fiance chapter 1

Finance and The Multinational Firm: The New Role Why Do Companies go abroad?

(companies go abroad because that is where the money is. Countries that are growing are China, India, Korea and Vietnam, Bangladesh) • U.S. firms are looking to international expansion to discover profits. For example, Coca-Cola earns over 80% of its profits from overseas sales. • In addition to US firms going abroad, we have also witnessed many foreign firms making their mark in the United States. For example, domination of auto industry by Honda, Toyota, and Nissan. Why Do Companies Go Abroad? • To increase revenues • To reduce expenses (land, labor, capital, raw material, taxes) • To lower governmental regulation standards (ex. environmental, labor) • To increase global exposure Risks/Challenges of Going Abroad • Country risk (changes in government regulations, unstable government, economic changes in foreign country) • Currency risk (fluctuations in exchange rates) • Cultural risk (differences in language, traditions, ethical standards, etc.)

Five PRINCIPLES THAT FORM THE FOUNDATIONS OF FINANCE Principle 1: Cash Flow Is What Matters Principle 2: Money Has a Time Value Principle 3: Risk Requires a Reward

Principle 1: Cash Flow Is What Matters in • profits can be manipulated, but cash corporations run on a accrual basis . That means they made a sale, but we do not know if that money is going to show up (they have counted income) • ex healthcare industry . The hospital only gets paid. Ideally on 60 days in reality , it might be a year and a half later until that bill gets paid until that money gets paid , you still have to pay your workers and that comes from cash, cash is what really counts). When we talk about should we invest in something it is not the profit from that project. It is what cash is going to come in, when is it going to come in, and how much more cash we get out of the project. Then, if we had done nothing, or something else incremental cash is the decision • Accounting profits are not equal to cash flows. It is possible for a firm to generate accounting profits but not have cash or to generate cash flows but not report accounting profits in the books. • Cash flow, and not profits, drive the value of a business. • We must determine incremental or marginal cash flows when making financial decisions. - Incremental cash flow is the difference between the projected cash flows if the project is selected, versus what they will be, if the project is not selected. Principle 2: Money Has a Time Value the dollar today is worth less tomorrow. It is better to have money today. than tomorrow, especially in a low interest rate environment, borrow as much as you can, because when you have to pay it back. It would be worthless • A dollar received today is worth more than a dollar received in the future. - Since we can earn interest on money received today, it is better to receive money sooner rather than later. Principle 2: Money Has a Time Value (cont.) • Opportunity Cost - It is the cost of making a choice in terms of next best alternative that must be foregone. - Example: By lending money to your friend at zero percent interest, there is an opportunity cost of 1% that could potentially be earned by depositing the money in a savings account in a bank. Principle 3: Risk Requires a Reward you are sitting here you are taking a risk by sitting here instead of doing something else you could have been doing. You are expecting a Reward your expecting to be hired for a better job . As a result of getting a degree if you are going to invest, they have to be a reason you have to get something for investing the fact that you're here, you are investing in something that means that you are delaying consumption. saving and investing is a delay in consumption you either can save, invest or consume not consuming means that you are saving it for something better. You want to be rewarded for putting it off • Investors will not take on additional risk unless they expect to be compensated with additional reward or return. • Investors expect to be compensated for "delaying consumption" and "taking on risk." - Thus, investors expect a return when they deposit their savings in a bank (ie, delay consumption) and they expect to earn a higher rate of return on stocks compared to a bank savings account (ie., take on risk). The greater the risk, the greater the reward The y intercept states that even if you do nothing, you get some reward and the minimum that you need is just for delaying consumption this is your basic inflation rate zero risk assumes that there is inflation and your money will start to deteriorate. The value of your money decays and you want to get a reward for that decay.

Shareholder wealth versus profit Maximization profit is measured by what?

