Notes of Corporate Finance

Corporate finance

Chapter 1

1. The type of firms

1. Sole proprietorships

no separation between the firm and the owner, only one owner, others can’t hold an ownership stake;

unlimited personal liability for the firm’s debts;

1. Partnerships

More than one owner;

All partners are liable for the firm’s debt (unlimited liability);

Partners can avoid liquidation if the partnership agreement provides for alternatives such as a buyout of a deceased or withdrawn partner;

A limited partnership: a partnership with two kinds of owners: general partners and limited partners; limited liability- liability is limited to the investment, have no management authority

1. Limited liability companies/corporation

Limits the owner’s liability to their investment;

Private company: are not allowed to trade their shares on an organized exchange;

Public company: are allowed to have their shares traded on an organized exchange;

1. Features of corporations:

is legally defined, artificial being, separate from its owners;

has legal power;

a legal document is created upon the formation of a corporation; higher cost to set up;

no limit to the number of owners; stock: ownership or equity; equity: collection of all the outstanding shares;

corporation’s profits are subject to taxation separate from its owners’ tax obligations; shareholders pay taxes twice; double taxation/ “classical system”;

an alternative system is imputation system, whereby the dividend is regarded as a flow of profits direct to the shareholders and is therefore considered to be only one source of income that is not subject to double taxation (for “S” corporations);

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1. The financial manager

1. making investment decisions
2. making financing decisions
3. cash for treasury management(managing working capital)
4. the goal of the firm

increase the value of their shares

1. The financial manager’s place in the corporation

board of directors

the corporate management team CEO

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Agency problems:

The interest of managers and stakeholders will conflict;

The interest of stakeholders will conflict with each other’s;

The CEO’s performance:

1. The share price of the corporation is a barometer for corporate leaders that continuously gives them feedback on the shareholders’ opinion of their performance
2. Hostile takeover

Corporate raider

1. The stock market

1. Stock market(stock exchange/bourse): these markets provide liquidity for a company’s shares and determine the market price for those shares.

Liquid:

1. Primary and secondary markets
2. Physical market

Market makers:

Bid price

Ask price

Auction market: share prices are set through direct interaction of buyers and sellers

Bid-ask spread (transaction cost)

1. Over-the-counter stock markets (OTC)

Dealer markets: a market where dealers are connected by computers and telephones

Listing standards

1. Financial institutions

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Chapter 2

1. Firm’s disclosure of financial information

Financial statements: accounting reports issued periodically;

Annual report;

GAAP(Generally Accepted Accounting Principles) and IFRS(International Financial Reporting Standard);

Auditor: a neutral third party;

1. Balance sheet or statement of financial position

A snapshot of firm’s financial position at a given time;

1. Assets

Current assets: can be converted to cash within one year; cash and other marketable securities, accounts receivable, inventories and others;

Non-current assets: produce tangible benefits for more than 1 year; property, plant and equipment; book value= acquisition cost less accumulated depreciation;

1. Liabilities

Current liabilities (be satisfied in 1 year): accounts payable, short-term debt, accrual items;

Net working capital: current assets-current liabilities;

Non-current liabilities: long-term debt;

1. Shareholder’s Equity or book value of equity (net worth of the firm)

Why the balance sheet can not provide an accurate assessment of the true value of the firm’s equity? (1) many of the assets listed in the balance sheet are valued based on its historical cost but not their true value today; (2) many of the valuable assets are not captured on the balance sheet

1. Market capitalization: total market value of a firm’s equity=shares outstanding*market price per share;

The book value of equity can be negative and is not necessarily an indication of poor performance;

1. Market-to-Book Ratio or Price-to-Book Ratio

Market value of equity/ book value of equity

Market-to-Book Ratio exceeds 1 indicating that the value of the firm’s asset when put to use exceeds their historical cost;

1. Enterprise value(TEV)

Assesses the value of the underlying business assets, unencumbered by debt and separate from any cash and marketable securities.

EV= market value of equity+debt-cash

Can be interpreted as the cost to take over the business;

1. The income statement

1. Earnings calculation

Gross profit: sales revenues-the cost of sales(manufacturing costs);

Operating expenses: administrative expenses and overhead, salaries, marketing costs, depreciation and amortization and research and development expenses; GP-operating expenses=operating income(profit);

Earnings before interest and taxes: include other sources of income or expenses that arise from activities that are not the central part of a company’s business.

Pretax and net income: EBIT- interest paid on outstanding debt= pretax income; pretax income- corporate taxes=net income; earnings per share(EPS)= net income/ shares outstanding;