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FIN111 Study Guide - Final Guide: Corporate Finance, Sole Proprietorship, Simple Explanation

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School
UOW
Department
Finance
Course
FIN111
Professor
Freda Hui

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Exam Study
Fin111 Exam Study
Financial Manager And The Company!
-The role of the financial manager make sure that the firm remains profitable by
generating cash flows so they do not fall into bankruptcy!
-The profits are also known as residual cash flows which can be reinvested into
the business or payed to the owners as a cash dividend!
-There are 3 main fundamental decisions in financial management which are…!
•Capital budgeting decision: Which productive assets should the company
purchase? How to finance the business, and what it does, day to day!
•Financing decision: How to raise funds? Debt or equity?!
•Working capital management decision: How to manage current assets and
current liabilities?!
-Three major types of business organisations!
•Sole trader!
•Partnership!
•Company!
-The goal of a company would be maximising shares (the value of their company)
as opposed to their profits —> this is because your responsibility is to make
money for the owners (shareholders)!
-Agency problems occur when there is a ‘divorce’ between what the owners want
and what the management want!
•The owners are called the principle and the management are called agents!
•Two of the main ways to resolve an agency conflict are to 1. hire a board of
directors to monitor decisions of the company and 2. is the ability to vote
controlling figures out () but 2 only happens when the majority shareholder or
the majority of shareholders decide that this is a necessary decision.!
Overview of Financial Markets, Institutions and Money!
-A simple explanation of the financial system is a combination of someone who
wants money and someone who wants money!
-It is composed of three things —> money, institutions and financial markets!
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-The roles of the financial system are…!
•To facilitate the flow of funds —> open your wallet and take out the money!
•To provide a mechanism to settle transactions —> pay your bill!
•To generate the disseminate information —> get a receipt!
•To provide the means to transfer and manage risk —> provide ways of dealing
with incentive problems goes under risk management!
-The flow of funds involves both SSU’s and DSU’s!
•An SSU is a supplier (surplus) of funds —> someone who keeps their savings in
a bank account!
•An DSU is a demander (deficit) of funds —> someone who wants to take out a
loan through the bank!
-Direct financing!
•The SSU directly lending to the DSU without an intermediary (such as a bank)!
-Indirect financing!
•Convert financial claims into indirect claims —> !
•Uses dealers, brokers!
•Banks use a combination of funds from SSU’s to loan out to DSU’s!
•The benefits of using a financial intermediation are…!
-Denomination divisibility —> pool all SSU’s together to make one big loan for
someone!
-Currency transformation —> digital transfers across different currencies!
-Maturity flexibility —> is flexible with when they are paid back loan!
-Credit risk diversification —> ‘don’t put all your eggs in one basket’, don’t put
all your money into one place!
-Liquidity —> take out however much money you need whenever you need it
for whoever long you need it!
-Types of Intermediaries!
•Commercial banks —> for a bank a loan is an asset (because they lend people
money which is theirs) while their liabilities are people deposits (because the
banks owes you money if you want it back)!
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•Nonbank Financial Corporations —> provide the same as a bank does but the
main difference is that they aren’t regulated the same way as banks!
-Building societies!
-Credit unions!
-Finance companies!
•Other Financial Institutions —> managed funds (self managed)!
•International organisations!
-Types of Financial Markets!
•Primary —> financial claims are sold by the DSU’s —> an example is initial
public offering (IPO)!
•Secondary —> previously issued financial claims are exchanged among
investors —> an example is anything after your IPO!
•Options market —> get the price now and pay later, don’t have to pay once you
know the price —> example is lay-by !
•Futures market —> bought part of it and keep paying it off, have to complete
transaction as you are already using product —> example is laptop loan!
•Money Markets —> highly liquid, their transaction is 12 months or less, !
-Money market instruments —>
•Capital Market —>
-Risks (three main risks) faced by financial institutions!
•Credit risk —> !
•Interest rate risk —>!
•Political risk —> if there is any political instability!
-Managing Risk!
•Diversification —> don’t only loan to one person or invest one one business!
•Credit analysis —> check reliability of DSU (borrowers)!
•Hedging —> !
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Document Summary

The role of the nancial manager make sure that the rm remains pro table by generating cash ows so they do not fall into bankruptcy. The pro ts are also known as residual cash ows which can be reinvested into the business or payed to the owners as a cash dividend. Three major types of business organisations: sole trader, partnership, company. The goal of a company would be maximising shares (the value of their company) as opposed to their pro ts > this is because your responsibility is to make money for the owners (shareholders) A simple explanation of the nancial system is a combination of someone who wants money and someone who wants money. It is composed of three things > money, institutions and nancial markets. Direct nancing: the ssu directly lending to the dsu without an intermediary (such as a bank)

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Related Questions

Competency

Design the steps to justify an information systeminitiative.

