Class notes + examples Business Model Assessment (E_MB_BMA)
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Cours
Business Model Assessment (E_MB_BMA)
Établissement
Vrije Universiteit Amsterdam (VU)
Book
Corporate Finance
Notes of lectures, tutorials, and mini-lectures of the course of Business Model Assessment in the Business Administration minor.
The document includes:
- chapters: 1,2,3,4,7,8,23 (not chapter 29)
- examples of exercises and explanations
- screenshots from book and lectures
- all formulas e...
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Vrije Universiteit Amsterdam (VU)
Business Administration Minor
Business Model Assessment (E_MB_BMA)
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WEEK 1
Types of Firms
Sole Proprietorship
Sole proprietorships represent the biggest percentage of businesses in the US. But corporations are the engines of the economy, they
are the ones that create the biggest revenue.
→ it is a business owned and run by one person only
→ typically has few employees, if any
Advantages Disadvantages
Easy to create Unlimited personal liability (if the firm
goes bankrupt, the owner has to pay
from his pocket, or by using their own
assets e.g. house)
Limited life
Partnership
→ similar to a sole proprietorship, but with more than one owner
There are 2 types of owners:
- General partners:
→ they are liable for all the losses
→ have management authority
- Limited partners:
→ have limited liability
→ have no management authority
Limited Liability Company (LLC)
→ All owners have limited liability but they can also run the business
→ it is relatively new to the US, but it exists for 100 years in Europe
→ much higher number of LLC in Europe
E.G.
- In the NL it’s called BV
- Germany GmbH
- America LLC
- England Ltd
Corporation
A legal entity separate from its owners
→ has many of the legal powers that individuals have (e.g. ability to enter into contracts, own assets, borrow money)
,→ the corporation is solely responsible for its own obligations. Its owners are not liable for any obligation that the corporation enters
into
Ownership of the corporations is represented by shares of stock
→ there is no limit to the number of shareholders, and thus the number of funds a company can raise by selling stock
→ owner(s) is entitled to dividend payments
Advantages Disadvantages
Unlimited life. Aka not tied to Double taxation
the owner
Easy transfer of ownership Cost of set up and report
filing
Limited liability
Ease of raising capital
Double taxation:
As a separate legal entity, the
corporation pays taxes first. After the
taxes are paid, the dividends that the
owners are entitled to are allocated to
them. And the shareholders have to
pay income taxes on these dividend
incomes.
Ownership vs control of corporations
Ownership and direct control are different things.
→ The control and ultimate decision-making of the corporation are in the hand of the BoD, which is elected by the shareholders.
→ CEO has day-to-day decision-making. This is typically delegated to them by the BoD
Corporate Finance Theory is about maximizing profits. So the firm’s goal is to make the shareholders better off, if the management
makes decisions that maximize the value of their shares.
How to maximize shareholder wealth?
- Investment decision
Invest in projects should result in positive NPV (net present value)
→ how the corporation uses its funds
→ Capital Budgeting
- Financing decision
→ How do you find sources of funds to make investments
→ the corporation has to find the right mix between debt and equity
→ Capital Structure of a firm
- Dividend decision
How to distribute the revenues to the shareholders
The Firm and Society
A corporation’s decisions that increase the value of the firm’s equity should benefit society as a whole
As long as nobody else is made worse off by a corporation’s decisions, increasing the value of the firm’s equity is good for society.
,It becomes a problem when increasing the value of the firm’s equity comes at the expense of others.
Ethics and Incentives within Corporations
Managers have the responsibility to make decisions for the company and for the employees. But they may have the tendency to act in
their own interest rather than in the best interest of the shareholders
→ A solution is tying management’s compensation to firm performance. This will give some incentive to perform well
What happens if the CEO doesn’t perform well?
Shareholders cannot directly affect the CEO, but they can express their dissatisfaction by selling their shares, This selling pressure
will drive the stock price down. This can also threaten a Hostile Takeover: low stock prices may entice a Corporate Raider: the
process of buying a large stake in a corporation and then using shareholder voting rights to require the company to undertake novel
measures designed to increase the share value, generally in opposition to the desires and practices of the corporation's current
management.
Shareholders are considered residual claimants. In case of bankruptcy, they can only get their assets after all debt holders are paid.
Agency costs: when the CEO does things that benefit them and not the shareholders. E.g buy an expensive company car…
How to make sure that the CEO runs your company in your best interest?
- Monitoring: actively supervise what the CEO does
- Incentives: performance-related salary or stake of the company
Financial statements Analysis
The firm has a Financial Manager, responsible for all financial activities.
The firm can raise cash from investors, which is used for the firm’s operations (aka invested in the firm). The firm’s operations
generate cash, which is then reinvested in the firm OR returned to investors.
The advantage of a corporation is that everybody with money can be a potential investor.
→ therefore companies are widely held.
Eg. IBM in 2012 has 1.2 billion shares outstanding and 600k shareholders. The larger shareholder had 6% of shares
How do investors learn enough about the company?
How can financial managers assess the performance of their firm?
This is done with Financial Statements
→ Firm-issued accounting reports with past performance information
→ For public companies in the US they are filed with the SEC (10Q- quarterly, 10k-Annualy)
→ There must also be an annual report with financial statements to shareholders
Financial Statements should be in a standard form so that you compare different companies and countries with each other:
- GAAP: generally accepted accounting principles
- Auditor: neutral third party that checks a firm’s financial statements. Previous reports show that auditors may not be
enough to assure the truthfulness
Financial statements are used to:
- Compare the company to itself over time
- Compare with other companies
, Types of financial statements:
· Balance sheet: picture of a point in time
· Income statement: for specific time (quarter or year)
· Statement of Cash Flows
· Statement of Stockholder’ equity
Balance Sheet | a snapshot in time of the firm’s financial position
The Balance Sheet identity:
Assets = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠’ 𝐸𝑞𝑢𝑖𝑡𝑦
Assets → What the company owns
Liabilities → What the company owes
Stockholders Equity → the difference between the value of the firm’s assets and liabilities.
The total of assets should be the same as the total of
liabilities. If something happens on the left side of
the balance sheet, it is also reflected on the right
side.
Assets |what the company owns
Current Assets: cash or what is expected to be turned into cash in the next year
- Cash, marketable securities
- Accounts receivable (belongs to the company but is not in their hands yet, if the company sells some product, but the
corresponding amount is not received/pet to company yet, it goes to accounts receivable.)
- Inventories (raw materials used to produce goods, work in progress products and finished goods available for sale)
- Other current assets (eg. pre-paid expenses)
In the balance sheet, you always start with the most liquid asset: cash.
Long-term Assets (or fixed assets): assets that are held by the company for many years. Also, they can’t be easily converted into cash.
- Land, buildings, equipment.
- Less accumulated depreciation: land, buildings, equipment is deducted with depreciation (according to accounting rules)
- Net Property, Plant, & Equipment (bovenstaand geeft ons de netto value of property, plant and equipment)
- Goodwill and intangible assets
- Other Long-Term Assets (Example: Investments in Long-term Securities)
→ Through time these assets lose value. By deducting the “less accumulated depreciation” we get net property, plant, and equipment
Liabilities | what the company owes
Current Liabilities: due to being paid within the next year
- Accounts payable (amount owed to suppliers for products or services purchased with credit)
- Short-Term debt/Notes payable
- Current maturities of long term debt (all payments of debt that will occur within the next year)
- Other current liabilities (taxes payable, wages payable)
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