September 3rd Introduction to Corporate Finance
Review Accounting Principles
Excess in Current Assets are immediate forms of liquid capital.
Forms of Business Organization
1. Sole Proprietorship
a. Business of a single individual
b. Unlimited Liability in this business
2. Partnership (general partnership vs limited partnership)
a. Set up a Partnership contract with another entity.
b. Pull more resources and have more sources of capital.
c. Hedge Funds, Ventura Capitalist are usually engaged in limited partnership.
d. General Partners are exposed to unlimited liability
e. Limited Partners enjoy limited liability.
3. Corporation (also known as joint-stock companies)
a. Limited Liability: If company fails to pay the debt, shareholders are not liable.
i. They loose money, but no responsibility towards debt.
Ease of Creation
Access to Capital
Taxation
Liability
Proprietorship
Easy
Small
Pass-through
Unlimited
Liquidity of Low
Ownership
Continuity Limited
Partnership
Relatively Easy
Medium
Pass-through
Unlimited (General
Partners)
Low
Corporation
Hard
Hard
Double Taxation
Limited
Limited
Unlimited
High
Government intervenes in IPO settings for corporations. They regulate how corporations should
run by telling who the mangers are and sharing financial statements.
Listed Companies in organized exchange list. More willing to buy stocks in a public stock market.
There is a bigger risk in private companies, but there is no market that buys that stock.
Double Taxation justified because two legal entities are part of the corporation. Tax Company and
Dividend also taxed.
Limited Liability Companies (LLC)
Hybrid of partnership and corporations. Only taxed when distributing dividends. (Ex. Investment
banking companies, large accounting firms.
September 5th Continuation of Introduction to Corporate Finance
In calculating Net Income do not take into consideration Depreciation as well as purchase of assets
and licenses. Does not do well in calculating inflow and outflow of money.
Goal of Financial Management: Maximize the current value of existing shareholder’s equity.
This is because share price today captures future earning possibilities.
Residual Claimants (RC): After paying the rest of the company (Tax to Government, Employee
wage, R&D, Assets) shareholders get their money last. Paid amount not predetermined, but they
have a contract to predetermined amount they earn. Shareholders are faced with huge amounts of
uncertainty.
RC: *If the last person gets paid, everyone else before him gets paid. In this case it’s the
shareholders. So, this theory states, that maximizing shareholders’ profit will make everyone
happy and this group of people appoint the board of directors, CEO and other people.
RC: Dark side, in the predetermined formula that gives wages to the employees, the money given
can be given such as they are predetermined methods to earn money for stakeholders.
Co-Determination: Dual board system that lets both shareholders and employees. Supervisory
board 50% shareholders and 50% employees and they elect the managing board.
There are labor laws, fair trade acts, tax laws to help and protect all stakeholders.
Agency Problems and Remedies
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Agency Relationship:
o Principal hires an agent to represent his/her interest
o For example, shareholders (principals) hire managers (agents) to run the company
Agency Problem:
o Agents not pursuing the interest of a principal
 CEO: Look at short-term, over pay himself (executive compensation),
increasing their domain, if acquisition  more money (due diligence) gets
paid more etc.
 Acquisitions are value destroying.
o Conflict of interest between principal and agent
o Interest misalignment between principal and agent
Agency Cost: arises because we need to monitor the CEO.
When do we see Agency Problem?
o In firms with dispersed share ownership management has de facto full control over
the firm (separation of control and ownership)
September 5th Financial Statements, Taxes & Cash Flows
Certificate of Deposit, Short Term Treasury Bills, Corporate Bill.
Account Receivables: Money owed by clients
Retained earnings: part of net income that is retained (in the form of dividends)
Ones the company buys back stock, voting rights are removed and dividend not payed because
bought back by the company.
Even among shareholders the common shareholders are the RCs.
Accrued principal.
September 9th Financial Statements, Taxes & Cash Flows
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Marginal Tax Rate: The tax rate at the highest level of economic bracket is called the
marginal tax rate (income bracket).
o Percentage pay on the next dollar earned
Average Tax Rate: the tax bill / taxable income
Progressive: depending on how much corporations earn
Flat: Does not change depending on profit (Marginal and Average is the same)
Ex. You earned 95k dollars.
You have earned from each income bracket (0-50k, 50k~75k and 5k~100k)
Marginal tax rate is the tax for any additional dollar you generate.
CF(A) = CF(B) + CF(S)
A = Assets; Distributable CFs; Free Cash Flow, B or D = Creditors, S = Share holders
Why add depreciation? To cancel out the initial subtraction on Assets.
September 9th Working with Financial Statements
Learn about sources and Uses of Cash
September 17th Continued
Ratio Analysis
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Short-term solvency or liquidity ratios
Long-term solvency or financial leverage ratios
Asset management or turnover ratios
Profitability ratios
Market value ratios
Short-term Solvency or Liquidity
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑡𝑙𝑖𝑡𝑒𝑠
Current Ratio: It is inefficient if the ratio is too high if there is too much money in the bank. If it
is too low there is danger in not being able to meet with current liabilities.
Long-term Solvency or Leverage
Ratios of debt of assets, equity. Popular one to use is debt to equity ratio.
Equity Multiplier: Assets = Debt + Equity. Useful in DuPont Analysis
Minimize tax liability with debt finance. Taxable income will be less because interest income
becomes low.
Depreciation: Tangible assets lose value over time.
Amortization: Intangible assets lose value over time.
Asset Turnover Ratios
How efficiently companies are using their assets.
Profitability Ratios
Measuring profitability as a fraction of sales.
Market Value Ratios
This tries to capture how much of a profit net income will the company be generating in the future.
One way to do this is by looking at stock price.
September 17th Long-Term Planning and Growth
Capital retained inside the company: Retained Earnings (for next year’s use)
Raise debt capital or equity capital.  Come up with External financing need.
Not given the growth rate, given financing policy. Given the policy, how much can the company
grow?
***Review Chapter 4 from the beginning***
Firms not Operating at Full Capacity
If the growth rate is less than the full capacity sales, it means that no new assets are needed to
achieve that growth rate.
565 – subtract net increment from previous slides (8).
Only need to increment 115.
EFN = External Financing needed.
September 24th Lessons from Capital Market History
Summarizing Return Data
R1+R2+ … + RT
If we do not square, some will be positive and others negative.
Equity Risk Premium
October 1st Return, Risk and the Security Market Line
Asset Pricing Model: Find the determined expected return.
Portfolio Beta: Weighted average of individual betas