Buillon Ag Finance: Exam 1

The Goal of the Firm

1. Maximize shareholder wealth

2. Create value for the company’s owners

3. Increase the market value of the company’s assets

Maximize Shareholder wealth

Main Goal

AKA: maximize market value of the company or increase stock price

Shareholders are the owners of the company

Create value for the company’s owners

This means increasing the owners’ wealth

Ex: higher profit, paying dividends, and increasing the stock price

Increase the market value of the company’s assets

We can do this by increasing profits, reducing costs, investing wisely, and using assets efficiently

Five Principles that form the foundations of Finance

Cash flow matters

Money has Time Value

Risk Requires A Reward

Market Prices are right

Conflicts of Agency problems

Cash Flow Matters

Cash flow > profit when measuring company value

Cash flow is money the business can actually use

High cash flow is preferred

Money has Time Value

$1 today is worth more than $1 later

You can invest today’s money and earn interest

Receive money sooner; pay money later

Risk Require A Reward

More risk = higher expected return

Investors want compensation for taking risks

Market Prices are Right

Market price reflect publicly available information

Efficient market = fair price

Conflicts of Agency Problems

Happens when managers’ interests conflict with shareholders’ interests

Ex: expensive company car, luxury office, unnecessary bonuses

Legal forms of Business Organization

Sole Proprietorship

Partnership

Corporation

LLC

Cooperative

Sole Proprietorship Characteristics

Owns and manages the business

Assumes all the risk

Receives all the profits and losses

Responsible for success or failure

Sole Proprietorship Pros

Simple

Freedom

All profits belong to owner

Flexible

Sole Proprietorship Cons

Responsibilities

Personally Iiable

Limited capital

Smaller size

Difficult to compete

Insufficient time & management skills

Poor continuity

Partnership

A partnership is an association of 2 or more people share ownership

Limited Partnership

At least one general partner

Limited partners usually cannot manage

Limited partners’ liability is limited to their investment

General partners may have personal liability

General Partnership

Partners share:

profits and losses

property/ control

management

Partnership Pros

Cheaper/ easier than a corporation

Less paperwork

Freedom

Flexibility

Partnership Cons

Unlimited liability

Any partner can act for the partnership

Joint and Several liability

Poor continuity

Corporations

is a separate legal entity from its owners

Own property

Borrow money

Enter contracts

Sue and be sued

Shareholders → Directors → Officers

Corporations Pros

Limited liability

Pool resources

Large size

Specialized management

Easier credit

Continuity

Transferring ownership

Income taxes

Fringe benefits (vehicles, insurance)

Corporation Cons

Costly to form/ maintain

Legal advice

Meetings

Double taxation

LLC → Limited Liability Company

Resembles a partnership

Provides limited liability

Can have any number of members

Members’ ownership based on the fair market value of their contributions

Cooperatives

Limited liability

Income passes to members before taxation

Members can receive tax-deductible benefits

Remaining income is distributed as patronage refunds

Each member gets a one vote

Life Cycle of an Operation

Entry → Growth → Consolidation → Exit

Entry

Choose farming as a career

Select enterprises

Acquire resources

Establish financial base

Growth

Expand

Purchase/ lease more land

Increase livestock

Merge with another operator

Consolidation

Reduce debt

Increase efficiency rather than size

Plan for the next generation

Exit

Consider taxes and retirement

Treat children equitably

Transfer property

Possibly liquidate the business

Reduce risk

Income Statement

Shows the firm’s performance over a period of time

Revenue

Money from sales

COGS

Cost of goods sold

Operating Expenses

Marketing, distribution, and administration

Financing Cost

Interest and preferred dividends

Tax Expense

Taxes owned

Income Statement Layout

Sales

less COGS

= Gross Profit

less Operating Expenses

= Operating Income

less Interest Expense

=Earning Before Taxes

less Income Taxes

=Net Income

Balance Sheet

A snapshot of the firm’s financial position on a specific date