Intro to Corporate Finance

Welcome to finance. Specifically corporate finance.

First things first, we have to explain a key principle:

Your job should be to maximize shareholder’s equity (wealth).

In order to do that, you need to consider

  • Investments – Gaining more cash flow from assets than their cost. How risky it might be.
  • Financing – The mixture of debt and equity that is best for your business/company.
  • Dividends – How much cash we return to those that help us grow or operate.

Corporate Financing seeks to maximize the value of the business. It is the key objective.

 



Three Major Forms of Business Organization

  • Sole Proprietorship
  • Partnership (either General or Limited)
  • Corporation (possibly an LLC)


What is a Sole Proprietorship?

A sole proprietorship is a business owned by a single individual.

Key Advantages: Easiest to start, Least regulated, Single owner (keeps all profits), and is taxed once as personal income.

Key Disadvantages: Limited to the life of the owner, Equity limited to the owner’s personal wealth, and unlimited liability.



What is a Partnership?

A partnership is a business formed by two or more individuals.

Key Advantages: Income taxed once as personal income, More capital is available, It is relatively easy to start, and there is more than one owner.

Key Disadvantages: Difficult to transfer ownership, The partnership dissolves when one partner dies/wishes to sell, and unlimited liability.



What is a Corporation?

A corporation is a business created as a distinct legal entity. It is owned by one or more individuals.

Key Advantages: Limited liability, It is easier to raise capital, Separation of ownership and management, Unlimited life, and Transfer of ownership is easy.

Key Disadvantages: Double taxation (Income that is taxed at the corporate rate before the dividends are taxed at the personal rate).

 


The Agency Problem

Principals (stockholders) hire agents (managers) to run the company and represent his/her interests.

The Agency Problem is when there is a conflict of interest between the agent and the principal.

 


Managers

Managers need compensation (bonuses/stock options/etc.).

  • Incentives help align management and stockholder interest.

 

Next Topic: Cash Flows, Financial Statements, & Taxes

 

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