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FINC 200 Chapter 1

Finance
Essentially the study of pricing and pricing relationships
Financial management
Concentrates on valuation from the firms perspective
Personal finance
Focuses on maintaining and expanding individual wealth
Successful financial markets
allow a flow of funds from individuals looking to increase wealth to businesses who want to expand their operations
Borrower-lender relationship
The relationships between the individual holding funds and the businesses who want to expand
Liquidity
The property of a strong financial system connecting the two groups (lenders and borrowers) quickly and at low costs
What does high liquidity lead to?
growth in the economy and employment opportunities once a firm has expanded
Strong economies have __________ financial systems.
Strong
4 types of of individuals in a theoretical financial system
Type 1: no money, no ides
Type 2: Money, no ideas
Type 3: No money, ideas
Type 4: money and ideas

Firms or individuals can more between groups through time

Type 2
Money, no ideas

Want to invest in companies and individuals that will be profitable

Look to asses the value of future cash flows, which is payments made to the firm for products or services

lend their money to type 3

can be individual investors, banks, or even other corporations

by lending money, type 2s inherently take on risks and want to be compensated for those risks

Firm cash flow expectations
high expected cash flows= safe investment

low or uncertain cash flows= risky

Type 3
Ideas, no money (think shark tank pitchers)

can be individuals entrepreneurs or large companies with R and D departments

Type 4
All companies and individuals want to be type 4

this is part of the reason companies hold retained earnings.

Retained earnings
Profits that are held by the company and no distributed to share holders

If a company has retained earnings, it can invest in projects without issuing debt or equity

What does the value of a financial asset depend on?
cash lows, but they are typically uncertain in the beginning

financial assets can be grouped into asset classes based on return characteristics

Sole propreitership
a single business owner that takes on unlimited liability

most common type of business in the US

relatively easy to start due to lighter regulation and paperwork

owner has complete control over business activities and is responsible for all firms profits and losses

considered unlimited liability because there is no distinction between business assets and personal assets

businesses do not typically lend to sole proprietorship due to the riskiness involved

S.P.s can raise capital from venture capitalists in exchange for a percentage of the firm (equity)

General partnership
Partners own the business together and are personally liable for legal actions and debts

unlimited liability for the partners

partners can own different percentages of company and are entitled to that percentage of profit

banks are more likely to lend to partnerships

multiple individuals are responsible for paying back debt

in order to raise substantial capital, partners may have to give up equity

Public corporation
A legally independent entity separate from its owners. Corporations tend to have many owners in the form of shareholders.

Corporate owners are stockholders, but day to day responsibilities are given to managers (CEO)

Considered limited liability since shareholders can own lose the amount paid for their stock

Maximization of shareholder wealth philosophy
View that management’s primary consideration is to consider the interest of shareholders in decision making

Academics favor this shareholder wealth maximization

Stakeholder maximization
business should maximize total satisfaction (includes bondholders, consumers, etc)
Adam Smith’s invisible hand
individuals acting in own self interest leads to efficient outcome
Who is a firm’s highest level financial manager?
Chief financial officer
What type of business organization is relatively easy to start, and it is subject to much lighter regulatory and paperwork burden than other business forms?
Sole proprietership
What type of business organization is entirely legally independent from its owners?
Public corporations
As individual legal entities, corporations assume liability for their own debts, so the shareholders hold:
only limited liabilty
For corporations, maximizing the value of owner’s equity can also be stated as:
maximizing the stock price
This should be the primary objective of a firm as it may actually be beneficial for society in the long run
Maximizing shareholder value
This is the set of laws, policies, incentives, and monitors designed to handle the issues arising from the separation of ownership and control
Corporate governance
This group is elected by stockholders to oversee management in a corporation
Board of directors
These individuals help firms access capital markets and advise managers about how to interact with those capital markets
investment bankers
These individuals examine a firms financial strength for debt holders
Credit analysts
Individuals who provide small amounts of capital and expert business advice to small firms in exchange for ownership in the firm
angel investors
The portion of a company’s profits that are kept by the company rather than distributed to the stockholders as cash dividends
retained earnings
The overall goal of the financial manager is to
maximize shareholder weath
Maximizing owner’s equity value means carefully considering:
how to best bring additional funds into the firm

which projects to invest in

how best to return profits from those projects to the owners over time

DOES NOT INCLUDE: how best to increase the firm’s risk

The most common type of business in the US
Sole propreitership
The biggest disadvantage of the sole proprietorship
unlimited liability
Advantages to organizing a corporation as a business organization
limited liability

easy access to capital

easy to transfer ownership

Which of the following statements are correct:

1. Sole proprietorship are easy to start.

2. If the sole proprietorship gets sued, the owner is not liable.

3. It is relatively easy for sole proprietorship to raise money.

4. Profits from the sole proprietorship are subject to double taxation

sole proprietorship are easy to start
From a taxation perspective, the form of business organization with the highest level of taxes is the:
corporation

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