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Chapter 1

comm 121- Chapter 1 and Chapter 4 Notes.docx

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Department
Commerce
Course
COMM 121
Professor
Fabio Moneta
Semester
Fall

Description
Chapter 1  Goal of firm is to maximize value of SH wealth Firm must create wealth: 1) Buy assets that generate more money than they cost 2) Sell securities that generate more money than they cost Three objectives of Finance 1) What should we invest in?  Capital Budgeting 2) How should we make these investments?  Capital Structure 3) How should we manage short term operational cash flows?  Net working capital = current assets – current liabilities Balance Sheet Model of Firm Total Value of Assets Total Value of Firm to Investors Current Assets Current Liabilities Assets with short lives Short-term debt that must be repaid within a year Long-Lived Assets Long-Term Debt Assets with long lives Long-term debt that does not have to be Tangible or intangible repaid within a year *In order to purchase long-lived Shareholders’ Equity assets, firm must obtain financing Difference between assets and debt Capital Structure Creditor: person/institution that buys debt from firm (B) Shareholder: holder of equity shares (S) The size of the firm is value of firm as determined by financial markets  V = B + S Capital Budgeting Process of making and managing expenditures of long-lived assets Important variable: cash flow to firm, NOT shareholders Two Important Considerations in Finance 1) Timing of cash flows - The value of investment depends on timing of cash flows - Prefer to receive sooner 2) Risk of cash flows - Important to consider Debt and Equity as Contingent Claims If value of firm is greater than or equal to F, debtholders get F If value of firm is less than F, debtholders get X Shareholders’ claim on value of firm is residual amount after debtholders have been paid  if value of firm is less than amount promised to debtholders, SH get nothing If value of firm is greater than amount promised to debtholders, SH get residual amount If value of firm is less than amount promised to debtholders, SH get nothing and debtholders get value of firm Corporation - Distinct legal entity - Three sets of distinct interests: SH, Board of Directors, corporate officers - Agency costs  cost of resolving conflicts of interest between SH and management - Set-of-contracts perspective  firm can be seen as nothing more than set of contracts - Principle-agent relationship  management (agent) is responsible for managing firm in best interest of principles (SH) - Advantages: 1) Ownership through shares  easily transferable 2) Unlimited lives  corporation separat
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