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ECN 320 (1)
Chapter 1-4

Chapters 1-4 Review

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Department
Economics
Course Code
ECN 320
Professor
Mercy Anselm

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Cody Brouwers February 3, 2010 1
Financial Economics
Chapter 1 Introduction to Corporate Finance
1.1 Corporate Finance and the Financial Manager
x Financial manager is concerned with 3 types of questions:
1. Capital Budgeting t Process of planning and managing investment in long-term assets.
2. Capital Structure t The mix of debt and equity maintained by the firm.
3. Working Capital Management t Wovv]vPvuvP]vPZ(]u[µvv
liabilities.
1.2 Forms of Business Organization
x Forms of business organization
x Sole Proprietorship t Owned by single individual.
x Partnership t Owned by two or more co-owners.
x Corporation t A distinct legal entity owned by one or more individuals or entities.
x Income Trust t A way to get around double taxation, trusts hold the debt and equity of
an underlying business and distribute the income generated to unit holders.
1.3 The Goal of Financial Management
x Goal of financial management is to maximize the current value per share of existing stock.
1.4 The Agency Problem and Control of the Corp.
x Agency problem t The possibility of conflicts of interest between shareholders and
management.
o Management usually has incentive to increase share value for 2 reasons:
Managerial compensation is usually linked to share value.
Job prospects improve with better performance.
x Corporate Governance t Rules for corporate organization and conduct that are usually laid out
ÇoPvo]lZKv]}dZ[Wv]}vWov}X
1.5 Financial Markets and the Corp.
x Cash flows between the firm and financial markets:
o Securities are issued (inflow)
o Firm invests in assets (outflow)
o Operations generate cash flow (inflow)
o Then cash is either:
Paid to government in form of taxes
Paid to shareholders and creditors in form of dividends and debt payments
Reinvested back into firm.
x Money Markets t Financial markets where short-term debt securities are bought and sold.
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Cody Brouwers February 3, 2010 2
x Capital Markets t Financial markets where long-term debt and equity securities are bought and
sold.
x Primary Markets t Corporations are the seller, the transaction raises capital for the firm.
x Secondary Market t One owner or creditor selling to another.
1.7 Trends in Financial Markets and Management
x Financial Engineering t Creation of new securities or financial processes.
x Derivative Securities t Options, futures, and other securities whose value derives from the price
of another, underlying asset.
x Regulatory Dialectic t The pressures financial institutions and regulatory bodies exert on each
other.
Chapter 2 Financial Statements, Taxes, and Cash Flow
2.1 The Balance Sheet
x Balance Sheet t Statement showing accounting values on a particular date.
x Liquidity t Refers to the speed and ease with which an asset can be converted into cash. Assets
on the balance sheet are listed in order of liquidity, meaning cash is always first. Highly liquid
assets are ones that can be converted to cash with as little price reduction as possible.
x Financial Leverage t DµZµ}(]v(]u[]oµµX
o The more debt (as a percentage of assets) means a higher degree of financial leverage.
o Debt acts as a lever that can magnify both gains and losses.
x Accountants use the historical price for book value to follow the principles of objectivity and
conservatism.
2.2 The Income Statement
x Income Statement t ^uvµuu]Ì]vP(]u[(}uv}À]}}(]uX
x Non-cash Items t Expenses charged against revenues that do not directly affect cash flow, such
as depreciation.
o A primary reason that accounting income differs from cash flow.
2.3 Cash Flow
x o LoEo
o L{o FzFzo
x Also called free cash flow, meaning cash free to be paid to shareholders
or creditors.
x Operating cash flow t ZPv(}u(]u[v}uoµ]v
activities.
{ Lqnu Ep F
x Capital Spending t Net amount from the cash spent on fixed assets
minus sales.
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Description
Cody Brouwers February 3, 2010 1 Financial Economics Chapter 1 Introduction to Corporate Finance 1.1 Corporate Finance and the Financial Manager N Financial manager is concerned with 3 types of questions: 1. Capital Budgeting J Process of planning and managing investment in long-term assets. 2. Capital Structure J The mix of debt and equity maintained by the firm. 3. Working Capital Management J 9oLL]L2LKL2]L2Z]K[Z LZZZL liabilities. 1.2 Forms of Business Organization N Forms of business organization N Sole Proprietorship J Owned by single individual. N Partnership J Owned by two or more co-owners. N Corporation J A distinct legal entity owned by one or more individuals or entities. N Income Trust J A way to get around double taxation, trusts hold the debt and equity of an underlying business and distribute the income generated to unit holders. 1.3 The Goal of Financial Management N Goal of financial management is to maximize the current value per share of existing stock. 1.4 The Agency Problem and Control of the Corp. N Agency problem J The possibility of conflicts of interest between shareholders and management. o Management usually has incentive to increase share value for 2 reasons: Managerial compensation is usually linked to share value. Job prospects improve with better performance. N Corporate Governance J Rules for corporate organization and conduct that are usually laid out o2LZo]lZKL]}@ ZZ[9LZ]}L9oL}: 1.5 Financial Markets and the Corp. N Cash flows between the firm and financial markets: o Securities are issued (inflow) o Firm invests in assets (outflow) o Operations generate cash flow (inflow) o Then cash is either: Paid to government in form of taxes Paid to shareholders and creditors in form of dividends and debt payments Reinvested back into firm. N Money Markets J Financial markets where short-term debt securities are bought and sold. www.notesolution.comCody Brouwers February 3, 2010 2 N Capital Markets J Financial markets where long-term debt and equity securities are bought and sold. N Primary Markets J Corporations are the seller, the transaction raises capital for the firm. N Secondary Market J One owner or creditor selling to another. 1.7 Trends in Financial Markets and Management N Financial Engineering J Creation of new securities or financial processes. N Derivative Securities J Options, futures, and other securities whose value derives from the price of another, underlying asset. N Regulatory Dialectic J The pressures financial institutions and regulatory bodies exert on each other. Chapter 2 Financial Statements, Taxes, and Cash Flow 2.1 The Balance Sheet N Balance Sheet J Statement showing accounting values on a particular date. N Liquidity J Refers to the speed and ease with which an asset can be converted into cash. Assets on the balance sheet are listed in order of liquidity, meaning cash is always first. Highly liquid assets are ones that can be converted to cash with as little price reduction as possible. N Financial Leverage J ,ZZZZ}]L]K[Z ]oZ : o The more debt
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