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Finance 1 complete summary
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Complete summary covering all chapters and lecture notes for the final exam for Finance 1.
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Finance(week 1)
The four types of firms
1. Sole proprietorship (eenmanszaak)
2. Partnership
3. Limited liability company
4. Corporation
Sole proprietorship (eenmanszaak)
Business is owned and run by one person.
Typically has few, if any, employees.
Advantages: easy to create
Disadvantages: no separation between the firm and the owner, unlimited personal
liability, limited life.
Partnership (VOF & maatschappen)
Similar to a sole proprietorship, but with more than one owner.
All partners are personally liable for all of the firm’s debts. A lender can require any
partner to repay all of the firm’s outstanding debts.
Examples are doctors, lawyers, consultants (the skill of the owners is the most
important asset of the firm).
General partners
(active investment managers)
Have the same rights and liability as partners in a “regular” partnership
Typically run the firm on a day-to-day basis
Limited partners
(passive investors)
Have limited liability and cannot lose more than their initial investment
Have no management authority and cannot legally be involved in the managerial
decision making for the business
Their interest can be transferred.
Limited Liability Companies (LLC)
All owners have limited liability, but they can also run the business. Relatively new
business form in the United States.
Usually, partnership tax rules apply
Hybrid of partnership and corporation
,Corporation
A legal entity separate from its owners
Has many of the legal powers individuals have; enter contracts, own assets.
Corporation is solely responsible for its own obligations.
Corporations must be legally formed
Ownership is represented by shares of stock
Owner of stock is called: shareholder, stockholder or equity holder
Sum of all ownership is called equity.
There is no limit to the number of shareholders and the amount of funds a company
can raise by selling stock.
Owner is entitled to dividend payments
Double taxation
- on the profit (paid by the corporation)
- on the dividend (paid by the individual owner)
(exception for an S corporation, these are not subject to corporate taxes but
allocated directly to shareholders based on their ownership share.)
Ownership vs. Control in Corporations
Corporate management team
In a corporation, ownership and direct control are typically separate.
Board of Directors
- Elected by shareholders
- Have ultimate decision-making authority
Chief Executive Officer (CEO)
Board typically delegates day-to-day decision making to the CEO.
Financial Manager
Responsible for investment decisions, financing decisions and cash management.
Goal of the firm
Shareholders will agree that they are better off if the value of their shares are
maximized.
As long as nobody else is made worse off by a corporate’s decisions, increasing the
value of the firm’s equity is good for society.
Corporate Bankruptcy
Reorganization
Liquidation
The stock market
The stock market provides liquidity to shareholders.
Liquidity; ability to easily sell an asset for a price close to for which you bought it.
Public company ; on the stock market and can be traded.
Private company; stock may be traded privately (more difficult)
Primary market; corporation itself issues new shares of stock and sell them
, Secondary market; after the initial transaction the shares continue to trade between
investors.
(week 2)
Competitive market = a market in which goods can be bought and sold at the same
price.
A dollar today and a dollar in one year are not equivalent!
Interest rate (exchange rate across time)
The rate at which we can exchange money today for money in the future is
determined by the current interest rate.
Risk-free interest rate (discount rate) Rf
Interest rate factor = 1+Rf
Discount factor = +Rf
When we express the value in terms of dollars today we call it the present value
(PV) of the investment.
If we express it in terms of dollars in the future, we call it the future value of the
investment.
Net present value (NPV)
NPV is the difference between the present value of its benefits and the present value
of its costs.
NPV = PV (benefits) - PV (costs)
NPV = PV (all project cash flows)
When making an investment decision, take the alternative with the highest NPV,
choosing this alternative is equivalent to receiving its NPV in cash today.
Accept projects with positive NPV, reject projects with negative NPV
Cash needs
Regardless of our preferences for cash today versus cash in the future, we should
always maximize NPV first.
We can then borrow or lend to shift cash flows through time and find our most
preferred pattern of cash flows.
Arbitrage
Arbitrage
The practice of buying and selling equivalent goods in different markets to take
advantage of a price difference.
An arbitrage opportunity occurs when it is possible to make a profit without taking
any risk or making any investment.
Normal market
A competitive market in which there are no arbitrage opportunities.
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