FIN301 Chapter-1

What is CORPORATE FINANCE?

Corporate finance is the area of finance dealing with the sources of
funding and the capital structure of corporations and the actions that
managers take to increase the value of the firm to the shareholders, as well
as the tools and analysis used to allocate financial resources.
It addresses the following questions1. What long-term investments should the firm engage in? (Capital
Budgeting)
2. How can the firm raise the money for the required investments?
(Capital Structure)
3. How much short-term cash flow does a company need to pay its bills?
(Net Working Capital)
What is CAPITAL BUDGETING?
The term capital budgeting is used to describe the process of making and
managing expenditures on long-lived assets.
What is CAPITAL STRUCTURE?
Capital structure represents the portions of the firms financing from current
and long-term debt and equity.
What is NET WORKING CAPITAL?
There is often a mismatch between the timing of cash inflows and cash
outflows during operating activities. Financial managers attempt to manage
the gaps in cash flow in the short-run with a firms net working capital. Net
Working Capital is defined as current assets minus current liabilities.
What is SOLE PROPRIETORSHIP?
A Sole Proprietorship is a simple type of business structure that is owned and
operated by the same person. It does not involve many of the complex filing
requirements associated with other types of business structures such
as corporations.
1.
2.
3.
4.
5.

It is the cheapest business to form.

Pays no corporate income taxes.
Unlimited liability for business debts and obligations.
Life of the business is limited by the life of the proprietor.
Equity money that can be raised is limited to the proprietors wealth.

What is PARTNERSHIP?
Any two or more people can get together and form a partnership, there can
be a maximum of 20 partners in a partnership. There are two types of
partnerships1. General Partnership- All partners agree to provide some fraction of the
work and cash to share the profits and losses. Each partner is liable for
all of the debts of the partnership.
2. Limited Partnership- Permits the liability of some of the partners to be
limited to the amount of cash each has contributed to the partnership.
Limited partnerships usually require that at least one partner be the
general partner and the limited partners do not participate in the
managing of the business.
Partnerships are usually inexpensive and easy to form.
General partners have unlimited liability for all debts, while limited
partners are liable only to the extent of their contribution to the
partnership.
General partnership is terminated when a general partner dies or
withdraws.
It is difficult for partnerships to raise large amounts of cash as equity is
limited to the partners wealth.
Income from a partnership is taxed as personal income to the partners.
Management control resides with general partners. Although majority
vote is required for big decisions.
What is CORPORATION?
A corporation is a distinct legal entity. Starting a corporation is more
complicated than starting a proprietorship or partnership. The incorporators
must prepare articles of incorporation and a set of bylaws. The articles of
incorporation must include1.
2.
3.
4.

Name of the corporation.

Intended life of the corporation. (it may be forever)
Business purpose.
Numbers of shares of stock that the organization is authorized to issue,
with a statement of limitations and rights of different classes of shares.
5. Nature of the rights granted to the shareholders.
6. Number of members of the initial Board of Directors.

What are the BYLAWS?

The bylaws are the rules to be used by the corporation to regulate its own
existence, and they concern its shareholders, directors and officers. Bylaws
range from the briefest possible statement of rules for the corporations
management to hundreds of pages of text.
ADVANTAGES & DISADVANTAGES OF CORPORATION:
Limited liability, ease of ownership transfer, and peretual succession are the
major advantages of the corporate form of business organization. These give
corporations an enhanced ability to raise cash. There is however, one great
disadvantage to incorporation. The federal government taxes corporate
income. This tax in addition to the personal income tax that shareholders pay
on dividends they recieve. This is also known as DOUBLE TAXATION.
COMPARISON OF PARTNERSHIPS & CORPORATIONS:
Corporation
Liquidity

Partnership

Shares can easily be exchanged

Subject to substantial restrictions.

Voting RightsUsually
General
each
Partner
share is
gets
in charge;
one vote
limited partners may have some voting r

Taxation

Reinvestment

Double with dividend taxPartnership

credit
income is taxable.

Broad latitude
All net cash flow is distributed to partners.

Liability General partners

Limitedmay
liability
have unlimited liability. Limited partners enjoy limit

Continuity

Perpetual life

What is AGENCY RELATIONSHIP?

Limited life

The relationship between stockholders and management is called an agency

relationship. Such a relationship occurs whenever someone hires another to
represent his or her interests. In all such relationships there is a possibility of
a conflict of intrest between the principal and the agent. Such a conflict is
called an agency problem.
What are MONEY MARKETS & CAPITAL MARKETS?
Money markets refer to those markets dealing with short term securities that
have a life of one year or less. Such as: Treasury bills, commercial papers etc.
Capital markets are defined as those markets where securities have a life of
more than one year. Such as: Common stock, preferred stock, corporate and
government bonds.
Types of FINANCIAL MARKETS?
Primary Markets- When a corporation uses financial markets to raise funds,
called an IPO, the sale of securities is said to be made in the primary market,
by way of a new issue. These IPO rates are fixed during the time of issue by
the company.
Secondary Markets- Once the securities have been sold to the
public/institutions, they can then be sold/traded between one another; this is
called the secondary market. In this secondary market, the prices are
continually changing as investors buy and sell securities based on their
expectations of a companys growth potential and profitability.