251 Week 2 Lecture 1

1. Unlimited Liability:

   • Sole Trader: Owners have unlimited liability; all personal assets at risk.

   • Limited Partnership: General partners have unlimited liability; limited partners have liability capped to their investment.

   • Company Forms: Differences between private (not traded publicly) and public companies (traded on stock exchanges).

2. Advantages and Disadvantages of Sole Trader:

   • Advantages: Easily set up a business with minimal registration requirements.

   • Disadvantages: Ownership transfer is complex, lack of talent attraction, and owners face unlimited liability.

   • Key Characteristics: Easy setup and limited potential for attracting skilled employees.

Corporate Management Goals

• Goal Definition: Identify appropriate goals for management.

  • Options:

    • Maximizing market share vs maximizing market value of the shares.

    • Current profits vs maximizing shareholder value.

• Strategic Focus: Major goal should center on maximizing the market value as it benefits shareholders directly unlike mere market share goals.

Residual Cash Flow Concept

• Definition: The cash leftover after meeting operating expenses, creditor payments, and taxes; belongs to the shareholders (termed as residual claim).

• Shareholders’ Position: They hold the last claim on business assets after all obligations are met, emphasizing the appeal of potential high returns due to associated risks.

Financial Market Types

• Equity & Debt Instruments: Traded in capital markets (long-term) vs money markets (short-term).

  • Capital Markets: Comprised of debt and equity markets; examples include stock exchanges.

  • Money Markets: Known for liquidity and large volumes; increasingly accessible to individual investors for diversification.

Learning Objectives for Time Value of Money

1. Defining Assets: Understanding how assets are related to cash flows they generate.

2. Understanding TVM: Distinct definitions of money’s value over time to aid in investment decision-making.

3. Future and Present Value Calculations: Fundamental techniques for assessing cash flow values over time.

Concept of Assets

• Definition in Finance: An asset is anything that brings potential value or cash inflows.

  • Types:

    • Physical Assets: Tangible like homes or equipment.

    • Intangible Assets: Non-physical but valuable like patents and goodwill.

    • Financial Assets: Instruments yielding cash flows, e.g., stocks and bonds.

• Common Attribute: All asset types can generate future cash flows, thus classified under finance as stream of future expected cash flows.

Cash Flow Attributes Defining Asset Value

1. Size: Importance varies; larger expected inflows usually imply higher value.

2. Timing: When cash flows are received affects their value, necessitating assessment of present vs future cash flows.

3. Riskiness: Assessment of cash flow risk, affecting potential returns and thus value.

Valuation Techniques

• Discounting and Compounding: Two key processes for determining present and future values:

  • Discounting: Converting future cash flows to present value, vital for assessing asset values today.

  • Compounding: Involves calculating future value from present cash.

• Discounted Cash Flow (DCF): Applied widely for asset evaluation by summing the present values of all future cash flows.

  • Critical Understanding: Knowing today's present value of future cash flows is essential for strategic financial decision-making.

Wrap-Up and Next Lesson Preview

• Conclusion on Asset Value: An asset's value today is comprised of the present value of all future expected cash flows.

• Next Steps: Tomorrow’s lecture will dive deeper into specific examples of applying these concepts.