Chapter 1. The Firm and the Financial manager
Finance is a body of concepts , theories and models dealing with the raising of capital or money or
funds, and the allocation of the funds by:
the individuals- Personal finance
the governments- public finance, and
businesses- Financial management of the firm.
“raising and delegation of capital”
Returns are not always favourable, and that’s why there is risk
I. Types of corporation:
a. Permanent entity, legally distinct from its owners who are called shareholder/ stockholders.
b. Confers limited liability to owners.
c. Initiation: prepare Articles of incorporation( purpose)
d. Incorporate under CBCA Canadian business corporation act or under provincial laws.
e. Resident of its jurisdiction: borrow, lend, sue or be sued in its own name
f. Two types:
i. Public: traded in the securities market, allows for easy raising financing and ask for
publicized detailed financial information in its annual reports.
ii. Private : Shares are owned by small group of managers and investors, not trade on
the stock market, do not raise money on stock market and does not require much
g. Board of directors- elected representative overseeing activities incl. Hiring of managers . It
ensures that management is acting in the shareholder’s best interest.
h. Legal separation of ownership and management.
i. The treasurer deals with financial activities.
a. Limited Liability
b. Ease of ownership
c. Flexibility in financing: Public company enjoys convenience of selling shares in the stock market
and raising funds, whereas private company finds it time consuming and subject to legal
a. Corporations pay tax on profits while shareholders pay taxes on dividend received ( double
taxation).Note that Owners and business are taxed separately in a corporation. This is called
double taxation: - Businesses pay tax on profits @ corporation tax rate
- Shareholders pay taxes on dividends @ personal tax rate
b. Public corporations cost time and money spent on the management of corporation’s legal
machinery. Pay the stock exchanges for listing their shares.
c. Need to comply with relevant corporate governance policies ( in the U.S, the Sarbanes- Oxley
d. No secrecy- Sharing of information with public.
2. Sole Proprietorships:
a. One person
b. Bear all cost and risk while enjoying all profits.
a. Ease of formation
b. Lack of regulations governing it.
a. Unlimited Liability
a. Partnership agreement sets out the rules for decision making, distribution of profits.
b. Partners pay personal income taxes on profits.Flow through entities like sole proprietorship
because business do not pay taxes on its own profit.
a. Unlimited Liability . “ know thy partner”
4. Hybrid forms of business organization
a. Limited Partnership, Limited Liability partnerships (LLPs). Both enjoy flow through entities,
with earnings taxed in the hands of the partners.
b. Limited Liability Corporations ( LLCs)
c. Professional Corporation (PC)-doctors, lawyers, accountants.
d. Income trust- investment fund legally known as mutual fund trust , who sells units to
investors to raise money to purchase shares and debt of operating business. ( unlike typical
funds, these invest in only one company)
II. The investment and financing decisions:
The financial manager has to determine:
- What capital investment projects to invest in ( capital budgeting decision). - How to pay for those assets( financing decision)
1. Investment decision ( capital Budgeting)
a. Identification of investment opportunities ( capital investment projects)
What and How much? Help the firm identify promising projects and decide how much to invest
in each project.
- Tangible assets: new pipeline etc.
- Intangible assets: Research and development (R&D), patents, trademarks.
Future cash flows are uncertain and attention must be paid on:
- Amounts of benefits ( cumulative returns)
- Timing of the benefits
- The risk associated with the future value produced by the asset ( riskier cashflows must be
discounted by higher discount rate)
Financial managers needs to calculate the value on the uncertain future cash inflows and find if the
value exceeds the cost, in which case it is profitable to invest in the project.
This requires teamwork with other departments. These decisions could be big or small in nature.
Objective is to find and make investments that are valuable in nature, i.e. they are worth more than
2. Financing Decision:
Decisions as to how to raise the money to pay for investments in real assets.
a. Debt financing- promise to pay back the investors’ cash plus fixed rate of interest ( must be repaid)
b. Equity financing- investors put up cash in exchange for a share of future profits.
Choice b/w the two is called capital structure decisions.
Capital: sources of long term financing
Raising capital: firm seeking to raise long term financing