FInance Discussion Topic
Forum Topic Responses: Students are required to research their selected forum topic, using a minimum of 3 reference sources in addition to the text book, and then compile a 1,000-word response to the forum topic. APA format is required. The answer will be checked for any signs of plagiarism through an online database -- review in Turnitin.com and achieve less than a 20% rating before posting to the course. Be sure to include reference sources. (Please see attachments for lecture information regarding the topics listed).
Comprehensive, forum topic response contributions will be critically graded on the thought quality of the response, work effort, research, and analysis.
Select one of the following forum topics to research and write about:
The goal of financial management
The agency problem and corporate control
The balance sheet
The income statement
Financial cash flow
Chapter 1
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Key Concepts and Skills
Know the basic types of financial management decisions and the role of the Financial Manager
Know the financial implications of the various forms of business organization
Know the goal of financial management
Understand the conflicts of interest that can arise between owners and managers
Understand the various regulations that firms face
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Chapter Outline
1.1 What is Corporate Finance?
1.2 The Corporate Firm
1.3 The Importance of Cash Flows
1.4 The Goal of Financial Management
1.5 The Agency Problem and Control of the Corporation
1.6 Regulation
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1.1 What Is Corporate Finance?
Corporate Finance addresses the following three questions:
What long-term investments should the firm choose?
How should the firm raise funds for the selected investments?
How should short-term assets be managed and financed?
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Capital budgeting
Capital structure
Working capital
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Balance Sheet Model of the Firm
Current Assets
Fixed Assets
1 Tangible
2 Intangible
Total Value of Assets:
Shareholders’ Equity
Current Liabilities
Long-Term Debt
Total Firm Value to Investors:
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It is sometimes helpful to relate corporate decisions to individual circumstances. For example, consider discussing how individuals choose to buy cars or homes and how this decision would affect a personal balance sheet.
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The Capital Budgeting Decision
Current Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders’ Equity
Current Liabilities
Long-Term Debt
What long-term investments should the firm choose?
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The Capital Structure Decision
How should the firm raise funds for the selected investments?
Current Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders’ Equity
Current Liabilities
Long-Term Debt
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Short-Term Asset Management
How should short-term assets be managed and financed?
Net Working Capital
Shareholders’ Equity
Current Liabilities
Long-Term Debt
Current Assets
Fixed Assets
1 Tangible
2 Intangible
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The Financial Manager
The Financial Manager’s primary goal is to increase the value of the firm by:
Selecting value creating projects
Making smart financing decisions
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Note, these actions explicitly relate to the three questions addressed in slide 3.
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Hypothetical Organization Chart
Chairman of the Board and
Chief Executive Officer (CEO)
President and Chief
Operating Officer (COO)
Vice President and
Chief Financial Officer (CFO)
Treasurer
Controller
Cash Manager
Capital Expenditures
Credit Manager
Financial Planning
Tax Manager
Financial Accounting
Cost Accounting
Data Processing
Board of Directors
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1.2 The Corporate Firm
The corporate form of business is the standard method for solving the problems encountered in raising large amounts of cash.
However, businesses can take other forms.
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Forms of Business Organization
The Sole Proprietorship
The Partnership
General Partnership
Limited Partnership
The Corporation
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It may be beneficial to discuss S-Corporations and LLCs in the context of this slide.
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A Comparison
Corporation
Partnership
Liquidity
Shares can be easily exchanged
Subject to substantial restrictions
Voting Rights
Usually each share gets one vote
General Partner is in charge; limited partners may have some voting rights
Taxation
Double
Partners pay taxes on distributions
Reinvestment and dividend payout
Broad latitude
All net cash flow is distributed to partners
Liability
Limited liability
General partners may have unlimited liability; limited partners enjoy limited liability
Continuity
Perpetual life
Limited life
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Cash flow
from firm (C)
1.3 The Importance of Cash Flow
Taxes (D)
Retained
cash flows (F)
Invests
in assets
(B)
Dividends and
debt payments (E)
Current assets
Fixed assets
Short-term debt
Long-term debt
Equity shares
Ultimately, the firm must be a cash generating activity.
The cash flows from the firm must exceed the cash flows from the financial markets.
Firm issues securities (A)
Government
Firm
Financial
markets
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It is important to remind students that net income is NOT cash flow.
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1.4 The Goal of Financial Management
What is the correct goal?
Maximize profit?
Minimize costs?
Maximize market share?
Maximize shareholder wealth?
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1.5 The Agency Problem
Agency relationship
Principal hires an agent to represent his/her interest
Stockholders (principals) hire managers (agents) to run the company
Agency problem
Conflict of interest between principal and agent
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A common example of an agency relationship is a real estate broker – in particular if you break it down between a buyers agent and a sellers agent. A classic conflict of interest is when the agent is paid on commission, so they may be less willing to let the buyer know that a lower price might be accepted or they may elect to only show the buyer homes that are listed at the high end of the buyer’s price range.
Direct agency costs – the purchase of something for management that can’t be justified from a risk-return standpoint, monitoring costs.
Indirect agency costs – management’s tendency to forgo risky or expensive projects that could be justified from a risk-return standpoint.
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Managerial Goals
Managerial goals may be different from shareholder goals
Expensive perquisites
Survival
Independence
Increased growth and size are not necessarily equivalent to increased shareholder wealth
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Managing Managers
Managerial compensation
Incentives can be used to align management and stockholder interests
The incentives need to be structured carefully to make sure that they achieve their intended goal
Corporate control
The threat of a takeover may result in better management
Other stakeholders
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Incentives – discuss how incentives must be carefully structured. For example, tying bonuses to profits might encourage management to pursue short-run profits and forego projects that require a large initial outlay. Stock options may work, but there may be an optimal level of insider ownership. Beyond that level, management may be in too much control and may not act in the best interest of all stockholders. The type of stock can also affect the effectiveness of the incentive.
Corporate control – ask the students why the threat of a takeover might make managers work towards the goals of stockholders.
Other groups also have a financial stake in the firm. They can provide a valuable monitoring tool, but they can also try to force the firm to do things that are not in the owners’ best interest.
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1.6 Regulation
The Securities Act of 1933 and the Securities Exchange Act of 1934
Issuance of Securities (1933)
Creation of SEC and reporting requirements (1934)
Sarbanes-Oxley (“Sarbox”)
Increased reporting requirements and responsibility of corporate directors
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Quick Quiz
What are the three basic questions Financial Managers must answer?
What are the three major forms of business organization?
What is the goal of financial management?
What are agency problems, and why do they exist within a corporation?
What major regulations impact public firms?