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First Test Cheat Sheet

First Test Cheat Sheet - Chapter 1 An Overview of Financial...

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Chapter 1 – An Overview of Financial Management Financial Management Issues of the new millennia o Changes in corporate governance o Globalization of Business o Improving information technology o Focus on business ethics Forms of Business Organization o Sole Proprietorship: Pros: Eas e of for mat ion Sub ject to few reg ulat ion s No cor por ate inc om e tax Cons: Li mit ed life Unl imi ted lia bili ty Dif ficu lt to rais e cap ital o Partnership Most revenues come from partnerships Roughly the same advantages and disadvantag es than a sole proprietorshi p Only advantage of a partnership over a sole proprietorshi p is that it can have a longer life as long as one partner is alive and more partners can be added. o Corporation Bondholders, Stakeholders , Board of directors, Managers/E mployees, Local Community, Suppliers/C ustomers, Federal/Stat e/Local Government Pros: Unl imi ted life Eas y tran sfer of ow ner shi p Li mit ed liab ilit y Eas e of rais ing cap ital Cons: Do ubl e tax atio n (inc om e tax ed at cor por ate rate and the n divi den ds tax ed at per son al rate ) Cos t of set- up and rep ort fili ng Agency Relationships o An agency relationship exists wherever a principal hires an agent to act on their behalf o Within a corporation, agency relationships exist between: Shareholders and managers Shareholders and creditors Goals of the Corporation o Primary: wealth maximization, which translates to maximizing stock price over long run Shareholders vs. Managers o Managers are naturally inclined to act in their own best interest o Management Goal: Make decisions designed to maximize the stock price o Actions designed to max firm’s intrinsic value, not current market price, and then communicate effectively with stock holders, causing intrinsic value to be high and actually stock price to remain close to intrinsic value over time o But the following factors affect managerial behavior: Managerial compensatio n plans Direct intervention by shareholders The threat of firing The threat of takeover o Stock Options: Given to employees and managers, Call Option Right to buy stock at strike (exercise price) o Compensating mgrs with stock options can help reduce conflicts of interest between stockholders and mgrs, but if all options are exercisable on a specific date in the near future, this can motivate managers to deceive stockholders o Managers of stable companies attempt to get their state legislatures to impose rules making it more difficult for raiders to succeed with hostile takeovers Increasing threat of corporate takeover reduces agency conflicts between stockholders and managers Shareholders vs. Creditors o Shareholders (through managers) could take actions to maximize stock price that are detrimental to creditors.
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