Practice1

P1

Proprietorship

owned by a proprietor who has unlimited liability

General partnership

owned by general partners who have unlimited liability

Limited partnership

owned by general partners who have unlimited liability and limited partners who have limited liability

Cooperative

owned suppliers or employees who usually have limited liability

Mutual

owned by customers who usually have limited liability

Trusts

run by lawyers acting as agents for a beneficiary who usually has limited liability

State owned

owned by the government which may have limited or unlimited liability

We will assume that **_ is the goal of corporate financial management** unless stated otherwise

maximizing returns to shareholders

Firms survive and grow over time if they can consistently obtain funding for their projects.  Because the **goal of _** is often the most effective way to encourage investors to contribute funds to a firm, this goal of financial management ends up being the most sustainable

maximizing returns to shareholders

The **goal of maximizing shareholder wealth** can be expressed in several equivalent ways:

* Maximizing shareholder returns
* Maximizing the long-term value of stock
* Maximizing the long-term stock price
* Maximizing the market capitalization of the firm

It should be noted that this goal is __NOT__ necessarily the same as:

* Maximizing profits
* Maximizing sales
* Maximizing firm size
* Maximizing market share

Profit maximization may not lead to the highest possible share price for at least three reasons:

* Timing is important—the receipt of funds sooner rather than later is preferred. Time is money!
* Profit maximization fails to account for risk – extremely profitable opportunities may be too risky.
* Profits do not necessarily result in cash flows available to stockholders. There is a difference in accounting values and cash flows

Maximizing profits is __NOT__ the same as maximizing shareholder wealth

Maximizing profits is __NOT__ the same as maximizing shareholder wealth

Firms need to satisfy all stakeholders to _

maximize shareholder value

_ are also known as the residual owners of the firm's cash flows. they only get paid after other stakeholders are __satisfied__

Shareholders

Capital Budgeting, Capital Structure, Working Capital Management, International Corporate Finance, and Raising investment capital

A **_** is really just a general term for anything that a firm does.  It usually involves an up-front cost that is then followed by some risky cash inflows in later periods

project

The Process of Capital Budgeting:

First, the financial manager must use accounting information to estimate the size, timing and risk of cash flows from a project. 

Then the financial manager can use capital budgeting tools to then decide if the firm should accept or reject a project

_ concerns the firm’s long-term investments or fixed assets

Capital budgeting

Funding for a project can be simplified to two choices:

debt or equity

_ is borrowed money that must be repaid at a fixed point in time

Debt

_ is an accounting term for debt

Liabilities

_ is a common term for debt from a bank

Loans

_ is a debt security traded in financial markets

Bonds

_ is a term for how much debt a firm has

Leverage

Lenders will often be referred to as *_* or _ , and often include institutions such as banks

Bond holders; debt holders

In some situations, the term **_** is used in place of equity

capital

Equity, or **ownership**, of a firm is documented by **_**

shares of stock

_ are generally **negotiable**, meaning they could be bought, sold, or transferred in other ways

Shares of stock

The total value of all shares of stock. This represents how much ownership of a firm is worth

Market capitalization

the management of liquidity

Working capital management

_ is also called Cash Management, Liquidity Management, or Short-term financial management

Working capital management

_ is concerned with liquidity how much cash and other short-term assets a firm should hold, as well as how many short-term liabilities the firm has.  This includes the choice between long-term versus short-term in financial planning

working capital management

The difference between short term assets and short-term liabilities is referred to as **_**

Net Working Capital

Short-term assets are also referred to as **_**

Current Assets

short-term liabilities are also referred to as **_**

Current Liabilities

Something is generally considered “current” or “short-term” if it is expected to be converted (bought or sold) into cash within _

one year

The _ includes commercial banks, investment banks, pension funds, hedge funds, and mutual funds

Financial system

Why do firms need the financial system?

Firms need the financial system to facilitate short term cash management policies and to accommodate near term cash inflows and outflows – receive payments from sales, pay employees, pay vendors, etc.  Firms also need a financial system to obtain long term funds

3 key long term financial management decisions that impact shareholder wealth

Investment, financing, and dividend decisions

A good investment decision increases shareholder wealth by making investments that earn a return greater than a _

Hurdle rate

What is a hurdle rate?

the cost of financing

As the hurdle rate (the cost of financing) decreases, the number of attractive investment opportunities _

increases

A good _ decision increases shareholder wealth by returning cash to owners when the firm doesn’t have good investment opportunities.  The financial system plays a role in all 3 decisions

Dividend

Firms can acquire external funding from 3 sources:

* Financial Institutions
* Financial Markets
* Private Placements

**Financial institutions** are **_** that channel the savings of individuals, businesses, and governments into loans or investments

intermediaries

**Financial intermediaries** provide a conduit between net suppliers of funds, on average individuals, and net demanders of funds - businesses and governments.  Note the word ‘_.’  Younger, early-career individuals may be users of funds (by borrowing money for education, house, cars, etc.) while older individuals are usually providers of funds.  Overall, individuals are net providers of funds

