Exam (elaborations) Corporate Finance20

1. Balance-sheet model of the firm: I. left-hand side of the sheet: in what long-lived assets should the firm invest? – capital budget. II. Right-hand side: how can the firm raise cash for required capital expenditures? – capital structure. III. Net working capital = current asset – current liabilities: how should short-term operating cash flows be managed? 2. a firm sold gold for $10 and has yet to collect from the customer. The cost is $9: Income statement: Accounting view: profit = 10-9=1 Corporate finance view: cash inflow = 0; cash outflow = -9. 3. the sole proprietorship I. it is the cheapest business to form. II. It pays no corporate income taxes. All profits of the business are taxed as individual income. III. It has unlimited liability for business debts and obligations. No distinction is made b/w personal and business assets. 4. the partnership: I. Partnerships are usually inexpensive and easy to form. II. General partners have unlimited liability for all debts. The general partnership is terminated when a general partner dies or withdraws. It is difficult for a partnership to transfer ownership without dissolving. The advantage is the cost of getting started. The disadvantages are: 1) unlimited liability, 2) limited life of the enterprise, and 3) difficulty of transferring ownership. These three disadvantages lead to 4) the difficulty of raising cash. 5. the corporation: limited liability, ease of ownership transfer, and perpetual succession are the major advantages; Disadvantage: government taxes corporate income. 6. agency costs: the cost of resolving the conflicts of interest b/w managers and shareholders are special types of costs. Residual losses are the lost wealth of the shareholders due to divergent behavior of the managers. 7. G. Donaldson concluded that managers are influenced by two basic motivations: I. survival. II. Independence and self-sufficiency: this is the freedom to make decisions without encountering external parties or depending on outside financial markets. The Donaldson interviews suggested that managers do not like to issue new shares of stock. Instead, they like to be able to rely on internally generated cash flow. III. Therefore, the basic financial objective of managers: the maximization of corporate wealth. Corporate wealth is that wealth over which management has effective control. Corporate wealth is not necessarily shareholder wealth. 2 Study notes By Zhipeng Yan 8. several control devices used by shareholders bond management to the self-interest of shareholders: I. shareholders control the directors, who in turn select the management team; II. contracts with management and arrangements for compensation, such as stock option plans, can be made so that management has an incentive to pursue the goal of the shareholders. III. Fear of a takeover gives managers an incentive to take actions that will maximize stock prices. IV. Competition in the managerial labor market may force managers to perform in the best interest of stockholders. The available evidence and theory are consistent with the ideas of shareholder control and shareholder value maximization. 9. Secondary markets: I. Auction market: the equity securities of most large US firms trade in organized auction markets. E.g. NYSE II. Most debt securities are traded in dealer markets. Some stocks are traded in the dealer markets. When they are, it is referred to as the OTC market. E.g. NASDAQ Chapter 2 Accounting Statements and Cash Flow 1. Balance sheet: I. The assets in the balance sheet are listed in order by the length of time it normally would take an ongoing firm to convert them to cash. II. The liabilities and the stockholders’ equity are listed in the order in which they must be paid. Assets Liabilities and Stockholders’ equity Current assets Current liabilities cash and equivalents account payable accounts receivable notes payable inventories and other accrued expenses Total current assets Total current liabilities Fixed assets Long-term liabilities property, plant and equipment deferred taxes Less accumulated depreciation Long-term debt Net property, plant and equipment Total Long-term liabilities intangible assets and others Stockholders’ equity Total fixed assets preferred stock common stock capital surplus accumulated retained earnings Less treasury stock Total equity