This summary is based on the book: Corporate Finance-Global Edition, Pearson, 5th Edition and
lecture notes.
Week 1
Lecture 1 (Videos 1-10)
The four main types of firms;
Sole Proprietorship Owned by one person and run by one person. It can have
employees but very few. Very easy to set up (just go online and set it
up in a few minutes time), however if the owner dies the business
dies. There is no separation between firm and owner so the owner
has unlimited liability.
Partnership More than one owner and all partners are liable for the firm’s debt.
General partners have unlimited liability but do have managing
power. Limited partners have limited liability but no management
authority. An example is a venture capital fund. The passive investor
has limited liability, they have the capital, they invest and let the
active investment managers do the work.
Limited Liability U.S. specific type of firm. Similar to the hybrid of partnership and
Company corporation. It has similar tax rules as a partnership as well.
Corporation A legal entity separate from its owners. It has many legal powers
(e.g. it can sign it’s own contracts, etc.). The corporation is solely
responsible for its own obligations and the ownership can transfer.
Difference between LLC and corporation;
In an LLC partners are owners, in a corp it is the shareholders. Ownership is not formally
distincted which means that in an LLC the owners have control while in a corp the shareholders
own but the CEO etc has control.
C and S Corporation;
In a ‘C’ corporation (majority of the corporations are ‘C’) you pay double taxes, a few
corporations are ‘S’ though. This means that they do not need to pay double taxes as the firm’s
profits are not subject to tax, only the stockholders’. There are very strict rules on this, hence not
many firms are ‘S’. Examples include; max 100 shareholders, all shareholders must be US
citizens, etc.
How to form a corporation?
A corporation must be legally formed, hence, it is not as cheap as forming a sole proprietorship,
some places even have minimum capital requirements. Ownership is represented by how many
shares of stock you have in the company, someone who owns shares is called a stockholder,
,shareholder or equity holder. Sum of all ownership is called equity (so if you have a 51% equity
then you own 51%). There is also no limit on how many shareholders you can have. Owners of
stocks are entitled to dividend payments.
Tax implication (double taxation);
In a corporation, since it is seen as a legal entity, the corporation must pay tax. Then once you
give dividends, the shareholders must pay tax again. In partnership or sole proprietorship, since
you are seen as one entity (not separate entities) you only need to pay tax once.
Ownership vs. Control in corporations;
In a corporation you have a management team. This consists of a board of directors who are
elected by the shareholders, this board has the ultimate decision making authority. They appoint
a Chief Executive Officer (CEO) who delegates the day to day decision making/activities. The
CEO chooses other managers like the CFO (Chief Financial Officer), etc. The Financial
manager is responsible for investment decisions, financing decisions, cash management, etc.
Wealth maximization makes the shareholders happy, however often they also ended to think
about the society. As harming the society can backfire and get lawsuits, or other hurting things
‘thrown’ at you. Hence, the government also often sets regulations. Agency problems is a term
we use which represents the case of managers acting for their own interest rather than for the
ebay interests of the shareholders. They can do this through private loans, corporate jet, etc.
Often they tie the manager’s compensation to the company’s success, this forces the manager
to do his best.
,What about corporate bankruptcy?
Bankruptcy happens when you can’t pay your debts, hence, you can only go bankrupt if you
take out a loan. If you do go bankrupt, your company dissolves. You can either do
reorganization or liquidation (depending where in the world you are).
Stock Market;
The stock market provides liquidity to shareholders, something is liquid if it provides the option
to turn an asset into cash quickly, with same price as which you can buy it. Public companies
sell stocks to the public, so anything (ofc you need to be old enough) can buy stocks. This can
be done through stock exchange systems like NASDAQ or the New York Stock Exchange. The
primary market is when the corporation itself issues new shares and the secondary market is
when the investors trade shares between each other. Market makers are people who find you
buyers for the shares you want to sell or sellers for the share you want to buy. They also often
buy it themselves to keep liquidity and then sell when they can. Private companies need to find
buyers themselves, so this process often takes longer as it is not as easy to buy or sell shares
of a private company.
Dark Pools;
When buying stocks you can buy at the ask price and sell at the bid price. The difference in
between is what the market makers typically accept. However, dark pools allow people to trade
at a better price, as you can not see the bid and ask prices. The only thing is that they run the
risk of their order not being filled. Hence, trading in dark pools is good for traders who do not
want to reveal their demand and who are willing to sacrifice the guarantee of immediacy for a
potentially better price. Nowadays there are regulations on how they should be, as there had
been issues.
, Week 2
Lecture 2 (videos 1-7):
Financial decision making
When doing financial decision making it is important to identify costs and benefits. This can be
done through many sectors, like marketing, economics, organizational behavior, strategy, etc. In
financial decision making you always need to convert everything to one common unit (not just
USD -if that is what you want to convert to-, but present USD or future USD).
A competitive market is one for which goods and services can be bought and sold at the same
price.
Time Value of Money;
The time value of money basically states that money now is not worth the same as it is tmr, in 1
year, or more. Lets say that the annual interest rate is 7%, then multiplying our value by 1.07
gives us the value in one year. The risk free interest rate (discount rate) is the rate for which
money can be borrowed or lent without risk. If we want to know the value of 1000 eur in the
future but in today’s terms, we would divide it by 1.07. Taking the value from now to the future is
called compounding, and taking money from the future to now is called discounting.
𝑁𝑃𝑉 = 𝑃𝑉(𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠 − 𝐶𝑜𝑠𝑡𝑠)
𝑁𝑃𝑉 = 𝑃𝑉(𝐴𝑙𝑙 𝑃𝑟𝑜𝑗𝑒𝑐𝑡 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤𝑠)
When making an investment you want to look at all alternatives, find the present values of the
benefits and costs and thus the net present values. Then you want to pick the one with the
highest NPV. But…. why????? It’s very simple, regardless of your cash needs, picking the
choice with the highest present value will be of benefit to you. You can borrow or lend to shift
cash flows through time and find the best preferred pattern of cash flows, may not be feasible
for starters who have borrowing constraints. Video 5 lecture two week one at min 23 shows
exactly why. This is VERY useful.
Arbitrage and law of 1 price.
Arbitrage is when you can buy a good in one market and sell it for more in the other, making
profit. However, natural economic forces would push prices up in one market and down in the
other because more people would start to do the same (so much demand in one market and so
much supply in the other). A security, like a bond or stock promises risk free payment. Let's say
a bond will give 1000 in 1 year, how much should the present price be? Well if it is 5% rate, then
we do 1000/1.05 which gives 952.38. If the price is too high or too low, arbitrage can happen.
Which would end up pushing the price to 952.38 and hence, the law of 1 price happens.