Net

_ **banks** such as Wells Fargo, Citibank, and  Bank of America, accept deposits and provide security and convenience to their customers. Also make loans that individuals and businesses use to buy goods or expand business operations, which in turn leads to more deposited funds that make their way to banks. If banks can lend money at a higher interest rate than they have to pay for funds and operating costs, they make money

Commercial

_ **banks** help firms obtain long term financing by facilitating debt and equity offerings in the **financial markets**, advise firms on major financial market transactions such as mergers and restructuring, and engage in trading and **market-making** activities.  A market maker assumes the risk of holding a certain number of shares of a particular **security** in order to facilitate the trading of that security

Investment

A market maker assumes the risk of holding a certain number of shares of a particular **_** in order to facilitate the trading of that security

Security

Prior to 1999, a bank could be either a commercial bank or an investment bank but not both.  The **Glass-Steagall Act** of 1933 created the federal deposit insurance program and separated the activities of commercial and investment banks. It was repealed it 1999 by the **Gramm-Leach-Bliley Act (of 1999)**

Prior to 1999, a bank could be either a commercial bank or an investment bank but not both.  The **Glass-Steagall Act** of 1933 created the federal deposit insurance program and separated the activities of commercial and investment banks. It was repealed it 1999 by the **Gramm-Leach-Bliley Act (of 1999)**

The **_** refers to financial intermediaries involved in facilitating the creation of credit - lending -  much like traditional banks but are not subject to regulatory oversight. These include investment banks, mortgage lenders, money market funds, insurance companies, hedge funds, private equity funds, and payday lenders - all of which are a significant and growing source of credit in the economy

shadow banking system

The shadow banking system has escaped regulation primarily because it does not accept _. As a result, many of the shadow banking institutions have been able to employ higher market, credit and liquidity risks, and do not have capital requirementscommensurate with those risks. Subsequent to the financial crisis and the subprime meltdown in 2008, the activities of the shadow banking system came under increasing scrutiny and regulations

traditional bank deposits

One of the fastest-growing segments of the shadow banking industry is _ lending

peer-to-peer (P2P)

The **_** is where firms obtain external long term financing.  Keep in mind that firms can also obtain long term financing via internally generated funds

capital market

the portion of net income not paid out to investors via dividends or stock repurchases

retained earnings

The capital market enables suppliers and demanders of long-term funds to make transactions.  Capital markets consist of the primary market, where new securities are issued and sold, and the secondary market, where already-issued securities are traded between investors. The major capital market securities are bonds and stock – both common and preferred

The capital market enables suppliers and demanders of long-term funds to make transactions.  Capital markets consist of the primary market, where new securities are issued and sold, and the secondary market, where already-issued securities are traded between investors. The major capital market securities are bonds and stock – both common and preferred

_ are long-term debt instruments used by businesses and the government to raise large sums of money, generally from a diverse group of lenders. Firms issue bonds because they are less expensive than loans from financial institutions.  However, only larger firms can issue bonds.  We discuss bonds in-depth in the Bonds and Bond Valuation section

Bonds

_ are units of ownership interest or equity in a corporation

Common stock

_ is a special form of ownership that has features of both a bond and common stock. We will discuss common and preferred stock in detail in the Stocks and Stock Valuation section

Preferred stock

From a firm’s perspective, the role of capital markets is to be a _

liquid market

a market with many available buyers and sellers and comparatively low transaction costs

Liquid market

From investors’ perspectives, the role of capital markets is to be an _ market that allocates funds to their most productive uses

efficient

An _ allocates funds to their most productive uses as a result of competition among wealth-maximizing investors __and__ determines and publicizes prices that are believed to be close to their true value

Efficient market

_ was an aristocrat who believed that informed elites, such as himself, should make the really important decisions in society since most people, ‘the crowds,’ were not educated, enlightened, or smart.  But Mr. Galton was a scientist and a statistician and wanted proof for his theory.  He came across a contest at a local fair that suited his purposes.  In the contest, contestants guessed the finished weight of an ox. There were two groups of contestants, a very large group of fairgoers who were mostly poor and undereducated city dwellers.  Certainly, not a group with any expertise in agriculture or food processing.  The second, much smaller, group consisted of professional butchers.  To Mr. Galton’s surprise, the average guess of the city dwellers was closer to the true finished weight of the ox than the average guess of the professional butchers. Then recognized that a diverse collection of independently deciding individuals is likely to make better value decisions than individuals or even experts

Francis Galton

Not everyone believes markets are efficient.  Advocates of **_**, an emerging field that blends ideas from finance and psychology, argue that stock prices and prices of other securities can deviate from their true values for extended periods

behavioral finance

Financial markets create securities products that provide a return for those who have excess funds (Investors/lenders) and make these funds available to those who need additional money (borrowers)

