FIN 357 Exam 1 Learning Objectives 1. Introduction to Corporate Finance 1.1. Define Corporate Finance a. Define Finance as making capital budgeting, capital structure and net working capital decisions ●Capital Budgeting: looking at long-term investments ●Capital Structures: the mix of debt and equity a firm needs for long-term investments ●Working Capital: managing short-term assets b. Describe the reporting structure of the typical finance function 1.2. Compare and contrast the 3 main forms of business organization (sole proprietorship, partnership, corporation) plus limited partnerships and LLCs, in terms of: a. Ease of creation b. Access to capital c. Pass-through vs. double taxation d. Limited vs. unlimited liability for owners e. Limited vs. unlimited life of the business f. Liquidity of ownership ●Sole proprietorship- A business owned by one person ○Pros: (1) cheapest form of business, (2) no corporate taxes ○Cons: (1) unlimited liability, (2) limited life, (3) limited equity ●Partnership-A business formed by two or more people - 2 types (general and limited) ○Pros: (1) inexpensive to form, (2) income taxes as personal income, (3) general partners control management ○Cons: (1) general partners have unlimited liability, (2) limited life, (3) difficult to transfer ownership, (4) difficult to raise large amounts of cash ●General partnership ○Each partner liable for all debts of the partnership ○Partnership agreement specifies how work & profits will be divided ○Partnerships agreement may be written or oral ●Limited partnership ○Liability of some partners is limited to the amount of cash contributed to the partnership ○One partner must act as the general partner ○Limited partners do not participate in managing the business ●Corporation ○A distinct legal entity with a name and many legal powers of a natural person (can acquire property, can sue & be sued, citizen of state in which it is formed, pays taxes separately from owners) ○Pros: (1) unlimited life, (2) limited liability, (3) easy to raise cash, (4) easy transfer of ownership ○Cons: (1) double taxation - corporations are first taxed on profits that are earned. Dividends and other payouts to shareholders are then taxed a second time as personal income of the shareholders.
1.3. Define the goal of financial management; that is, the goal of the corporation a. Understand that "the goal of the corporation is to maximize the current value per share of the existing stock" b. Generalize the goal to "maximize the value of existing owners' equity" to apply to all forms of business c. Explain the necessary constraints to maximizing shareholder wealth 1.4. Define the agency relationship in a corporation a. Identify agency problems and how they create agency costs ●Agency Problem: the possibility of a conflict of interest between stockholders and management of a firm ○Affected by compensation (think realtors) b. Identify mechanisms employed to control agency costs ●Financial compensation to high performers ●Job prospects (promotion) c. Differentiate between stockholders and stakeholders ●Stakeholder: someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm. d. Explain key provisions of Sarbanes-Oxley and why it exists ●"SOX" is intended to protect investors from corporate abuses. This was in response to corporate scandals such as Enron, WorldCom and Tyco. ●Section 404 states that each company's annual report must have an assessment of the company's internal control structure and financial reporting. ● Insure independence of board of directors ● Maintain accounting controls ● Establish compliance, ethics programs ● Committee oversight 2. Financial Statements, Taxes, and Cash Flow 2.1. Given a data set, define the major balance sheet accounts and prepare a balance sheet a. Define the accounting identity (also called the balance sheet identity) b. Identify and explain the logic in organization of the balance sheet (eg., order of liquidity, order of claims) ●Assets are organized from most to least liquid (easy to get rid of) ●Liabilities are organized from current→LTD c. Define liquidity ●How quickly and easily an asset can be converted to cash d. Define and calculate net working capital ●Current assets-Current Liabilities;a positive number means that the firm spent cash aka additions to net working capital e. Differentiate between current and long-term assets, tangible and intangible assets
●Current assets have a life of less than one year (ie. accounts receivable) ●Tangible is something physical (e.g. truck, computer) ●Intangible is the non-physical (e.g. trademark, patent) f. Differentiate between current and long-term liabilities ●Current liabilities have a life of less than one year (ie. accounts payable) g. Differentiate between assets and claims on assets ●Assets are what a company owns ●Claims on assets include owner's equity and liabilities h. Understand the difference between debt and equity ●When a firm borrows money it is debt. The debt holders have the first claim on the cash flows of the company. ●Equity holders only have a residual or a claim to what is left over when debt holders are paid. i. Define financial leverage ●The use of debt in a firm's capital structure ●Magnifies gains and losses j. Understand how depreciation impacts the balance sheet ●When firms depreciate their assets, accumulated depreciation on the balance sheet increases and reduces the net book value of the asset k. Differentiate between market (economic) values and book (accounting) values ● Historical costs can be objectively and precisely measured whereas market values can be difficult to estimate l. Determine common stock's accounting value ●Amount added to Common Stock Account = issued shares*par value per share 2.2. Given a data set, prepare an income statement a. Differentiate between the operating and non-operating sections of the income statement ●Operating costs refer to the costs incurred to maintain day-to-day operations b. Contrast accrual accounting and cash accounting; recognize how cash benefits and costs differ from revenues and expenses ● c. Define the matching principle of GAAP ● d. Compute straight-line depreciation ●Cost of fixed asset/useful life e. Understand how depreciation impacts the income statement and cash flows ● f. Record the interest portion of debt payments on the income statement ● g. Differentiate between variable and fixed costs ● h. Define and compute profit: gross, operating (EBIT), EBITDA, net 2.3. Given a partial income statement and tax table, calculate income tax expense a. Calculate and differentiate among marginal, average and flat taxes b. Explain the impact of the TCJA of 2017 on tax rates c. Calculate income tax expense for firms and owners, given various forms of business organization d. Explain the concept of double taxation