Scenario Information

BeGood Baking Supply is a small bakery supply company formed asa closely held corporation. The company supplies raw bakingmaterials, paper goods, and equipment to restaurants and bakeriesin three states in the upper mid-west. Most of its business,however, is located in a large metropolitan area. BeGood wants toincrease its presence in the region and serve five states. In fact,the owners of BeGood would like 75% of their business to come fromthroughout the region rather than the current metropolitan area. Inorder to do this, the owners understand they must diversifyofferings and lines of business.

Currently, BeGood has a phone center where customer orders aretaken; these orders are then sent to shipping where the order isfilled in its large warehouse and shipped within four days. BeGoodoutsources its shipping to a local trucking company. Once the orderships, all paperwork goes to the accounting department where it isentered into the accounting system. BeGood still uses the sameaccounting system it has used since the inception of the company.All aging of receivables and other analysis is done using Excelspreadsheets. Purchasing and tracking of inventory are done solelyby the warehouse manager. Invoices for inventory purchasing aresent to the accounting department when goods are received.

The owners at BeGood are wondering how they can utilize anonline presence and further automate its systems in order tofacilitate its growth and diversify its business. The owners mayalso like to expand into the retail business.

You have been hired as a full-time staff accountant at BeGoodBaking Supply and have been given the task of evaluating andrecommending a viable accounting information system for theaccounting and financial data of BeGood in order to facilitateexpansion and diversification. As you begin your research, yourealize that many departments are involved in the informationsystem, and communication is key.

BeGood Baking Supply is considering adding an automated orderingmodule to their current AIS system. As the accountant pushing forthis change, you are in charge of the analysis and presentation ofthe information and recommendation for the new system. Inperforming the analysis for your presentation, you have identifiedtwo possible modules that will fill the needs of the company. Bothmodules return a positive NPV.

Module Vendor A B
Useful Life 5 years 5 years
Acquisition Cost 300,000 250,000
Yearly Operating Costs 95,000 100,000
Yeaerly Benefits 205,000 150,000
Cost of Capital 10% 10%
Payback 1.5 years 2.5 years

Instructions

Your task is to present to management a proposal outlining youranalysis and recommendation of which system to purchase. Write aproposal to management outlining the decision-making process andthe system you recommend. Include in your proposal:

  1. The steps necessary in evaluating and recommending an AISmodule. Note: these are the steps you would take to educateyourself on the need for a new model, the options available, andthe choice of the best module.
  2. List of needs BeGood has with respect to this automatedordering module. Include present needs as well growth needs
  3. List of criteria you used in choosing a module. Includefinancial criteria, expansion and growth criteria, and currentneeds. Be sure to address internal control and audit needs.

Take a look at and read this article that discusses the cost of capital. What are your thoughts? Elaborate and Explain

Capital for a small business is simply money. It is the financing for the small business or the money used to operate and buy assets. Cost of capital is the cost of obtaining that money or financing for the small business. The cost of capital is also called the hurdle rate.

Should very small businesses even worry about their cost of capital? The answer to that is absolutely yes! Even very small businesses need money to operate and that money is going to cost something. Companies want that cost to be as low as possible.

What is Capital?

Capital is the money businesses use for financing their operations. The cost of capital is simply the rent, or interest rate, it costs the business to obtain financing. In order to understand cost of capital, you must first understand the concept of capital. Capital for very small businesses may just be the supplier credit they rely on. For larger businesses, capital may be the supplier credit and longer term debt or liabilities, which are the firm's liabilities.

If a company is public or takes on investors, then capital will also include equity capital or common stock. Other equity accounts will be retained earnings, paid-in capital, perhaps preferred stock.

Why is Capital Important?

In order to build new plants, buy new equipment, develop new products, and upgrade informationtechnology, businesses have to have money or capital. For every decision like this, a business owner or Chief Financial Officer (CFO) has to decide if the return on the investment is greater than the cost of capital or the cost of the money it takes to invest in the project.

Business owners do not usually invest in new projects unless the return on the capital they invest in these projects is greater than or at least equal to the cost of the capital they have to use to finance these projects. Cost of capital is the key to all business decisions.

What is the Cost of Capital?

A company's cost of capital is simply the cost of money the company uses for financing. If a company only uses current liabilities and long-term debt to finance its operations, then it uses debt and the cost of capital is usually the interest rate on that debt.

If a company is public and has investors, then cost of capital gets more complicated. If the company only uses funds provided by investors, then the cost of capital is the cost of equity. Usually, this type of company has debt but it also finances with equity financing or money that investors supply. In this case, the cost of capital is the cost of debt and the cost of equity.

