Summary Corporate Finance week 1-3 Vrije Universiteit Amsterdam | H1.1, 1.2 and 14 to 17 Berk & DeMarzo
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Course
Corporate Finance (E_EBE2CF)
Institution
Vrije Universiteit Amsterdam (VU)
Book
Corporate Finance, Global Edition
Summary of the book Corporate Finance by Berk & DeMarzo. This is the material for the mid-term quiz for the Corporate Finance course at the Vrije Universiteit in Amsterdam.
Occasionally Dutch words in the summary, but overall it is written in English.
Week 1
Chapter 1.1
Types of firms:
• Sole proprietorship: business owned + run by one person
o Characteristics:
§ Straightforward to set up
§ No separation between firm and owner à only one owner
§ Owner has unlimited personal liability for any of the firm’s debts
§ The life of a sole proprietorship is limited to the life of the owner à di?icult to transfer ownership
• Partnership: identical to sole proprietorship, except it has more than one owner
o Characteristics:
§ All partners are liable for the firm’s debt
§ Partnership ends on the death or withdrawal of any partner à could avoid liquidation if partnership agreement
provides alternatives à buyout
o Limited partnership: partnership with two kinds of owners
§ General partners: have the same rights and privileges as partners in a (general) partnership
§ Limited partners: have limited liability à dependent on their investment
- Private property cannot be seized to pay o? debts
- Death/withdrawal of limited partner does not dissolve partnership
- Limited partner’s interest is transferable
- No management authority + cannot legally be involved in managerial decisions
• Limited liability company (LLC): limited partnership without a general partner
o All owners have limited liability + run the business
o Similar to the Dutch BV and German GmbH
• Corporation: a legal entity, separate from its owners à solely responsible for its own obligations, owners are not liable for any
obligations and corporation is not liable for any personal obligations
o No limit on number of owners + no limitation on who can own its stock
o Stock = shares: that are derived from an entire ownership stake
o Equity: all outstanding shares
o Shareholder = stockholder = equity holder: owner of a share of stock
§ Receive dividend payments
o Free trade in shares
S corporation: corporation that elect subchapter S tax treatment à no double taxation
• Profits/losses are not subject to corporate tax à are allocated directly to shareholders based on ownership share
o Include these profits to their own tax returns à even when no money is received
Chapter 1.2
Board of directors: group of people who have the decision rights/authority
• Are selected by shareholders à investors with most shares have most influence
CEO = chief executive o?icer: running corporation by following rules and policies set by board of directors
CFO = chief financial o?icer: most senior financial manager
• Tasks:
o Investment decisions à weigh costs and benefits which project to do
o Financing decisions à how to pay for the project
§ Raise money from new and existing money = equity
§ Borrow money = debt
o Cash management = managing working capital à ensure the firm has enough cash to meet obligations
Agency problem: when managers put their own interest above the interests of shareholder, the group where managers work for
• Decrease this agency problem:
o Minimizing the number of decisions managers must make
Shareholders can encourage managers to work in their interest to set pressure on the board à make the CEO resign
• Also: dissatisfied investors often sell their shares à only by lowering the price someone will buy the shares
• Stock price is a barometer for corporate leaders for feedback on their performance
Hostile takeover: individual or organization purchases a large fraction of the stock + has enough votes to replace the board of directors and
CEO
• Could be called a corporate raider
Corporate bankruptcy is not the same as liquidation à sometimes debt holders and equity holders have no need to liquidate the organization
• Corporate bankruptcy is a change in ownership à debt holders can take control of the firm if the company cannot meet its
obligations
2
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