Financial markets create securities products that provide a return for those who have excess funds (Investors/lenders) and make these funds available to those who need additional money (borrowers)

inefficient policies and practices _ borrowing costs and _ investor returns.  Discrimination against certain groups of people is not only wrong from a moral and ethical perspective, but it is also inefficient because it reduces opportunities for profitable investment

Increase; lower

_ is a discriminatory practice denying neighborhoods financial services based on race or ethnicity. It began in the 1930s as part of New Deal housing policies. The Home Owners' Loan Corporation (HOLC) made redlining maps to categorize neighborhoods by risk. This resulted in limited access to mortgages, insurance, and investment, leading to disinvestment and decline. Redlining primarily impacted minority communities, perpetuating racial segregation and wealth disparities. While the Fair Housing Act of 1968 outlawed redlining, its effects persist today

Redlining

Despite these laws, discriminatory practices continue to adversely affect some minority borrowers.  One reason discrimination persists is that it is often hard or even impossible to equate racial, gender, religious, and other disparities with intentional taste-based discrimination

Despite these laws, discriminatory practices continue to adversely affect some minority borrowers.  One reason discrimination persists is that it is often hard or even impossible to equate racial, gender, religious, and other disparities with intentional taste-based discrimination

_ arise from unintentional statistical discrimination

Disparities

_ occurs when decision-makers have racial preferences and tend to avoid interaction with those towards whom they harbor animus

Taste based discrimination

_ is based on hidden, but outcome-relevant, characteristics that are correlated with easily observable factors such as race, gender, and performance

Statistical discrimination

_ requires decision-making about how a firm should raise and spend money

Financial management

The data financial managers use to make these decisions primarily comes from _

Accounting statements

Accounting statements summarize past decisions and reflect _ costs

historical

Finance is _ looking

Forward

Accounting and Finance are two different perspectives on the same issues

Accounting and Finance are two different perspectives on the same issues

Accounting is concerned with summarizing the data we already have, while finance is concerned with using that data to make decisions

Accounting is concerned with summarizing the data we already have, while finance is concerned with using that data to make decisions

Financial statements need to be prepared in compliance with quality standards to ensure and _ so that equity investors, creditors, managers, and regulators can evaluate performance and make informed decisions

Accuracy; reliability

_ form the set of accounting standards widely accepted for preparing financial statements

Generally Accepted Accounting Principles (GAAP)

Generally accepted accounting principles (GAAP) are the practice and procedure guidelines used to prepare and maintain financial records and reports; authorized by the _

Financial Accounting Standards Board (FASB)

International companies follow the  which are set by the _ and serve as the guideline for non-U.S. companies

International Financial Reporting Standards (IFRS); International Accounting Standards Board

Financial accounting primarily uses _ value

Book

Financial managers deal with _ values

Market

_ measures how much money flows through a corporation over a set period of time (usually one quarter or one year)

Income statement

Recall that ownership of a corporation is represented by shares of stock. One of the main things that an owner gets is a claim on any cash flow or assets that are left after all other debts have been paid.  These cash flows determine the value of a project and are therefore necessary for capital budgeting.  We can use information from the income statement to compute these cash flows

Recall that ownership of a corporation is represented by shares of stock. One of the main things that an owner gets is a claim on any cash flow or assets that are left after all other debts have been paid.  These cash flows determine the value of a project and are therefore necessary for capital budgeting.  We can use information from the income statement to compute these cash flows

Revenue - Expenses =

Profit

**Cash inflows** are usually called  *_* or *.* Sometimes even _

Revenues; sales; gross cash flows

**Cash outflows** are usually called **_** or **_**

Expenses; costs

**Profits** are often called **_** or **_**

Earnings; Income

PIC IN CAMERA ROLL

PIC IN CAMERA ROLL

_ represents an estimate of how much our equipment has been degraded or worn-out through its use.  It does not represent any change in cash.  However, it does change our earnings before taxes and so it impacts the amount we pay in taxes

Depreciation

_ is not actually a cash flow

Depreciation

amortization, accruals, depreciation, and goodwill does not represent _

actual cash flows

Much of our _ will concern how to take net income and then adjust for depreciation in order to get an estimate of cash flow

capital budgeting analysis

Different methods that can be used to compute depreciation expense:

Accelerated Cost Recovery System (ACRS), Modified Accelerated Cost Recovery System (MACRS), and Straight-line Depreciation

The top corporate tax rate is **_** for 2018 and thereafter

21%

Once a firm pays its corporate income tax, then any profit remaining can be distributed to shareholders as _. or they can be retained by the firm and reinvested in the firm’s projects

Dividends

The funds retained from dividends are called _

Retained earnings