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408 Study Guide

408 Study Guide - Study Guide-Book Chapters 1 Chapter 1 o...

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Study Guide-Book Chapters 1. Chapter 1 o What is Finance? What long term investments should the firm undertake? Capital budgeting How should the firm raise money to fund these investments? Capital structure How can the firm best manage its cash flows? Working capital management o 3 types of business organizations Sole proprietorship Owned by single individual Entitled to all firm's profits Responsible for all firm's debt Often used in initial stage of a firm's life Partnership More than one owner General partnership: association of two or more persons who come together as co-owners for purpose of operating a business for profit Limited partnership: two classes of partners General partner: runs business and faces unlimited liability for firm's debt Limited partner: only liable up to the amount the limited partner invested Corporation: an artificial being, invisible, intangible, and existing only in the contemplation of the law Legally functions separately and apart from its owners (shareholders) Owners liability is confined to amount of their investment Life of business isn't tied to status of investors Has an ease of raising capital Board of directors: management who are responsible for determining firm's direction and policies Appointed by shareholders Drawback Double taxation of earnings that are paid out in form of dividends Corporation pays tax on profit and pays some of the profit back to shareholders as a dividend Shareholders then pay personal income tax on those dividends Limited liability company (LLC): cross between partnership and corporation Tax benefits of partnership Limited liability benefit of corporation Alternative for small businesses
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o Goal of financial manager Maximizing shareholder wealth Because shareholders are true owners of a firm Achieved by maximizing the stock price Ethical and agency considerations Agency problem: conflict of interest between the shareholders and the managers of a firm When managers have little/no ownership in a firm, they are less likely to work energetically for shareholders End result Value of stock isn't maximized and goal of firm isn't being achieved Measures to mitigate agency problem Compensation plans that reward managers when they act to maximize shareholder wealth Monitor actions of managers Sarbanes-Oxley Act (SOX-2002): holds corporate advisors who have access or influence on company decisions legally accountable for any instances of misconduct Provides greater protection against accounting fraud and financial misconduct o Four basic principles of finance Money has a time value Dollar received today is worth more than a dollar received in the future Because we can earn interest, better to receive money sooner rather than later Opportunity cost There is a risk-return tradeoff
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