COMMERCE 2FA3: Midterm 1 Slides

Capital budgeting decision

What financial management decision answers the question "what long-term investments or projects should the business take on?"

Capital structure decision

What financial management decision answers the questions "how should we pay for our assets?" and

"should we use debt or equity?"

Working capital management

What financial management decision answers the question "how do we manage the day-to-day finances of the firm?"

...sole proprietorship, partnership, and corporation.

The three major forms of business organizations are...

1. Easiest to start

2. Least regulated

3. Single owner keeps all the profits

4. Taxed once as personal income

The advantages of a sole proprietorship are...

1. Unlimited liability

2. Limited to decision/ life of owner

3. Limited capital

4. Difficult to transfer ownership

5. Firm and owner inseparable

The disadvantages of a sole proprietorship are...

Sole Proprietorship

A business owned by a single individual.

Partnership

A business formed by two or more co-owners.

1. Two or more owners

2. More human and financial capital available

3. Relatively easy to start

4. Income taxed once as personal income

The advantages of a partnership are...

1. Unlimited liability (depending on whether is a General partnership or Limited partnership)

2. Partnership dissolves when one partner dies or wishes to sell

3. Difficult to transfer ownership

4. Possible disagreements between partners

The disadvantages of a partnership are...

...general partners and limited partners.

The two types of owners in limited partnerships are...

General Partners

Partners who run the firm on a day-to-day basis and have the same rights and liability as partners in a "regular" partnership.

Limited partners

Partners who have no management authority or decision-making ability; have limited liability; interest in the business transferrable without partnership amendments.

Limited Liability Partnership (LLP)

A type of partnership where all owners have limited liability, but they can also run the business - used in the legal and accounting professions. There is limitation of liability in cases related to actions of negligence of other partners or those supervised by other partners.

Corporation

A business created as a distinct legal entity owned by one or more individuals or entities

1. Limited personal liability

2. Unlimited life

3. Separation of ownership and firm

4. Easy transfer of ownership

5. Easier to raise capital

The advantages of a corporation are...

1. Agency problem

2. Double taxation (income is taxed at the corporate rate and then dividends are taxed at the personal rate)

The disadvantages of a corporation are...

...maximize the current value of the company's stock or maximize shareholders' wealth or maximize firm value

The goal of a corporation is to...

Agency problem

Conflicts of interest between the owner (principal) and the agent (managers) including diverging motivation, time-frame, etc.

...direct and indirect agency costs.

Types of agency costs include...

...corporate expenditures and monitoring costs.

Direct agency costs include...

Corporate expenditure

A direct agency cost where managers extract benefits at the expense of the owners. An example is managers buying a private jet instead of investing back into the company.

Monitoring cost

A direct agency cost where costs are incurred to ensure objective alignment. Examples include compensation packages and oversight committees.

Direct agency costs

A type of agency cost that comes directly from the wallet of the owners.

Indirect agency costs

A type of agency cost that is the lost opportunity cost of investment.

1. Managerial compensation (internal governance mechanism)

2. Market for corporate control (both)

3. Monitoring by other stakeholders (external governance mechanism)

The 3 ways to tackle the agency problem are...

ESG Investing

Investing with an eye on environment, social, and corporate governance standards in mind.

Intermediaries

Banks and other depository institutions providing the 'intermediary' service between the investors and the firms

....the half-year rule and declining balance of UCC.

The two rules for usage of an asset when depreciating assets are...

Half-year Rule

In the first year, only half of the asset's cost can be used for CCA purposes irrespective of when the asset is procured.

Declining Balance UCC

Each subsequent year's CCA is calculated on the lowered/declined ending UCC of the previous year.

Scenario 1

When the last asset in an asset class is sold, the asset class is terminated. This can result in a terminal loss or recaptured CCA. If the asset is sold at a higher price than the original purchase price capital gains needs to be recorded.

...scenario 1.

Our base assumption when dealing with the disposal of an asset is...

Terminal Loss

The difference between the UCC and the disposal value when the UCC is greater. This amount is tax deductible.

Recaptured CCA

The difference between the disposal value and the UCC when the UCC is smaller. This amount is taxable.

...record a terminal loss of the difference between the UCC and the selling price.

In scenario 1 of disposition of an asset, if you sell at a price lower than the UCC you...

...record a recapture of CCA on the difference between the selling price and the UCC.

In scenario 1 of disposition of an asset, if you sell at a price higher than the UCC but lower than the original purchase price you...

...record a recapture of CCA on the difference between the selling price and the UCC AND you record a capital gain on 50% of the difference between selling price and original purchase price.

In scenario 1 of disposition of an asset, if you sell at a price higher than both the UCC and the original purchase price you...

Scenario 2

When an asset is sold and there are other assets in the asset class, the asset class is reduced by the realized value of the asset, or by its original purchase price, whichever is less. If the asset is sold at a higher price than the original purchase price capital gains needs to be recorded.

1. Inflation

2. Opportunity cost

3. Uncertainty

The time value of money changes because of...

...go up.

For a given interest rate (r) the longer the time period, the more future value will...

...go up.

For a given time period (t) the higher the interest rate, the more future value will...

Simple interest

Interest earned only on the original principal.

Compound interest

Interest is earned on principal and on interest received.

...go down.

For a given interest rate (r) the longer the time period (t), the more the present value will...

...go down.

For a given time period (t) the higher the interest rate (r), the more the present value will...

Rule of 72

An approximation of the amount of time it takes to double your money calculated as 72 divided by the rate expressed in a percentage number.

...(1) equal amount of cash flow, (2) at equal intervals, (3) for a finite amount of time.

The three checks of an annuity are...

...(1) equal amount of cash flow, (2) at equal intervals, (3) for infinite time.

The three checks of an perpetuity are...

Ordinary annuity

An annuity where the first payment occurs at the end of the period.

Annuity due

An annuity where the first payment occurs at the beginning of the period.

Perpetuity

An infinite series of equal payments.

Annuity

A finite series of equal payments that occur at regular intervals.

Growing perpetuities

Have cash flows that grow at a constant rate and continue forever.

...1 more compounding period when finding the future value and 1 less discounting period when finding the present value.

With annuities due compared to ordinary annuities every given cashflow will have...

...a higher value.

With annuities due compared to ordinary annuities both the future value and present value will have...

Growing annuities

Have a finite number of growing cash flows.

...the cashflow at period 1 (end of first year) to calculate the present value and future value (FV calculation is only available for growing annuities).

With both growing annuities and growing perpetuities we have to use...

Annual Percentage Rate (APR)

The rate that has to be quoted legally calculated as the period rate times the number of periods per year.

Effective Annual Rate (EAR)

This is the actual rate paid or received after accounting for compounding that occurs during the year.

1. Pure discount loans

2. Interest only loans

3. Amortized loans

The 3 different types of loans are...

Pure discount loan

A type of loan where the borrower receives money today and repays a single lump sum at some time in the future.

Interest only loan

A type of loan where the borrower pays interest each period and repays the entire principal at some point in the future.

Amortized loan

A type of loan where the borrower pays a combination of interest and principal each period.

1. Fixed principal payment loan

2. Fixed payment loan

The 2 types of amortized loans are...