Shareholder wealth versus profit Maximization profit is measured profit can be manipulated . If you're working in a Corporation (you can negotiate) . If you are buying a car and it is the tail end of the sales here . The buyer have more leverage to negotiate they are other non-cash expenses that are important , particularly real estate companies that have huge non-cash expenses. (Depreciation) . They have huge depreciation expenses that do not make money, but they make a profit because the non-cash expenses lower their income taxes example, oil and gas as well • Profit maximization goal is unclear about the time frame over which profits are to be measured. • It is easy to manipulate the profits through various accounting policies. • Profit maximization goal ignores risk and timing of cash flows. 59 . Financial crisis (due to reselling bad mortgages . The prophet and the risk was not connected to each other)

Sole Proprietorship Partnership (general Partnership and limited Partnership) Corporation S type corporations and LLC's

Sole Proprietorship • a Business owned by an individual • Owner maintains title to assets and profits . Because he holds the title to everything he must also absorb the loss • which means that he has Unlimited liability (if he goes broke them. That means if he goes broke in the business than the business isdead) (if he owes money, the creditors would go after him). Example, if he owns a restaurant and the restaurant is burned down any owes money creditors can go after his property) • Termination of the sole Proprietor occurs on owner's death or by the owner's choice, if the owner dies, the business die Partnership the difference between a partnership and the sole proprietorship is that the partnership has more than one owner. Partnership • is Two or more people come together as co-owners for the purpose of operating a business for profit. Partnership falls into two types, general partnership, and limited partnership General Partnership • : All partners are fully responsible for liabilities incurred by the partnership. • Gen. partners are like 2 sole proprietors, working together, and they are obligated to each other • if one partner is in debt the creaditor can go after the other • ex . If you also real estate and you can't pay your taxes. The credit will go after the other partner • Nelson, a partner, faulty condom even having the appearance of relating to the firm business, renders the remaining partner liable as well. The relationship among partners is dictated entirely by the partnership agreement, which may be an oral commitment or informal documents Limited Partnerships: • what ever money you put in. That is the limit. And because of that you can't make decisions. Theoretically , however, they have to be one general partner with unlimited liability (One or more partners can have limited liability, restricted to the amount of capital invested in the partnership. There must be at least one general partner with unlimited liability. Limited partners cannot participate in the management of the business and their names cannot appear in the name of the firm. (The downside, the partnership is that it is hard to get out. And if you want to sell in order to get out. You have to sell door. Blood upon the and you will sell at a discount) • limited partnership, is different from state to state Corporation • is a Legally functions separate and apart from its owners - Corporation can sue, be sued, purchase, sell, and own property and its personnel are subjected to criminal punishment for crimes. • The Owners (shareholders) dictate direction and policies of the corporation, oftentimes through elected board of directors. Run the shareholders/owners elected Board of Directors whose members in terms selects individuals to serve as corporate officers, including the company president, vice president, secretary and treasurer. • Ownership is reflected in common stock certificates each decimating the number of shares owned by its holders. The number of shares relative to the total number of shares outstanding determines the stockholder proportionate ownership in the business. • Shareholder's liability is restricted to amount of investment in company. • Life of corporation does not depend on the owners ... corporation continues to be run by managers after transfer of ownership through sale or inheritance. • Taxed separately • Benefits - Limited liability for all shareholders - Easy to transfer ownership - Easier to raise capital - Unlimited life (unless the firm goes through corporate restructuring such as mergers and bankruptcies) - the shareholders own a piece of the Corporation and they elect the board of directors as a shareholder, you have limited liability only about the money that you put in the life of the corporation does not depend on owner's and is run by managers - Drawbacks - No secrecy of information - May be delays in decision making - Greater regulation - Double taxation.-This occurs when Corporation, arms, a prophet, pays taxes on those profits (the first taxation warnings), and pays of those profits back to the shareholders in the form of dividends and then the shareholders pay personal income tax on those dividends (the second taxation)) double taxation is resolved by hybrid Organization such as S type corporations and LLC's Hybrid Organizations: S-Corporation and Limited Liability Companies (LLCs)-it treats corporations as if they were a partnership - Benefits • Limited liability • Taxed as partnership (no double taxation like corporations) - Limitations • Owners must be real people so cannot be used for a joint ventures between two corporations (and I believe needs to be about 50 people) • Limited Liability Companies (LLC) (every state has its own LLC laws) - Benefits • Has Limited liability • Taxed like a partnership - Limitations • Qualifications vary from state to state • Cannot appear like a corporation otherwise it will be taxed like one

