Marketing and finance

Back 6

1. Marketers constantly work with budgets

2. Financial analysts rely heavily on marketing analyst

3. Finance industry will employ marketers to help sell financial products

Front 7

Accounting and finance

Back 7

1. In smaller businesses accountants are often required to make financial decisions

2. Accountants have to know finance to understand the implications of many of the newer types of financial contracts and the impact they have on financial statements

Front 8

Management and finance

Back 8

Management strategists must have a very clear understanding of the financial implications of business plans.

Front 9

Personal finance

Back 9

How to invest your retirement funds

Front 10

What is Business Finance?

Back 10

Business finance is the study of ways to answer three questions: what long term investments should you take on? Where will you get the long term financing to pay for your investments? How will you manage your everyday financial activities, such as collecting from customers and paying suppliers?

Front 11

Financial manager

Back 11

CFO, or vice-president of finance, coordinates the activities of the treasurer and the controller.

Front 12

Capital budgeting

Back 12

The process of planning and managing a firm's long term investments. The financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire. Financial managers must be concerned with how much cash they expect to recieve, when they expect to recieve it, and how likely they are to receive it.

Front 13

What is considered the essence of capital budgeting?

Back 13

Evaluating the size, timing, and risk of future cash flows.

Front 14

Capital structure

Back 14

A firm's capital structure refers to the specific mixture of long term debt and equity the firm uses to finance its limitations.

Front 15

What two concerns does a financial Manager have with capital structure?

Back 15

How much should the firm borrow? What are the least expensive sources of funds for the firm?

Front 16

Working capital management

Back 16

Working capital refers to a firm's sort term assets, such as inventory, and its short term liabilities, such as money owed to suppliers.

Front 17

What are the three areas af corporate financial management?

Back 17

Capital budgeting, capital structure, and working capital

Front 18

What are the three different legal forms of business organizations?

Back 18

Sole proprietorship, partnerships, and corporation

Front 19

Sole proprietorship

Back 19

A business owned by one person. Keeps all the profits, has unlimited liability for business debts, creditors can look to proprietor personal assets for payment, no distinction between personal and business income so all business income is taxed as personal income. Life of a sole proprietorship is limited to the owner's life span, and, importantly, the amount of equity that can be raised is limited to the proprietors personal wealth. This means that the business is unable to exploit new opportunities because of insufficient capital.

Front 20

Partnership

Back 20

Similar to a proprietorship, except that there are two or more owners (partners).

Front 21

Two types of partnerships

Back 21

General partnership and limited partnership

Front 22

General partnership

Back 22

All partners share in gains or losses, all have unlimited liability for all partnership debts, not just some particular share. The way partnership gains and losses are divided is described in the partnership agreement either informal or formal.

Front 23

Limited partnership

Back 23

One or more general partners will run the business and have unlimited liability, but there will be one or more limited partners who do not actively participate in the business. A limited partner's liability for business debts is limited to the amount that partner contributes to the partnership. This is common in real estate ventures.

Front 24

What are the primary disadvantages of sole proprietorship and partnerships?

Back 24

Unlimited liability for business debts on the part of the owners, limited life of the business, and difficulty of transferring ownership

Front 25

Corporation

Back 25

A corporation is a legal "person" seperate and distinct from its owners, and it has many rights, duties, and privileges, can sue and be sued, and can enter into contracts. A corporation can even be a general partner or a limited partner in a partnership, and ac corporation can own stock in another corporation.

Front 26

Forming a corporation involves...

Back 26

Preparing articles of incorporation (or a charter) and a set of bylaws. The articles of incorporation must contain a number of things, including the corporation's name, its intended life (which can be forever), its business purpose, and the number of shares that can be issued. The bylaws are rules describing how the corporation regulates its own existence. For example, the bylaws describe how directors are elected.

Front 27

Corporate advantages

Back 27

Ownership (represented by shares of stock) can be readily transferred, and the life of the corporation is, therefore, not limited. The corporation borrows money in its own name. As a result, the stockholders in a corporation have limited liability for corporate debts. The most they can lose is what they have invested.

Front 28

Corporate disadvantage

Back 28

Because a corporation is a legal person, it must pay taxes. Moreover, money paid out to stockholders in the form of dividends is taxed again as income to those stockholders. This is double taxation, meaning that corporate profits are taxed twice: at the corporate level when they are earned and again at the personal level when they are paid out.

Front 29

Limited liability company

Back 29

Respectively new. Goal is to operate and be taxed like a partnership but retain limited liability for its owners. Thus, an LLC is essentially a hybrid of a partnership and a corporation.

Front 30

Goal of financial management

Back 30

To maximize the current value per share of the existing stock

Front 31

A more general financial management goal

Back 31

Maximize the market value of the existing owners equity

Front 32

Sarbanes-Oxley Act (Sarbox)

Back 32

Passed in 2002, became effective in November 2004. Contains requirements designed to ensure that companies tell the truth in their financial statements. Officers must review and sign the annual report. They must attest that the report does not contain false statements or material omissions and also that the financial statements fairly represent the company's financial results.

Front 33

What are some unintended consequences due to Sarbox?

Back 33

Because of its extensive requirements, compliance to Sarbox can be very costly. Since it's implementation hundreds of public firms have chosen to go dark, meaning that their shares are no longer traded in the major stock markets. The law had the effect of eliminating public disclosure instead of improving it. Sarbox also probably affected the number of companies going public in the United States. Recently, many U.S.-based companies have chosen to go public on the London Stock Exchange's Alternative Investment Market (AIM) instead. The cost savings can be enormous, especially for small companies.

Front 34

What is the relationship between stockholders and management called?

Back 34

Agency relationship

Front 35

Agency problem

Back 35

Possibility of conflict of interest between the principal and the agent.

Front 36

What factors decide whether managers will act in the best interest of stockholders?

Back 36

How closely are management goals aligned with stockholders goals? and can management be replaced if they do not pursue stockholders goals?

Front 37

Managerial compensation

Back 37

Two incentives for managers; managerial compensation is usually tied to financial performance in general and oftentimes to share value in particular. Managers are frequently given the option to buy stock at a fixed price. The second incentive managers have relates to job prospects. Better performers within the firm will tend to get promoted. More generally, those managers who are successful in pursuing stockholder goals will be in greater demand in the labor market and thus command higher salaries.

Front 38

Control of firm

Back 38

Control of firm rests with the stockholders. They elect the board of directors who in turn hires and fires management.

Front 39

Two ways to replace management

Back 39

Proxy fight- a proxy is the authority to vote sometime else's stock. A proxy fight develops when a group solicits proxies in order to replace the existing board, and thereby replace existing management. Another way management can be replaced is by takeover. Firms that are poorly managed are more attractive as acquisitions than a well managed firm.