Finance (Introduction)

Created @September 9, 2022 6:34 PM

Class Finance 01

Reviewed

📌 WHAT IS THE GOAL OF A BUSINESS?

First Impression: To earn profit or money

Profit Maximization:

Profits depend on sales; sales require that firms develop desirable products and services, produce them
efficiently, and sell them at competitive prices.

Management should try to maximize stock prices, but their actions should be subject to government-
imposed constraints.

The Goal of a business is not only profit maximization but also stock value maximization
Stock Value Maximization:

The “true, long-run value,” which may be different from the current stock price.

Good managers understand the importance of ethics, and recognize that maximizing long-run value is
consistent with being socially responsible.

FINANCE

Finance (Introduction) 1
 the system that includes the circulation of money, the granting of credit, the making of investments,
and the provision of banking facilities (Webster)

Areas of Finance
A. Financial Management

“Corporate Finance”

Decisions relating to - how much and what type of assets to acquire, how to raise the capital
needed to purchase assets, and how to run the firm so as to maximize its value.

B. Capital Markets

Markets where interest rates, along with stock and bond prices, are determined

Financial institutions that supply capital to businesses

Extend their scope outside the business or the company

C. Investments

Relate to decisions concerning stocks and bonds

Includes a number of activities:

1. Security analysis - finding the proper values of individual securities (i.e., stocks and bonds)

2. Portfolio theory - deals with the best way to structure portfolios, or “baskets,” of stocks and bonds

3. Market analysis - whether stock and bond markets at any given time or “too high,” “too low,” or
“about right”

FINANCE VS. ECONOMICS AND ACCOUNTING

In a nutshell, accounting talks about money that has been spent (talks about money that is in the past)

Finance talks about how money could and should be spent (talks about the future)

Economics talks about the bigger picture, it involves supply and demand chain (macroeconomics and
microeconomics theories)

Finance lies between economics and accounting

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 FORMS OF BUSINESS ORGANIZATION
PROPRIETORSHIP PARTNERSHIP CORPORATION LLC & LLP

- Legal entity created by a

state, separate and distinct
- Legal arrangement from its owners and Limited Liability Company
- Unincorporated business between two or more people managers (ex. in the eyes of (LLC) - Hybrid between a
owned by one individual who decide to do business the law, apple is separate partnership and a
together from its owner, this is why corporation
first advantage is limited
liability.)

Limited Liability
Advantages: Advantages: Advantages:
Partnership (LLP)
- Easy and inexpensive to - Easily established and - Limited liability of
- Similar to an LLC
form inexpensive stockholders

- Income is allocated on a
pro rata basis to the partners - Used in the fields of
- Subject to few
and taxed on individual basis - Unlimited lives accounting, law, and
government regulations
(income and tax allocation architecture
are fair)

Similar to corporations, LLCs

and LLPs provide limited
- Subject to lower income - Easier to transfer shares of
liability protection, but
taxes than are corporations stock
they are taxed as
partnerships

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 PROPRIETORSHIP PARTNERSHIP CORPORATION LLC & LLP

- Easier for corporations to

raise capital

Disadvantages: Disadvantages: Disadvantages:

- Partners are generally

- Unlimited personal liability subject to (and share) - Corporate income taxes
unlimited personal liability

- Double taxation -
- Unlimited liability makes it
corporation’s earnings are
- Limited Life (limited difficult for partnerships to
taxed and its dividends are
lifespan on that individual) raise large amounts of
taxed again as personal
capital
income to the stockholders
- Difficulty in obtaining large
sums of capital (since
you’re only depending on
yourself to form that
capital)

KEY TAKEAWAYS
Limited liability - reduces the risks borne by investors, and, other things held constant, the the firm’s risk,
the higher its value.

A firm’s value is dependent on its growth opportunities, which are dependent on its ability to attract
capital. Because corporations can attract capital more easily than other types of businesses, they are
better able to take advantage of growth opportunities.

The value of an asset also depends on its liquidity - which means the time and effort it takes to sell the
asset for cash at a fair market value. Because the stock of a corporation is easier to transfer to a potential
buyer than is an interest in a proprietorship or partnership, and because more investors are willing to
invest in stocks than in partnerships (with their potential unlimited liability), a corporate investment is
relatively liquid.

📌 MAIN FINANCIAL GOAL:

CREATING VALUE FOR INVESTORS (delivering consistently high returns on their

capital)

Managers and employees work on behalf of the shareholders who own the business, and therefore they
have an obligation to pursue policies that promote stockholder value

Other company goals should not take precedence over the main financial goal, which is to create value
for investors.

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 The value of any asset is the present value of the stream of cash flows that the asset provides to its
owners over time.

1. Managerial Actions, the Economic Environment, Taxes, and the Political Climate - these are all
information that investors must consider before investing money into a business. This information is
subdivided into two: true and the perceived

2. “True” Investor Cash Flows and “True” Risk - True refers to Cash flows and Risk that investors would
expect if they had all the information, that existed about the company.

3. “Perceived” Investor Cash Flows and “Perceived Risk” - If we’re talking about perceived, what
investors expect given the limited information they have.

📌 True is when all information is available while Perceived is when limited information is available.

4. Stock’s Intrinsic Value - if the information we have is true, we are able to estimate a stocks true value
based on accurate risk and return data. This can be estimated but not measured precisely

5. Stock’s Market Price - if the information we have is perceived, then we are able to know the stock’s
market price, which is the actual market price but possibly incorrect information as seen by the marginal
investor.

6. Market Equilibrium: Intrinsic Value = Stock Price

This is the phenomenon when the investors are indifferent between buying and selling the stock. Because
intrinsic value is equal to stock price, thus, there is no pressure for a change in the stocks price.

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 KEY TAKEAWAYS

Managerial actions, combined with the economy, taxes, and political conditions, influence the level and
riskiness of the company’s future cash flows, which ultimately determine the company’s stock price.

Investors like higher expected cash flows, but they dislike risk; so the larger the expected cash flows and
the lower the perceived risk, the higher the stock’s price.

Finance (Introduction) 6