day 1

Framework and terminology

  • Finance terms can be ambiguous; focus on underlying concepts rather than specific wording.

  • The primary goal of large firms is to maximize the long-run intrinsic value of equity, not just short-run profits.

Potential GDP and the business cycle

  • Potential GDP represents the long-run growth trend around which the economy naturally fluctuates.

Valuation framework: intrinsic value vs market price

  • Intrinsic value is a security's rational assessment using all available information.

  • Market price is the current trading price, which may differ from intrinsic value due to information gaps.

  • Minimizing uncertainty through better information is crucial in finance.

Long-run value optimization and project selection

  • Decisions should maximize the long-run intrinsic value of equity for shareholders.

  • Firms should undertake a project if its expected return (e.g., 7\%) exceeds the shareholders' alternative opportunity cost (e.g., 5\%).

  • If the opportunity cost is higher (e.g., 9\%), profits should be returned to shareholders.

Key ratios, rates, and numerical references (illustrative)

  • Project yields: 7\% vs 5\% opportunity cost.

  • Alternative opportunity cost: 9\%.

  • Example stock valuation: NVIDIA intrinsic value 250 vs market price 2.70 (illustrative of mispricing).

  • Proprietorships : approximately \dfrac{3}{4} of entities, but generate about 21\% of economic activity.

  • S corporations: limited to 100 investors.

Capital structure: debt vs. equity

  • Debt market: Largest source of financing (bonds are IOUs) for firms and households.

  • Equity financing: Supports growth through reinvestment and provides capital for expansion.

  • Smaller firms often use bank loans; larger firms can issue bonds.

  • Choice involves trade-offs: risk, control, dilution, and growth.

Fiduciary duty, risk, and information

  • Fiduciary duty requires decision-making in shareholders' best interests, using available information.

  • Poor outcomes aren't always fraud; they can stem from imperfect information and ex ante risk. Ethical considerations should align with customer values and long-run profitability.

Principal-agent problem: ownership vs. control

  • Conflicts arise when managers (agents) pursue personal goals over shareholder (principals) value.

  • Performance-based compensation and board oversight (e.g., pension funds) help align incentives.

Ownership, governance, and market structure

  • Business organization impacts liability, taxes, funding, and governance.

  • Key concepts: principal-agent dynamics, board oversight, and potential conflicts between shareholders and bondholders.

Forms of business organization and their pros/cons

  • Sole proprietorships:

    • Easy to form, low regulation.

    • Unlimited personal liability, broader risk exposure.

  • Partnerships (general, professional):

    • Easy for service professions.

    • Joint liability (unless limited liability structures).

  • Limited liability partnerships (LLP) and companies (LLC):

    • Hybrid structures offering liability protection and flexible tax/governance.

  • Corporations (C corporations):

    • Limited liability (personal assets protected).

    • Easy ownership transfer, facilitated large-scale financing.

    • Double taxation (corporate profits taxed, then dividends taxed).

  • S corporations:

    • Liability protection, cap of 100 investors.

    • Pass-through taxation (profits taxed only at shareholder level).

    • More restricted ownership transfer than C-corps.

  • Tax and regulatory considerations vary by form, impacting liability, financing, and growth.

Financing, leverage, and incentives in practice

  • Lenders often require a significant stake (e.g., down payment) from borrowers to ensure commitment and reduce risk.

Regulation, risk, and practical implications

  • Regulation varies by industry, form, and scale (e.g., higher for manufacturing).

  • Limited liability may reduce profitability due to risk management or governance constraints.

  • Selling a business can be more complex in partnerships/LLCs than selling shares in a public corporation.

Real-world implications and takeaways

  • Fiduciary duty means acting honestly and informed for clients and shareholders.

  • Integrate client values (e.g., green energy) if they align with long-run profitability.

  • Governance must align management incentives with long-run shareholder value.

  • Business forms have trade-offs in liability, taxation, and capital access; understanding these helps explain diverse business structures.