Beruflich Dokumente
Kultur Dokumente
What is Finance
Financial Management is concerned with the maintenance and creation of wealth. Finance focuses on decision making with an eye towards creating wealth.
What is Finance
As such finance deal with decisions such as 1. When to introduce a new product 2. When to invest in new assets 3. When to replace existing assets 4. When to borrow from banks 5. When to issue stocks and bonds 6. When to extend credit to a customer, and 7. How much cash to be maintained.
Goal of a firm
Profit maximization vs. maximization of shareholder wealth The timeline for profit maximization affects the outcome. Financial managers decisions must take into account the risk and returns of each project, as well as the timing of the returns.
Goal of a firm
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.
Goal of a firm
Sole proprietorship
Owned by an individual with full rights to profits and responsible for all liabilities. Unlimited liability. Initiated simply by starting business operations. Termination occurs by owners choice or death.
Partnership
Two or more people acting as co-owners to operate a business for profit.
General Partnership
General Partnership each partner is fully responsible for liabilities.
Limited Partnership
Limited Partnership one or more partners have liability limited to the amount of capital invested.
One or more partners can have limited liability 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.
Corporation an entity that legally functions separately and apart from its owners
Owners of the corporation hold shares of common stock that are transferable. Liability is limited to the amount of investment in the companys common stock. Corporations continue even with transfer of shares or death of owners.
Benefits: Limited liability Easy to transfer ownership Unlimited life (unless the firm goes through corporate restructuring such as mergers and bankruptcies) Drawbacks: No secrecy of information Maybe delays in decision making Greater regulation Double taxation
S-Type Corporations
Benefits
Limited liability Taxed as partnership Owners must be people Cant be used for joint ventures between two corporations
Limitations
Limited liability Taxed like a partnership Qualifications vary from state to state Cant appear like corporation otherwise will be taxed like one
Limitations
Would you invest your savings in the stock market if it offered the same expected return as your bank? We wont take on additional risk unless we expect to be compensated with additional return.
Higher the risk of an investment, higher will be its expected return.
A dollar received today is worth more than a dollar to be received in the future.
Because we can earn interest on money received today, it is better to receive money earlier rather than later.
In measuring wealth or value, we use cash Flow, not accounting profit, as our measurement tool.
Cash flows are actually received by the firm and can be reinvested. On the other hand, profits are recorded when they are earned rather than when money is actually received. It is possible for a firm to show profits on the books but have no cash!
The 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.
This difference reflects the true impact of a decision.
The values of securities at any instant in time fully reflect all publicly available information. Prices reflect value and are right. Price changes reflect changes in expected cash flows (and not cosmetic changes such as accounting policy changes). Good decisions drive up the stock prices and vice versa.
The separation of management and the ownership of the firm creates an agency problem.
Managers may make decisions that are not in line with the goal of maximization of shareholder wealth. Agency conflict reduced through monitoring (ex. Annual reports), compensation schemes (ex. stock options), and market mechanisms (ex. Takeovers).
The cash flows we consider for decision making are the after-tax incremental cash flows to the firm as a whole.
Principle10:
Ethical Behavior Is Doing the Right Thing, and Ethical Dilemmas Are Everywhere in Finance
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. Ethics are relevant in business and unethical decisions can destroy shareholder wealth (ex. Enron Scandal).