Vertical Hierarchy structure

Vertical Hierarchy structure • they have many levels a flat hierarchy only have a few levels organic structure • one manager can be more flexible in different departments and can do more things • an example is a consulting firm when people have particular consulting expertise. They are let out the various departments within the organization • ex . You work for Main company . You can apply your skills to different departments and they can report to you, or you can report to them. • Organic structure. Are not true hierarchies Board of Directors • they represent the shareholders. They are elected by the shareowners • the board of directors hires the CEO and CFO and the C sweet (which is the chief financial officer, the chief executive officer,) the new CEO often brings his own management with him because he is more comfortable The Legal Forms of Business Organization • Part of the CEO job is to provide the vision for the company • the big part of the job is to get the president of marketing financing and operation to work together the controller • deals with taxes accounting and data processing the treasurer • is responsible for cash management credit capital expenditures and so on, also strategic planning

What is the Goal of the firm? Maximize shareholder wealth Is any moment in time a good time to measure shareholder wealth? When is the majority of trading done on the New York Stock Exchange?

What is the Goal of the firm? • The goal of the firm is to create value for the firm's legal owners (that is, its shareholders). Thus the goal of the firm is to "maximize shareholder wealth" by maximizing the price of the existing common stock. • Good financial decisions will increase stock price and poor financial decisions will lead to a decline in stock price. What is the Goal of the Mayor of NYC ? • Increase the amount of jobs in the city • If jobs are increasing, Then revenue for the city are in increasing if you are running a you use what is the goal for the union? • The goal for the union President is to increase the union membership because its power is based on how many people will vote with him. When he say go and vote for this person . How many people will go out and would that person.? Maximize shareholder wealth Is any moment in time a good time to measure shareholder wealth? • No, because there is something called emotional behavior versus rational behavior • It is the behavioral theory of fiancé where people react and don't always take everything into consideration that might be more obvious like the next day or futher along • so maximization of shareholder wealth is what the price ought to be at any one point in time , and is not always going to be perfectly reflected • generally speaking, good financial decisions will increase stock price and poor financial decision will lead to a decline. When is the majority of trading done on the New York Stock Exchange? (program stock exchange drive the stock market) • the majority of trading that is being done on the stock exchange is twice a day At the open and at the close 9:30am for a half an hr and 3:45 pm. This is important because the computers are running the stock exchange, they take last night close and they look and make decisions. And they wait until the end of the day and the computers kick in again. We have less and less impact on what stock prices are doing • so maximize shareholder wealth are true in the long run e but the min to min fluctuation are not a reflection of changes in shareholder wealth

see notes on inflation

see notes

The Role of Finance in Business

financing. • Is the study of how people in business evaluate investments and raise capital to fund them. They are Three basic issues addressed by the study of finance: • What long-term investments should the firm undertake? (Capital budgeting decision) (example may be building a factory, building software, starting new advertising program) • How should the firm raise money to fund these investments? (Capital structure decision) (a company may fund this by selling stock or bonds • How to manage cash flows arising from day-to-day operations? (Working capital decision) (in other words, how do you keep your company running, how do you keep paying your employees) • Knowledge of financial tools is relevant for decision making in all areas of business (be it marketing, production etc.) and also in managing personal finances. • Decisions involve an element of time and uncertainty ... financial tools help adjust for time and risk. (You have to think of it in terms of risk versus reward) . Example may be in terms of real estate example If the economy is bad, the decision would be, which property should you get rid of and which property should you keep Decisions taken in business should be financially viable ... financial tools help determine the financial viability of decisions

