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FIN 300
Sirajum Sarwar

Class 1 (Chapter 1 & 2) Corporate Finance - Specific field of finance that attempts to find the answers to the following 1. What long-term investments should the firm take on? - Investment decision Long term decision - Capital budgeting = process of planning and managing a firm’s investment in long term assets - Evaluating the size, timing and risk of future cash flows is essence of capital budgeting 2. Where will we get the long-term financing to pay for the investment? - Finance decision Long term decision - Capital structure = the mix of debt and equity maintained by the firm - What % goes to the creditor and what % goes to the shareholders - Flexibility in choosing structure 3. How will we manage the everyday financial activities of the firm? - Working capital management  Short term decision - Working capital= planning and managing the firm’s current assets and liabilities - # of activities all related to the firm’s receipt and disbursement of cash Financial Managers - Top financial manager = Chief Financial Officer (CFO) - Treasurer = oversees cash management, capital expenditures and financial planning. - Controller = oversees taxes, cost accounting, financial accounting and data processing Forms of Businesses - Sole proprietorship  Business owned by a single individual  PROS = simple to start with no regulations, keeps all profits  CONS = unlimited liability, business income taxed to personal income, limited ability to ↑ financing, difficult to transfer ownership - Partnership  Business formed by 2 or more co-owners  PROS = simple start with little regulation, keeps all profit, access to ↑ human & financial capital, limited partners have limited liability  CONS = general partners have unlimited liability, business income taxed to personal income, difficult to transfer ownership and possible disagreement over partnership - Corporations  Business created as a distinct legal entity owned by 1 or more individuals/entities  PROS = limited liability, unlimited life, transfer ownership easily, easier to ↑ capital  CONS = double taxation (income is taxed at the corporate rate and then dividends are taxed at the personal rate)  Separation of ownership and management o PRO = diversification b/c ↑brains = better ideas o CON = owners don’t know what is going on and managers may have different opinions Goal of the Firm - Only goal is to maximize shareholder’s wealth  ↑ profit = adding value to the firm = ↑ stock price = ↑ shareholder’s wealth  Maximize (1) shareholder’s wealth, (2) share price and (3) firm value  How? By maximizing the current value per share of existing stock  Non-profit corporations + firms’ with no stocks = maximize the market value of the owner’s equity Agency Problems and Cost - Agency relationship = stockholders (principals) hire managers (agents ) to run the company or act in their interest  B/c from the separation of management and ownership = agency relations b/w stockholders and managers & stockholders and creditors exists - Agency problem = conflicts of interest between the shareholders and the management of the firm  B/c from the separation of management and ownership = managers might try to maximize his own wealth, not the value per share of existing stocks - Agency cost = cost of the conflict of interests b/w shareholders and management  Indirect = (1) management’s tendency to forgo risky/expensive projects that could be justified from a risk-return standpoint and (2) is the value of what is lost due to missed opportunity o Ex. Forgone investments opportunities, excessive investment to ↑ the firm’s size may not necessarily ↑ value of the firm’s stock  Direct = the purchase of something for management that can’t be justified from a risk-return standpoint, 2 forms: o (1) corporate expenditures that benefits management but costs the shareholders: (a) managers hires ↑ staff not b/c they need them but b/c they want a big empire/more power, (b) ex. buying luxury corporate jet, (c) excessive management pay and unauthorized compensation (↑ share value b/c they have stocks of their own or to get promoted = ↑ salaries) o (2) Expenses arising from the need to monitor management action = monitoring costs, ex. Paying outside auditors to monitor management actions Financial Markets - market where securities are issued and traded - Market value/ capitalization = # of Shares Outstanding x Current Market price of the stock  The value of the company today and that is how you judge the company - Stock market vs. Fixed-income (Bond) market  Stock market = where investors go to trade (buy n sell) equity securities like c/s and derivatives, stock exchange = Nasdaq, TSX (Toronto Stock Exchange)  Bond market = where investors go to trade (buy n sell) debt securities, bonds. o Bonds are sold over-the-counter (OTC)- via dealer network as opposed to on a centralized place like stock market  Bonds are less risky compared to stocks - Firms can list on stock exchanges if they are sufficiently larger and widely-held - TSX requires a market value of $2 million and at least 300 shareholders with at least 100 shares each and other minimum levels - Money market or Capital market  Money market = financial markets where short term debt securities are bought and sold o Essentially IOUs (treasury bills) o Dealer market, buy n sell at their own risk, largest money market dealers = chartered banks and investment dealers (no physical location}  Capital market = financial markets where long term debt and equity securities are bought and sold o Ex. TSX is a capital market - Primary vs. Secondary markets  Primary market = original sale of securities by gov’t and corporations o Corporation is engaged in 2 types:  Public offerings = selling securities to general public o Underwriters buy n sell to public to gain profit o Registered with provincial authorities = OSC  Private placements = negotiated sale involving specific buyer o No underwriters and no need of OSC authority  Secondary market = where these securities are bought and sold after the original price o Dealer markets = dealer arrange the transaction  Dealer market in stocks and long term debt are called over-the-market (OTC) = electronically o Auction = buyers and sellers meet to exchange, like the stock market (physical location) dealer role is limited - Third and Fourth markets  Third markets = investors trading stocks without broker/dealer  Fourth market = trading of exchange-listed securities b/w institutions on a private over-the-counter computer network (without broker/dealer) - Financial Intermediaries/Institution  Act like intermediaries b/w investors (fund suppliers) and firms raising funds o Financial institutions includes chartered banks and other depository institutions (trust companies, credit unions, investment dealers, insurance companies, pension funds, and mutual funds  Indirect finance = (1) Funds are supplied to demanders through a financial intermediary. One example is a bank loan and (2) Earn interest on the spread between (a) loans and (b) deposits  Direct finance = (1) Funds are supplied to demanders directly from suppliers - with no financial intermediary. One example is a bond issue directly to the end bondholder and (2) Service fees (ex. bankers acceptance and stamping fees
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