FIN test1 - Ch1 Financial management decisions - Financial...

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Ch1 Financial management decisions - Financial managers try to answer some or all of the following questions 1. Capital budgeting decisions : long-term investments (fixed assets) or projects What long-term investments or projects should the firm take on? 2. Capital structure decisions : long-term financing (long-term liability) or owner’s equity How should the assets be paid for? Where will the long-term financing come from? 3. Working capital management decisions : current asset (cash, accounts receivable, inventory), current liability (accruals, account payable – by manager decision, short-term notes) How are the everyday financial activities of the firm managed? Financial management’s goal - Maximize the current value per share of the company’s stock - Maximize shareholder wealth - Maximize owner’s equity Price today = cash flow in the future Forms of business organization (in the United States) - Sole proprietorship 1. Advantages Easiest to start Least regulated Single owner keeps all the profits Taxed once as personal income 2. Disadvantages Limited to life of owner Equity capital limited to owner’s personal wealth Unlimited liability Difficult to sell ownership interest - Partnership 1. Advantages Two or more owners More capital available Relatively easy to start Income taxed once as personal income 2. Disadvantages Unlimited liability Partnership dissolves when one partner dies or wishes to sell Difficult to transfer ownership - Corporation 1. Advantages Limited liability Unlimited life Separation of ownership and management
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Transfer of ownership is easy Easier to raise capital 2. Disadvantages Separation of ownership and management Double taxation (income taxed and dividends taxed) 1) Dividend is not taxed deductible) 3. Corporate complications (separation of ownership and management) Advantages 1) You can benefit from ownership in several different businesses (diversification) 2) You can take advantage of the expertise of others 3) It is easier to transfer ownership Disadvantages 1) Agency problem can exist if management goals and owner goals are not aligned The agency problem - Agency relationship 1. Principal hires an agent to represent his/her interests 2. Stockholders (principals) hire managers (agent) to run the company - Agency problem 1. Conflict of interest between principal and agent - Agency costs 1. Direct costs Corporate expenditure that benefits management but costs stockholders Cost of monitoring management actions 2. Indirect costs Lost opportunities (manager – worry about job VS stockholders – benefits) Managing managers - Managerial compensation 1. Incentives can be used to align management and stockholder interests 2. The incentives need to be structured carefully to make sure that they achieve their goal - Corporate control: the threat of a takeover may result in better management
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FIN test1 - Ch1 Financial management decisions - Financial...

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