the benefit to maximize shareholder wealth are

the benefit to maximize shareholder wealth are • if you make good corporate decisions shareholders would be grateful for you because you have created wealth for them • from a society goal point of view society benefits from the maximization of shareholder wealth. • Society benefits because scarce resources are directed to the most profitable use by businesses competing to create wealth . One of the issues are globalization If some American company outsources some aspect of its business to another country and thereby it is cutting American cost Is that good for the world? • The issues is American lose their jobs so Americans have to adapt and learn the skills that are in demand • overall society benefits. If poor parts of the world can move up relative to where they had been and Some of the wealthier parts of the world • (basically you are better off then some of the other parts of the world , relatively speaking , so if society can benefit as a whole then it is a good thing) ppt • Good corporate decisions are those that create wealth for the shareholder. • Society benefits as scarce resources are directed to the most profitable use by businesses competing to create wealth.

Principle 5: Conflicts of Interest Cause Agency Problems Ethics & Trust in Business Discussion: The Current Global Financial Crisis • What led to the global financial crisis?

• The separation of management and the ownership of the firm creates an agency problem. - Managers may make decisions that are not consistent with the goal of maximizing shareholder wealth. - Agency conflict is reduced through monitoring (ex. annual reports), compensation schemes (ex. stock options), and market mechanisms (ex. takeovers) the issue here is the United States with operations as a corporate shareholder, you're not running the company. Somebody else is running the company you selected the Board of Directors and they hired a CEO that CEO hires VP (basically, if you own shares of a certain company. You have no say of how the company is run. People that have pension plans your money goes to certain companies and have no say on how it is run ) the agency problem is, you have people running the company on your behalf who may not know who you are or care. The managers may only want the company be run how you want it to be run if They are incentivize in order to do so. They will not on their own volition. Do the things you want them to do unless there are incitive to do so such as you pay them in shares and you give them options in order to approve the value of those shares , and your value goes up as well. What would management goals be if it did not matter The results? Management goals would be to minimize risk, just so they can hang onto their jobs. the point is, if management about-these of the shareholders. They will do whatever they can do in order to minimize risk and not get fired. Example is government jobs. They do not get a reward in order to do a terrific job in agency problem • problems, and conflict result from the separation of the management and ownership of the firm (conflict of interests leads the agency problem) Discussion: The Current Global Financial Crisis • What led to the global financial crisis? The immediate cause of the financial crisis attributed to the collapse of the real estate market in the United States and the resulting real estate loan (mortgages). Defaults. The focus of the loan defaults has been on what are commonly referred to as subprime loans. • People were lending money to people who should not have been lending to. What do we mean by subprime loans? • Subprime loans are loans made to borrowers whose ability to repay them is highly doubtful • How are mortgages securitized? They clump the good and bad mortages and sold them to people who needed income and mortagegs got sold to people who couldn't pay it and the mortage didn't got defaulted • How can the financial crisis be explained by using the five principles of finance? • Pg9 Ethics & Trust in Business • Ethical behavior is doing the right thing! ... but what is the right thing? • Ethical dilemma -- Each person has his or her own set of values, which forms the basis for personal judgments about what is the right thing. • Sound ethical standards are important for business and personal success. Unethical decisions can destroy shareholder wealth (ex. Enron scandal, Bernie Madoff).

The Role of the Financial Manager

• the vice president for finance, also called the chief financial officer, (CFO) serves on the firm's chief executive officer (CEO) and is responsible for overseeing financial planning, strategy, planning, and controlling the firm cash flow. Typically, a treasure that control is served under the CFO. The treacherous generally handles the firm financial activities, including cash and credit management, making capital expenditures decisions, raising funds, financial planning and management of any foreign currency received by the firm. The control is responsible for managing the firm accounting duties, including producing financial statements, cost accounting, paying taxes, and gathering and monitoring the data necessary to oversee the firm's financial well-being.