Chapter 1 - Corporate Finance

What is a Limited Liability Company (LLC)?

The goal of this entity is to operate and be taxed like a partnership but retain limited liability for owners, so an LLC is essentially a hybrid of partnership and corporation.

What do you call the specific mixture of long-term debt and equity that a firm chooses to use?

A firm's capital structure (or financial structure) is the specific mixture of long-term debt and owners equity the firm uses to finance its operations. The financial manager has two concerns in this area. First, how much should the firm borrow? That is, what mixture of debt and equity is best? The mixture chosen will affect both the risk and the value of the firm. Second, what are the least expensive sources of funds for the firm

What is the capital budgeting decision?

Capital budgeting: planning and managing of a firm's long term investments. In capital budgeting, the financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire. For example, for a large retailer such as Walmart, deciding whether to open another store would be an important capital budgeting decision. Financial managers must be concerned not only with how much cash they expect to receive, but also with when they expect to receive it and how likely they are to receive it. Evaluating the size, timing, and risk of future cash flows is the essence of capital budgeting.

What is the disadvantage of having a large corporation?

If a corporation needs new equity, for example, it can sell new shares of stock and attract new investors. Apple is an example. The company was a pioneer in the personal computer business. As demand for its products exploded, it had to convert to the corporate form of organization to raise the capital needed to fund growth and new product development.

How are the board of directors and managers of a corporation chosen/elected?

In a large corporation, the stockholders and the managers are usually separate groups. The stockholders elect the board of directors, who then select the managers. Managers are charged with running the corporation's affairs in the stockholders' interests. In principle, stockholders control the corporation because they elect the directors.

A firm's Capital Structure (financial structure) Continued...

In addition to deciding on the financing mix, the financial manager has to decide exactly how and where to raise the money. The expenses associated with raising long-term financing can be considerable, so different possibilities must be carefully evaluated. Also, corporations borrow money from a variety of lenders in a number of different, and sometimes exotic, ways. Choosing among lenders and among loan types is another job handled by the financial manager

Goals of Financial Management

Survive. Avoid financial distress and bankruptcy. Beat the competition. Maximize sales or market share. Minimize costs. Maximize profits. Maintain steady earnings growth. The goal of financial management is to maximize the current value per share of the existing stock

True or False? managers who are successful in pursuing stockholder goals will be in greater demand in the labor market and thus command higher salaries.

TRUE!

True or False? The total value of the stock in a corporation is simply equal to the value of the owners' equity.

TRUE! Yes, a more general way of stating our goal is as follows: Maximize the market value of the existing owners' equity.

Relationship between stockholder and management: Agency Relationships and agency problems

The relationship between stockholders and management is called an agency relationship. Such a relationship exists whenever someone (the principal) hires another (the agent) to represent his or her interests. For example, you might hire someone (an agent) to sell a car you own while you are away at school. In all such relationships, there is a possibility of conflict of interest between the principal and the agent. Such a conflict is called an agency problem.

Why are large corporations better at raising cash?

The relative ease of transferring ownership, the limited liability for business debts, and the unlimited life of the business are why the corporate form is superior for raising cash. If a corporation needs new equity, for example, it can sell new shares of stock and attract new investors. *Apple is an example. The company was a pioneer in the personal computer business. As demand for its products exploded, it had to convert to the corporate form of organization to raise the capital needed to fund growth and new product development.

True or False? The vice president of finance coordinates the activities of the treasurer and the controller. The controller's office handles cost and financial accounting, tax payments, and management information systems. The treasurer's office is responsible for managing the firm's cash and credit, its financial planning, and its capital expenditures.

True

Agency cost: the costs of the conflict of interest between stockholders and management. These costs can be indirect or direct. An indirect agency cost is a lost opportunity

imagine that the firm is considering a new investment. The new investment is expected to favorably impact the share value, but it is also a relatively risky venture. The owners of the firm will wish to take the investment (because the stock value will rise), but management may not because there is the possibility that things will turn out badly and management jobs will be lost. If management does not take the investment, then the stockholders may lose a valuable opportunity. This is one example of an agency cost.

Management goals

management may tend to overemphasize organizational survival to protect job security. Also, management may dislike outside interference, so independence and corporate self-sufficiency may be important goals.

Working Capital

working capital refers to a firm's short-term assets, such as inventory, and its short-term liabilities, such as money owed to suppliers. Managing the firm's working capital is a day-to-day activity that ensures that the firm has sufficient resources to continue its operations and avoid costly interruptions.