FIN310 - Exam 1 Need to Knows

Capital Budgeting

Planning and managing the firm’s long-term investments and deciding which to acquire

Capital Structure

Determining the specific mixture of long-term debt and equity to fund operations

Working Capital Management

Managing day-to-day financial activities and short-term assets/liabilities to ensure smooth operations.

Sole Proprietorship

One owner, easy to form with single layer of taxation, unlimited liability for business debts, limited capital, limited life

General Partnership

All partners share profits/losses, unlimited liability for debts

Limited partnership

At least one general partner (unlimited liability) and limited partners (limited liability) who do not manage daily operations + not responsible for debt

Corporation

Independent legal entity owned by stockholders

Advantages of corporation

Limited liability for shareholders, easy transfer of stock ownership, unlimited ownership, perpetual life

Disadvantages of corporation

Complex setup, double taxation

Net gain/loss

Distributed cash flow - initial equity investment

Who only loses the amount they invested in situations of debt?

Corporation shareholders and limited partners

Who has to pay debt out of pocket?

Sole proprietors and general partners

Goal of financial management

Maximize current stock value/market value of owner’s equity

Agency relationship

When principals (stockholders) hire agents (firm managers) to run the firm

Agency problem

Conflict of interest between stockholders and firm management

Agency costs

Cost of the agency problem, such as executive perks, audit fees, cautious investment choices by managers

Primary market

Sale of securities by corporations or governments, either public offerings or private placements

Secondary market

Trading of existing securities between investors after the original sale, such as dealer markets (post bid ask prices) or auction markets (large corporate stock trades)

Balance Sheet identity

Assets = liabilities + owner’s equity

Net working capital

Current assets - current liabilities

Book/accounting value

Original monetary value - accumulated depreciation

Market value

What assets, liabilities, or equity are worth today

Earning before interest and taxes

Sales - costs - depreciation

Taxable income/earnings before taxes

EBIT - interest expense

Net income

Taxable income - taxes

Is depreciation a cash outflow

No

Cash flow from assets

Cash flow to creditors + cash flow to stockholders, or operating cash flow - net capital spending - net working capital

operating cash flow

EBIT + depreciation - taxes

Net capital spending

Ending net fixed assets - beginning net fixed assets + depreciation

cash flow to creditors

Interest paid - (ending long term debt - beginning long term debt). so basically debt without the interest

cash flow to stockholders

dividends paid - (ending common stock and surplus - beginning common stock and surplus)

Increase in assets

use of cash (buying assets)

Decrease in assets

Source of cash (selling assets)

Increase in liabilities/equity

source of cash (borrowing money)

Decrease in liabilities/equity

Use of cash (paying off debt or buying back equity)

Goal of financial planning

Targeting sales growth to reach financial goals

Sales forecast

Externally projected sales growth target

Pro forma statement

Projected income statements and balance sheet based on the sales forecast

Assets requirements

capital spending required in new assets to reach sales growth projection

financial requirements

how much capital to raise and how much net income gets paid out as dividends

plug variable

balance sheet account that you choose to vary in financial projections

4 determinants of sustainable growth rate

Operating efficiency (profit margin), asset use efficiency (total asset turnover), financial policy (financial leverage), dividend policy (retention ratio)

Equity multiplier

1 + debt equity ratio

Retention rate

1 - dividend payout ratio