FIN303
Vicentiu Covrig
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Vicentiu Covrig
FIN303
 Financial management/ Corporate finance
 Investments
 Money and capital markets
Check out the file Careers in Finance posted on the course’s web site
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Vicentiu Covrig
FIN303
Alternative Forms of Business Organization: Sole proprietorships & Partnerships
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Sole proprietorship: un unincorporated business owned by one individual
Partnership: un unincorporated business owned by two or more individuals
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Advantages
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages
Difficult to raise capital
Unlimited liability
Limited life
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Vicentiu Covrig
FIN303
 Advantages
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
 Disadvantages
Double taxation
Cost of set-up and report filing
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Vicentiu Covrig
FIN303
Stock Prices and Shareholder Value
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The primary financial goal of management is shareholder wealth maximization, which translates to maximizing stock price.
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Value of any asset is present value of cash flow stream to owners.
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Most significant decisions are evaluated in terms of their financial consequences.
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Stock prices change over time as conditions change and as investors obtain new information about a company’s prospects.
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Vicentiu Covrig
FIN303
 Projected cash flows to shareholders
 Timing of the cash flow stream
 Riskiness of the cash flows
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Vicentiu Covrig
FIN303
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In equilibrium, a stock’s price should equal its “true” or intrinsic value.
To the extent that investor perceptions are incorrect, a stock’s price in the short run may deviate from its intrinsic value.
It’s a BUY if the market stock price is below the investor’s intrinsic value
It’s a SELL if the market stock price is above the investor’s intrinsic value
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Vicentiu Covrig
FIN303
 No, despite a generally high correlation amongst stock price,
EPS, and cash flow.
 Current stock price relies upon current earnings, as well as future earnings and cash flow.
 Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa).
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Vicentiu Covrig
FIN303
Conflicts Between Managers and Stockholders
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Managers are naturally inclined to act in their own best interests (which are not always the same as the interest of stockholders).
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But the following factors affect managerial behavior:
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Managerial compensation packages
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Direct intervention by shareholders
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The threat of firing
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The threat of takeover
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Vicentiu Covrig
FIN303
Conflicts Between Stockholders and
Bondholders
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Stockholders are more likely to prefer riskier projects, because they receive more of the upside if the project succeeds. By contrast, bondholders receiving fixed payments are more interested in limiting risk.
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Bondholders are particularly concerned about the use of additional debt.
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Bondholders attempt to protect themselves by including covenants in bond agreements that limit the use of additional debt and constrain managers’ actions.
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Vicentiu Covrig
FIN303
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What are the key differences between sole proprietorship, partnerships, LLC,
LLP and corporations?
What is the primary goal of a corporation? Shareholder wealth maximization
(text page 8-9)
What is the difference between a stock’s current market price and its intrinsic value? (text pages 10 to 13)
What are some mechanisms that encourage managers to act in the best interest of stockholders? Executive compensation (text pages 10 to 13)
Business ethics (text p. 15-18)
Conflicts Between Managers and Stockholders (text p. 18-20)
Conflicts Between Managers and Bondholders (text p. 20)
No calculations required for this chapter
Recommended practice questions: ST-1, 1-1, 2, 3, 4, 6, 8, 10, 11,
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