Chapter 1 Corporate Finance Flashcards

Learning Objectives

• Define the basic types of financial management decisions and the role of the financial manager.
• Explain the goal of financial management.
• Articulate the financial implications of different forms of business organization.
• Explain the conflicts of interest that can arise between managers and owners.

Chapter Outline

• Overview of finance.
• The role of corporate finance and the financial manager.
• Different forms of business organization.
• The overarching goal of financial management.
• Understanding the agency problem and control of corporations.
• The interaction of financial markets with corporations.

Key Areas of Financial Management

• Corporate Finance: Focus of the textbook, answering three core questions:
  1. What long-term investments to undertake (business lines, required infrastructure)?
  2. How to finance those investments (equity vs. debt)?
  3. How to manage daily financial activities (collecting receivables, paying suppliers)?
• Career Paths in finance include: financial advisor, portfolio manager, security analyst.

The Financial Manager

• Role: Represents owners' (stockholders') interests in decision-making.
  • Top positions include Vice President of Finance and Chief Financial Officer (CFO).
• Key Financial Management Functions:
  • Treasurer: Manages cash, credit, and financial planning.
  • Controller: Handles accounting, tax payments, and financial systems.

Types of Financial Management Decisions

1. Capital Budgeting:
   • Planning and managing long-term investments.
   • Evaluating future cash flow size, timing, and risk.
2. Capital Structure:
   • Mix of debt and equity.
   • Decide how much to borrow and least expensive funds.
3. Working Capital Management:
   • Short-term assets and liabilities management.

Forms of Business Organization

1. Sole Proprietorship:

   • Owned by one individual.
   • Advantages: Easy to start, owner keeps profits.
   • Disadvantages: Unlimited liability, limited lifespan, difficult to transfer ownership.

2. Partnership:

   • Multiple owners, can be general or limited.
   • Advantages & Disadvantages similar to sole proprietorship with added complexities.

3. Corporation:

   • Distinct legal entity, separate from owners.
   • Advantages: Limited liability, unlimited lifespan, easy ownership transfer.
   • Disadvantage: Double taxation on profits.

Variations of Corporations

• Recognized globally as joint stock companies, public limited companies, etc.
• Benefit Corporations have additional requirements:
  • Accountability: Consideration of impacts on all stakeholders.
  • Transparency: Annual reporting on public benefit pursuits.
  • Purpose: Must provide a public benefit.

Goal of Financial Management

• Primarily aims to increase owners' value.
• Potential Financial Goals:
  • Profitability (sales, market share).
  • Risk control (stability, bankruptcy avoidance).
• The ultimate goal in for-profit firms is to maximize current stockholder value.

Agency Problems and Control

• Agency Relationship: Conflict between the interests of stockholders (principals) and management (agents).
• Agency Costs:
  • Direct: Costs related to conflict, e.g., unnecessary management expenditures.
  • Indirect: Lost opportunities from management choices.
• Management compensation often incentivizes alignment with stockholder interests.

Stakeholders

• Stakeholders include employees, customers, suppliers, and the government.
• A stakeholder has a claim on the firm's cash flows and can influence operations.

Financial Markets and Corporations

• Financial Markets: Facilitate buying/selling debt/equity securities.
  • Distinguish between primary (raising funds for corporations) and secondary (transferring ownership of securities) markets.

Types of Secondary Markets

• Dealer Markets: Trade done electronically (e.g., OTC markets).
• Auction Markets: Physical locations where buyers and sellers meet (e.g., NYSE).

Key Concept Questions

• Major areas in finance.
• Capital budgeting decisions and their implications.
• Description of the optimal long-term debt and equity mix (capital structure).
• Difference in fundraising capabilities of various business organizations.
• The nature of agency problems and costs.
• Distinctions between dealer and auction markets.