Chapter 1 Summary

1. What is Corporate Finance?

Corporate Finance is the area of finance that deals with how businesses:

1. Raise money (funding their operations)

2. Invest money (deciding what projects/assets to invest in)

3. Manage cash flow (ensuring the company runs smoothly)

Goal of Corporate Finance:
✅ Maximize Shareholder Value → This means increasing the price of company shares.

📌 Example: Apple issues bonds (borrows money) to fund R&D for new iPhones.

🔹 2. Types of Business Organizations

1. Sole Proprietorship (1 Owner)

📌 Key Features:
✅ Easiest and cheapest to start
✅ No corporate taxes (income taxed as personal income)
❌ Unlimited liability (owner’s personal assets can be taken if business fails)
❌ Difficult to raise money (funding is limited to owner’s savings, family, and banks)
❌ Limited life (business dies with owner)

📍 Examples:

• Small grocery stores

• Local tax services

• Freelancers (photographers, consultants)

2. Partnership (2+ Owners)

📌 Key Features:

Pros:
✅ Easy to form (oral or written agreement)
✅ More capital available than sole proprietorships
✅ No corporate taxes (profits taxed as personal income)

Cons:
❌ Unlimited liability for general partners
❌ Limited life (ends if a partner leaves)
❌ Hard to transfer ownership

Types of Partnerships:

• General Partnership → All partners share liability and manage the business.

• Limited Partnership → At least one general partner (with unlimited liability) and limited partners (who only provide money and have no control over business decisions).

📍 Examples:

• Investment banks (Goldman Sachs was once a partnership)

• Law firms

• Medical practices

3. Corporation (Legal Entity Separate from Owners)

📌 Key Features:

Pros:
✅ Limited liability (owners not personally responsible for company debts)
✅ Unlimited life (business continues even if owners change)
✅ Easier to raise money (can issue stocks & bonds)
✅ Easy transfer of ownership (buy/sell shares on stock market)

Cons:
❌ Double taxation (corporation pays taxes + shareholders pay taxes on dividends)
❌ Expensive to start (legal & administrative costs)

📍 Examples:

• Apple, Tesla, Amazon

💡 Corporation Structure:

1. Shareholders → Own the company & vote for the Board of Directors

2. Board of Directors → Appoints CEO & senior management

3. CEO & CFO → Manage daily operations and finance

4. Limited Liability Company (LLC) – Hybrid

📌 Key Features:

Pros:
✅ Limited liability like a corporation
✅ No double taxation (taxed like a partnership)
✅ More flexibility than a corporation

Cons:
❌ Ownership transfers can be complicated

📍 Example: Small law firms, medical practices

🔹 3. Role of a Financial Manager

The Chief Financial Officer (CFO) makes major financial decisions:

1⃣ Financing Decision – Where to get money?

• Borrowing (Debt) 💰 → Bank loans, bonds

• Selling Ownership (Equity) 📈 → Issuing stocks

2⃣ Investment Decision (Capital Budgeting) – Where to spend money?

• Buy new equipment? Expand into new markets?

3⃣ Cash Flow & Payout Decision – What to do with profits?

• Reinvest into company?

• Pay dividends to shareholders?

📌 Example: Tesla CFO decides whether to borrow money or issue stock to fund a new factory.

🔹 4. Corporate Goals

🚀 Maximizing Shareholder Value (stock price) is the primary goal!

❌ Why NOT Just Maximize Profits?

• Profits ≠ Stock Price Growth

• Cutting costs too much (e.g., no R&D) can hurt future growth

• Profit manipulation is possible (e.g., using accounting tricks)

📌 Example: Amazon focused on growth, not profits, for years → Stock price skyrocketed!

🔹 5. The Agency Problem (Conflict of Interest)

👥 Agency Relationship = Owners (Shareholders) hire Managers (Executives) to run the company.
Problem: Managers may act in their own interest rather than the company’s interest.

📌 Examples of Agency Problems:

• CEO buys a private jet instead of reinvesting in company growth ✈

• Manager avoids risky projects to keep their job, even if risks could benefit shareholders

✅ Solutions:
✔ Stock-based compensation (Executives get company shares → want stock to go up)
✔ Strong Board of Directors (oversees management)
✔ Threat of Takeovers (if company is mismanaged, investors can buy it & fire executives)

📌 Example: Tesla CEO Elon Musk owns a lot of Tesla shares → His wealth depends on Tesla's stock price!

🔹 6. Financial Markets & Institutions

🔹 Financial Institutions – Connect investors & borrowers.
🔹 Financial Markets – Where financial assets are traded.

Primary Market – Where companies sell securities for the first time (IPO).
📍 Example: Facebook issued stock in 2012 in an IPO (Initial Public Offering).

Secondary Market – Where existing stocks/bonds are traded.
📍 Example: NYSE (New York Stock Exchange)

💡 Stock Exchanges:

• NYSE → Physical trading floor

• NASDAQ → Electronic exchange

• OTC Market → Direct stock trading

🔹 7. Important Regulations

📌 The Securities Act of 1933

• Companies must provide financial statements before selling stocks.

📌 The Securities Exchange Act of 1934

• Created SEC (Securities and Exchange Commission) to regulate stock markets.

📌 Sarbanes-Oxley Act (2002) – “Sarbox”

• Passed after Enron & WorldCom scandals.

• Requires CEOs/CFOs to personally sign financial reports.

💡 EASY MEMORY TRICKS (For Exam Recall)

1. Business Types:

   • SPC → Sole Proprietorship, Partnership, Corporation

   • LLC → Limited Liability Company

2. Finance Manager’s Job (R-I-G-H-T)

   • Raise capital

   • Invest wisely

   • Generate profits

   • Handle cash flow

   • Transfer value to shareholders

3. Stock Markets (P-S-N)

   • Primary Market → IPOs

   • Secondary Market → NYSE, NASDAQ

   • New Investors Buy in Secondary Market

🎯 Summary – What You Must Know for A+

• Goal of Finance = Maximize shareholder value 📈

• Business Structures = Sole Proprietorship, Partnership, Corporation 🏢

• Financial Manager’s Role = Raise, Invest, Manage Cash 💰

• Agency Problem = Executives vs. Shareholders 💼

• Financial Markets = IPOs (Primary), Stock Exchanges (Secondary) 📊

• Key Laws = 1933 & 1934 Acts, Sarbanes-Oxley ✅