Financial management note
Finance can be through of as the study of the following 3 questions:
1. In what long-term assets should the firm invest? (Capital budgeting)
2. How can the firm raise cash for required capital expenditures? (Capital structure)
3. How should short-term operation cash flows be managed? (Working capital management)
Forms of business organization:
Proprietorship- single owner
Partnership- more than one owner
Corporation- legal entity separate and distinct form its owners and managers.
Corporations
Advantages:
Unlimited life- independent of owners
Ease transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Double taxation
Cost of set-up and report filing
Maximizing value
Limited liability- the lower the risk the higher the value, all else equal
Growth opportunities: corporations can raise capital easier to take advantage of these opportunities.
Liquidity: an asset value also depends on how easy it is to sell it.
Management’s primary goal
Our focus: profit, publicity held companies
Management’s goal: maximize shareholder wealth, which translates into maximizing the stock price.
Maximizing shareholder value:
A company’s shareholder wealth is equal to the number of shrares outstanding times market value per share.
We need to know what factors affect the stock price.
The value of a share of stock is the present value of the cash flows an “average investor” expects to receive in the future id he or she bought the stock.
Long-term view important.
Market price VS intrinsic value
Stock’s market price: actual market price of the share of stock. Value based on perceived returns and risk. (could be wrong)
Intrinsic value: what a fully informed analyst would estimate as the “true” value of a stock based on “true” risk and return data.
Analyst’s estimates of the intrinsic value of a stock vary.
A firm’s management has the best information.
Management’s goal
Take actions that are designed to maximize the
1. In what long-term assets should the firm invest? (Capital budgeting)
2. How can the firm raise cash for required capital expenditures? (Capital structure)
3. How should short-term operation cash flows be managed? (Working capital management)
Forms of business organization:
Proprietorship- single owner
Partnership- more than one owner
Corporation- legal entity separate and distinct form its owners and managers.
Corporations
Advantages:
Unlimited life- independent of owners
Ease transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Double taxation
Cost of set-up and report filing
Maximizing value
Limited liability- the lower the risk the higher the value, all else equal
Growth opportunities: corporations can raise capital easier to take advantage of these opportunities.
Liquidity: an asset value also depends on how easy it is to sell it.
Management’s primary goal
Our focus: profit, publicity held companies
Management’s goal: maximize shareholder wealth, which translates into maximizing the stock price.
Maximizing shareholder value:
A company’s shareholder wealth is equal to the number of shrares outstanding times market value per share.
We need to know what factors affect the stock price.
The value of a share of stock is the present value of the cash flows an “average investor” expects to receive in the future id he or she bought the stock.
Long-term view important.
Market price VS intrinsic value
Stock’s market price: actual market price of the share of stock. Value based on perceived returns and risk. (could be wrong)
Intrinsic value: what a fully informed analyst would estimate as the “true” value of a stock based on “true” risk and return data.
Analyst’s estimates of the intrinsic value of a stock vary.
A firm’s management has the best information.
Management’s goal
Take actions that are designed to maximize the