Finance 303 - Widener

Exam #1

Finance

the study of how economic agents raise, allocate, and use monetary resources over time, take into consideration the risk entailed in their investments

What is an unusual way to raise money?

Tesla asked for a deposit for the electronic vehicles before production began. This pre-order model allowed Tesla to gauge demand and secure funding for production.

What is important for any business?

You can be unprofitable, but you cannot run out of cash

Disciplines in Finance

Consists of household (personal), corporate, and public finance

What is the goal of the firm?

Creating value for the firm’s owner which is to maximize shareholder wealth

How do they create value for the shareholders?

By maximizing the price of the existing common stock

Five Principles of the Foundation of Finance

1. Cash Flows Matters

2. Money Has a Time Value

3. Risk Requires a Reward

4. Market Prices are Generally Right

5. Conflicts of Interest Cause Agency Problems

Opportunity Cost

The cost of making a choice in place of the next best alternative(s)

Agency Problem

A conflict of interest in any relationship where one party is expected to act in another’s best interest

Cash Flow Matter

Profits does not equal cash flow; Cash flow drives the value of a business

Incremental Cash Flow

The difference between the projected cash flows if the project is selected versus what they will be if the project is not selected

Money Has a Time Value

A dollar received today is worth more than a dollar received in the future; earning interest on the money received today decreases its value or inflates it

Risk Requires a Reward

Investors do not take on additional risk unless they expect or know that they can be rewarded for said risk

Market Prices are Generally Right

In efficient markets, market prices of all traded assets fully reflect all available information at any moment in time

Ethical dilemma

Each person has their own set of values that forms the basis off personal judgement about what is the right thing

What destroys shareholder wealth?

Unethical decisions such as overstating profits and net income or understating other assets and liabilities for financial benefit

What long-term investments should the firm undertake?

This would be a capital budgeting decision

How should the firm raise money to fund these investments?

This would be a capital structure decision

How should cash flows arising from day-to-day operations be managed?

This would be a working capital decision

Sole proprietorship (individual)

1. Owner maintains title to assets and profits

2. Unlimited liability

3. Termination occurs on owner’s death or by choice (passing the company on through agreement or will)

Partnership (2+ people)

1. The general partnership means that all partners are fully responsible for liabilities incurred by the partnership

2. The limited partnership means that 1+ partners can have limted liability which is represented by the amount of capital invested, but there is a primary partner who will have unlimtied liability.

Corporations

1. Can sue, be sued, purchase, sell, and own property

2. Shareholders constitute policies and maintain control of the direction of the corporation through the elected board

3. Shareholder’s liability is restricted to their investment

4. Life of corporation doesnt’t depend on the owners

5. Transfer of ownership can happen by selling shares or stock.

6. No secrecy of information, delays in decision-making, and double taxatioN

7. Limited liability

What is the benefit of being a public company vs. a private company?

Public companies have access to more capital wealth, but there are risks such as being pushed out, forced to give up the company, and other drawbacks

S-Type Hybrids

1. Limited liability

2. No double taxation

3. Cannot proceed with joint ventures because they are not entitites.

LLC

1. Limited liability

2. No double taxatioN

3. Qualifications vary from state to state

4. Cannot behave like a corporation or it will have double taxation

5. Don’t have to give social security number, just give employer ID.