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.