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Midterm

MGCR 341 FINANCE 1 Midterm Notes.pdf

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Department
Management Core
Course
MGCR 341
Professor
Greg N Gregoriou
Semester
Fall

Description
MGCR 341 FINANCE 1 Chapter 1: Introduction  Corporate Finance: financial management of assets and corporate financing decisions  The Financial Manager should maximize shareholder wealth and increase firm value by increasing the firm’s profits and share price o Shareholders are not involved in making business decisions but are represented by managers, employed by the corporation, to represent shareholder’s interest o Must be concerned with capital budgeting, capital structure and working capital management o Capital Budgeting: planning and managing a firm’s long-term investment, investment opportunities (must be worth more to the firm than they cost to acquire) o Capital Structure: mixture of short and long term debt and equity the firm uses to finance itself, i.e.: debt or equity, effect of mixture on risk, etc. o Working Capital Management: difference between a firm’s short term asset and its short term liabilities  Day-to-day activity of managing firm’s money to continue operations  Present day, firms are more competitive worldwide, and the stock markets are more volatile  Sole Proprietorship: owned by one person who assumes unlimited liability for debts o There is no distinction made between personal and business income, it is least regulated and easiest to start of the business organizations in Canada  Partnerships: two or more owners can form a partnership, where every partner assumes unlimited liability o General Partnership: a business organization where two or more owners share in the gains and losses of the partnership though each partner is liable for all the debts of the partnership  It is difficult to transfer ownership without dissolving it or if a general partner dies out o Limited Partnership: one or more general partners runs the business and has unlimited liability, and where the limited partners do not actively participate in the business  Limited partner’s liability is limited to the amount of cash each has contributed to the partnership  Corporation: legal entity separate and distinct from its owners, though it is more complicated to start o Articles of Incorporation: set of bylaws which must be prepared and contain: name of the corporation, business purpose, number of shares that can be issued, intended life of the corporation o Ownership is represented by shares of stock which can be transferred and may be of different classes o Consists of three sets of separate interests: 1) Shareholders, 2) Directors of the Board and 3) Corporation Officers  Shareholders control the corporation’s direction, policies, and activities by electing a board of directors which in turn selects top management  Have limited liability to the amount invested in shares o Advantages: limited liability, unlimited life, separation of ownership and management, transfer of ownership is easy, perpetual succession and easier to raise capitals o Disadvantages: corporate profit dividends are taxed twice at the corporate level and personal level when dividends are paid to shareholders  Business income trusts hold the debt and equity of a business which can hold stocks, debt and real estate of an underlying business  Goal of financial management is to make money for shareholders (maximize stock price, shareholder wealth) referring to long-run not short) o Can increase market share by lowering prices or relaxing credit terms, cannot cut costs by doing away with R&D o Goals fall into two categories: 1) Profitability or 2) Bankruptcy avoidance, stability and safety related to controlling risk  Two goals are contradictory, pursuit of profit involves risk  Agency Relationship: relation between shareholders and management, existing when stockholders hire an agent to represent their interests  Agency Problem: conflict of interest can exist between the stockholders and the managers  Agency Cost: an indirect (lost opportunity) or direct consequence (expenditure that benefits management but costs the stakeholders, expense of monitoring management actions) resulting from an agency problem  How managers act in the stockholders’ interests, o Are management goals aligned with stockholder goals?  Relates to the way managers are compensated, important incentive to act in the interests of stockholders  The first incentive is tied to financial performance and share value though committees within firms try to regulate compensation since SOX  SOX intends to protect investors from corporate abuses o Can managers be replaced if they do not pursue shareholder goals?  This issue relates to control of the firm, i.e.: better performers within the firm will get promoted (managers successful in pursuing stockholder goals will be in greater demand)  Control of the firm rests with stockholders by electing the board of directors (hire and fire management) o Firms that are poorly managed are more attractive acquisitions, avoiding takeover gives management incentives  Stakeholders of a Corporation: someone other than a stockholder who potentially has a claim on the cash flows of the firm o Will also try to exert control over the firm, which may be harmful to shareholders  Corporate Social Responsibility Investing (SRI) or Ethical Investing: good reputation as good corporate citizens with detailed policies on important social issues (Jantzi Social Index, XEN-TSX)  Financial managers create value try to buy assets that generate more cash than they cost by selling debt and equity to investors to raise money  Money markets provide short-term funds to corporations (maturities of <1 year) or treasury bills VS. capital markets are markets for long-term debt and stocks  Primary Market is the sale of securities by government and corporations VS. secondary market are where securities are bought and sold after the original sale o For primary markets, corporations engage in: 1) Public Offering and 2) Private Placement  When a public offering is underwritten an investment group purchases the shares from the firm and market them to the public  Third Market: involves trading exchange listed securities in OTC markets  Fourth Market: involves institution-to-institution trading without using the services of brokers  Proxy Fight: method used by stockholders to replace corporate management Chapter 5: Introduction to Time Value of Money  Compounding: process of accumulating interest in an investment over time to earn more interest ◦ Interest on Interest: interest earned on the reinvestment of previous interest payments ◦ Compound interest occurs when interest is earned on the principal and the reinvested amount VS. simple interest where interest is only earned on the principal  Discounting: to calculate the present value of some future amount using a discount rate, i.e.: interest rate t Future Value Factor = (1+r) Present Value Factor = 1/(1+r)t Chapter 6: Discounted Cash Flow Valuation  Annuity: a level stream of cash flows for a fixed period of time ◦ Annuity Due: an annuity for which the cash flows occur at the beginning of the period Annuity PV Factor = (1/r) x (1 – PV Factor)  Perpetuity: an annuity where the cash flow payments continue forever Perpetuity PV = Cash Flow Payments/r  Growing Perpetuity: a constant stream of cash flows without end that is expected to rise indefinitely PV = C/(r – g)  Growing Annuity: a finite number of growing annual cash flows PV = [C/(r – g)] x [1 – (1 + g/ 1 + r) ]  Stated Interest Rate or Quoted: interest rate expressed in terms of the interest payment made each period  Effective Annual Rate: interest rate expressed as if it were compounded once per year m EAR = [1 + (Quoted Rate/m)] – 1 ◦ For tricky EAR problems, such as a rate which is compounded semi-annually but payments are to be made monthly 1. Convert the initial Quoted Rate into an EAR 2. Convert that EAR into a monthly quoted rate by the following, Quoted Rate/m = (EAR + 1) 1/m– 1 3. Solve the rest of the problem with the newly derived quoted rate  Annual Percentage Rate: interest rate charged per year multiplied by the number of periods (much like the quoted rate above, used to solve EAR in the same fashion)  Continuous Compounding: an upper limit of EAR, i.e.: maximum EAR if compounding is done continuously EAR = e – 1 Chapter 7: Interest
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