Chapter 1 - Principles of finance.ppt

8/10/2019 Chapter 1 - Principles of finance.ppt

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Three types of business

organizations

The legal forms of business organization fall

into three categories:

The sole proprietorship

The partnership

The corporation


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The sole proprietorship

Owned by a single individual

who is entitled to all the firms profits and

who is also responsible for all the firms debt

(unlimited)

Forming a sole proprietorship is very easy

Limited access to outside sources of financing Personal taxes


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Partnership

General partnership

Owned by two or more persons

who are entitled to all the firms profits and who

are also responsible for all the firms debt

(unlimited)

Limited access to outside sources of financing

Personal taxes


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Partnership (cont.)

Limited partnerships

There are two classes of partners: general and limited

The general partner actually runs the business and

faces unlimited liability for the firms debts, while thelimited partner is only liable up to the amount the

limited partner invested.

It is difficult to transfer ownership of the general

partners interest in the business; However, the

limited partners shares can be transferred to another

owner


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Corporation

There are too many onwers

The owners liability is confined to the amount

of their investment in the company (limited)

The life of the business is not tied to the status

of the investors

The ease of raising capital and they can easilysell their stock

Double taxation


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A Comparison

Corporation Partnership

Liquidity Shares can be easily

exchanged

Subject to substantial

restrictions

Voting Rights Usually each share gets one

vote

General Partner is in charge;

limited partners may havesome voting rights

Taxation Double Partners pay taxes on

distributions

Reinvestment and

dividend payout

Broad latitude All net cash flow is

distributed to partners

Liability Limited liability General partners may have

unlimited liability; limited

partners enjoy limited

liability

Continuity Perpetual life Limited life


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The goal of the financial manager

A firm has several goals: revenue, profit,

market-share, etc

Because the shareholders are their true

owners, companies commonly have a

principle goal described as maximizing

shareholder wealth, which is achieved by

maximizing the stock price.


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Agency problem

Managers often face situations where their own

personal interests differ from the interests of

shareholders

The conflict of interest between the stockholders

and the managers of a firm as an agency problem

When the managers have little or no ownership

in the firm, they are less likely to workenergetically for the companys shareholders


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Agency problem (cont.)

The managers will have an incentive to enrich

themselves: luxury corporate jets, expensive

corporate apartments, or resort vacations.

To turn down projects that have an element of

risk in order to avoid jeopardizing their jobs

Debt may be the cheapest source of financing,

but managers might want to avoid debt

financing


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Agency problem (cont.)

Compensation plans can be put in place that

reward managers when they act to maximize

shareholder wealth (shareholder)

The board of directors can actively monitor

the actions of managers

Auditors, bankers, and credit agencies monitor

the firms performance


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Factors impact on the cost of money

(the interest rate or the cost of equity)

Production opportunity (user side)

The higher production opportunity, the higher thecost of money the user pays.

Time preference for consumption (supplierside)

The supplier prefers consumption rather thensaving, they ask higher cost of money

Risk (supplier side)

Inflation (supplier side)

Chapter 1 - Principles of finance.ppt

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