Finance Chapter 1 (1.1-1.5) Midterm content

What is corporate finance?

How a business chooses to mange its money, funding, and investments to grow and make a profit. Should answer the following 3 questions

1. what long term investments or projects should a firm undertake

2. How should a firm raise money to pay these investments (debt, equity, or a mix)

3. How should the firm manage its day-to-day finances such as cash, inventory, and receivables

What is Capital Budgeting

The process of planning and managing a firms investments in. Long term assets

• look into investment opportunities that are worth more to the firm than what they cost

What is working capital?

Planning and managing the firms current assets and current liabilities

• deals with day to day activities

What is working capital?

Planning and managing the firms current assets and current liabilities

• deals with day to day activities

Sole Proprietorship

A business owned by a single individual

• easiest to start as its not heavily regulated

• Owner keeps all the profits

• Personal tax is applied

• Unlimited liability

• Not easy to transfer ownership or raise money

• Ownership and management are not separated

Partnership

A business formed by two or more co-owners

• easy to start as its is not heavily regulated

• Unlimited liability (unless you’re a limited partner)

• Not easy to transfer ownership or raise money

• Personal tax

• No separation from owner and management for general partners (unless you’re limited partner)

General Partnership

All partners share in gains or losses and all have unlimited liability for all partnerships debts

• partnership terminates when GP wishes to sell or dies

• Manage and own the business

Limited partnership

A limited partnership liability for business debts is limited to the amount contributed to the partnership

• they do not actively manage/participate in the business

• Their interest can be sold without dissolving partnership

Corporation

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

• is not easy to start and thus is heavily regulated

• Shareholders keep the profits

• Double taxation (corporate tax + personal tax)

• Limited liability

• Easy to transfer ownership via shares

• Easy to raise money

• Ownership and management are separated

Co-operative (Co-op)

An enterprise that is equally owned by its members who share the benefits of a Co-op based on how much they use the services

Consumer Co-op

Provide product or services to its members (i.e. retail co-op, housing etc)

Producer Co-op

Markets the goods and services produced by its members, and supplies products and services necessary to the members professional activity (i.e. Farmers)

Worker Co-op

Provides employment for its members.

Multi-stakeholder Co-op

Serves the needs of many different stakeholder groups such as employees, clients, and other interested parties (ex. Health, home care etc)

The goals of Financial Management:

1. Maximize current share value

2. Maximize Firm value

3. Maximize Shareholders wealth

Overall financial managers are acting in the best interest of the shareholders.

Agency Relationship

A principal delegates decisions to an agent who acts on the principal’s behalf

• common whenever we rely on someone else’s expertise

• In a corporation: shareholders → managers

Agency Problem

A problem can arise within an agency relationship when different interests are mixed with imperfect monitoring

• managers interests may differ from shareholders’ and they cannot perfectly observe/evaluate managerial decisions

Agency cost

The resulting cost in value to shareholders can’t be both

• direct: perks, misuse of firm resources, monitoring costs

• Indirect: value lost from distorted decisions or missed opportunities

Agency solutions

Align incentives

• managers are given a greater job prospects when they perform successfully

• Managers are given stock options

Monitor managers

• Board of directors oversea management

Money Markets Vs. Capital Markets

Money Markets: financial markets where short term debt securities are bought and sold (i.e. chartered banks, investment dealers, treasury bills)

• dealers market → dealers buy and sell things themselves at their own risk

Capital Markets: financial markets where long term debt and equity securities are bought and sold (i.e. Toronto stock exchange - TSX)

Primary Markets Vs. Secondary Markets

Primary Markets: refers to the original sale of securities by government and corporations

• typically conducted by investment dealers

• Financial institutions

Secondary Markets: trading conducted after the original sale - general public

The 2 kinds of secondary markets

• Auction markets: directly matches those who wish to sell with those who wish to buy (ex. TSX). Broker dealers play a more limited role.  

• Dealer markets: in this market most of the buying and selling is done by dealers on behalf of clients (ex. Agency trading), or for their own account after transacting with clients themselves (ex. principal trading)