The combination of debt and equity financing for a company is the company's capital structure.

What is Return on Capital?

Return on capital is the amount of profit you earn out of a business or project as compared to the amount of capital you invested. The key to cost of capital for a company is that a company's return on capital must always equal or exceed the cost of capital for any project in which the firm wants to invest. In other words, the company's investment rate of return (return on capital) must equal or exceed their financing rate of return (cost of capital) in order for the firm to be profitable.

What Composes the Cost of Capital

One component of the cost of capital is the cost of debt financing. For larger businesses, debt usually means large loans or bonds. For very small companies, the debt can mean trade credit. For either, the cost of debt is the interest rate the company pays on debt.

Another component of the cost of capital is the cost of equity financing if your company is a public company; in other words, if you have investors in your company who provide money in exchange for an ownership stake in the company.

There are several components of the cost of equity capital. First, there is the cost of retained earnings or the money that the company invests back into the company, instead of paying outdividends. Next, there is the cost of new common stock or stock that the company issues to raise money. Last, the company may even issue preferred stock to raise money.

For very small firms, the cost of capital may be much simpler. There are advantages and disadvantages to both debt and equity financing, including cost, that any business owner must consider before adding them to the capital structure of the company. Very small firms may just useshort term debt, in which case we have to establish a cost for this capital component.

The Company's Weighted Average Cost of Capital

Once the business owner understands the concepts of capital and cost of capital, the next step is to understand weighted average cost of capital. Each capital component is a certain percentage of the company's capital structure. In order to arrive at the true cost of capital for a business firm, the owner must multiply the percentage of the company's capital structure for each component by the cost of that component and sum them.

Summary of Cost of Capital

Before a company can engage in buying assets or obtaining financing for its operations, it must make some determination of its cost of capital -- what it really costs the firm for the money it has to have to for all its financing. That cost of financing must never exceed its return on capital. Here is a cost of capital video series that you may find helpful. It helps put the return on capital and cost of capital in real world terms for you.

Over the past few years, the number of start-up companies attracted to either doing business themselves in the cloud, or specifically creating applications for others to use in the cloud, has grown significantly. A few but very promising enterprises have launched applications in “container” technology, which enables companies, programmers, or other enterprises to both launch and run applications solely in the cloud. There is still a lot of room in this emerging marketplace, and you are diving in. The product you’ve developed has a unique angle to tap into the local-grown/local-made/local-paid movement that’s also growing larger every day. Your initial market is your own small city, which operates independently but which is linked economically and via public safety provision to another small city sitting directly across a river separating the two. Once you’ve been able to launch your company in your city, you plan to approach the “sister city” leaders, then the county, state, and eventually go national. It’s too soon now, but your future plans entail an IPO offering to accomplish all this. Eventually, you hope to be able to re-imagine your product to go global. You have big plans, are close to being tapped out financially and you now need to plan for additional investors. Address the following considerations as they apply to your product launch. Describe an agency relationship and how it may/will take shape for your small company. As the sole employee and investor in your startup, what agency conflicts might arise? Six months have transpired, and you’ve been able to add two employees. In this new arrangement, what agency disputes might now develop that need to be addressed, and how might you address them? What resources do you need to use or consider? Another three months have passed. You are now ready to expand to your sister city and you need more capital. You decide the wisest path is to sell some stock to outside investors, but you will maintain control over your company by holding onto the majority of the stock. In this new scenario, what type of agency conflict might occur? How can you address this in advance? The IPO was a success, and you have a robust number of shareholders. With board support, you determine it is time to hire a financial manager to help your firm achieve current goals and set new ones appropriate to the firm’s growth strategy. What professional strengths and skills will an individual seeking this position need to possess? Another consideration you feel you need to address at this point, now that your firm’s stock is publicly traded, is how to sustain the high ethical standards you’ve fostered thus far as you move into the firm’s future. What strategies can your management team implement to conduct your business with both personal and professional integrity? What steps can you take to ensure that ethical considerations for financial and other management decisions are embedded into the firm’s culture? Congratulations - you are now at Year One, and everything is moving along faster than you anticipated. While this is great, you are at the point where you need to raise additional capital from outside lenders. With this decision, what type of agency costs might the company incur? How might a lender mitigate any agency costs? Year Two rolls around. Your company has been able to expand beyond your local communities and into to localities and governments in half the counties of the state. The stakes are getting bigger and you welcome the idea of high-level input to ensure the company keeps growing and expanding. You cash out the majority of your stock and turn the company over to an elected board of directors. Neither you nor any other stockholders own a controlling interest (which is also the situation at most public companies). List six potential managerial behaviors the new board might take that could harm your company’s value, and what steps overall can put into place to avoid or mitigate these.