Chapter 1: Overview of Corporate Finance Flashcards
1
Q
Real estate investment trust (REIT)
A
A real estate investment trust is a company that owns or finances income-producing real estate.
2
Q
Three questions that must be answered when starting a business
The job of the financial manager to answer these
A
1) What long-term investments should you take on? (capital budgeting)
2) Where will you get the long-term financing to pay for your investment? AKA what type of financing (debt or equity financing) (capital structure)
3) How will you manage your everyday financial activities, such as collecting from customers and paying suppliers? (working capital management)
3
Q
1) What long-term investments should you take on?
A
That is, what lines of business will you be in and what sorts of buildings, machinery, equipment, and research and development facilities will you need?
4
Q
2) Where will you get the long-term financing to pay for your investment?
A
2) Where will you get the long-term financing to pay for your investment?
5
Q
A striking feature of large corporations is that the ____________ are usually not directly involved in making business decisions, particularly on a day-to-day basis.
A
owners (the shareholders)
6
Q
What have raised the stakes in financial managers decisions?
A
1) Globalization of markets,
2) advanced communications and computer technology,
3) and increased volatility of interest rates and foreign exchange rates
7
Q
CFO
A
Chief Financial Officer
8
Q
The COO reports to the_______, who may also be CEO
A
chairman
9
Q
The ____ reports to the president, who is the chief operating officer (COO) in charge of day-to-day operations
A
CFO
10
Q
However, as businesses become more complex, there is a growing pattern among large companies to separate the roles of chair and _____
A
CEO
11
Q
The CEO has overall responsibility to the ______
A
board
12
Q
The vice president of finance coordinates the activities of the ________ and the _______
A
treasurer and the controller
13
Q
The ___________ handles cost and financial accounting, tax payments, and management information systems
A
controller’s office
14
Q
The ____________ is responsible for managing the firm’s cash, its financial planning, and its capital expenditures
A
treasurer’s office
15
Q
Who is above the board of directors in the hierarchy?
A
The shareholders
16
Q
capital budgeting
A
The process of planning and managing a firm’s investment in long-term assets.
17
Q
In ___________, the financial manager tries to identify investment opportunities that are worth more to the firm than they will cost to acquire
A
capital budgeting
18
Q
Example of an capital budgeting decision
A
capital budgeting
19
Q
Evaluating the _____, _________and __________ of future cash flows is the essence of capital budgeting
A
size, timing, and risk
20
Q
The financial manager must be concerned with three basic types of questions, these are:
A
1) The first question concerns the firm’s long-term investments
2) The first question concerns the firm’s long-term investments
3) The third major question concerns working capital management
21
Q
capital structure (aka financial structure)
A
The mix of debt and equity maintained by a firm.
Refers to the mixture of short-term debt, long-term debt, and equity the firm uses to finance its operations
22
Q
The financial manager has two concerns when it comes to capital structure
A
1) First, how much should the firm borrow; that is, what mixture is best? The mixture chosen affects both the risk and value of the firm
2) Second, what are the least expensive sources of funds for the firm?
23
Q
In addition to deciding on the financing mix, the __________ has to decide exactly how and where to raise the money.
A
financial manager
24
Q
working capital management
A
Planning and managing the firm’s current assets and liabilities.
25
Working capital
Refers to the difference between a firm's short-term asses, such as inventory, and its short-term liabilities, such as money owed to suppliers
26
Managing the firm’s _________is a day-to-day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions
working capital
27
Some of the questions about working capital that must be answered are
1) How much cash and inventory should we keep on hand?
2) Should we sell on credit and on what terms?
3) How do we obtain short-term financing?
4) Will we purchase on credit or borrow short term and pay cash?
5) If we borrow short term, how and when should we do it?
28
The three questions can be visualized on a balance sheet model
(1) What assets should the corporation invest in (left-hand side of balance sheet)?
(2) How should the corporation set the mix of debt and equity (right-hand side of balance sheet)?
(3) How should the corporation manage the short-term assets and liabilities (top of the balance sheet)?
29
Five different legal forms of business organization
1) Sole proprietorship
2) Partnership
3) Corporation
4) Income trust
5) Co-operative
30
Sole Proprietorship definition
A business owned by a single individual.
31
What is the simplest type of business to start and the least regulated form of organization
1) Sole proprietorship
32
What is most common type pf business?
Sole Proprietorship
33
Sole Proprietorship keep all the ______ but the owner has _________________ for business debts
Profits
Unlimited Liability
34
Unlimited Liability
This means that creditors can look beyond assets to the proprietor’s personal assets for payment.
35
Sole proprietorship get taxed how?
Similarly, there is no distinction between personal and business income, so all business income is taxed as personal income
36
When does a Sole proprietorship end?
When the owner of the business dies orrrr if they sell their entire business to someone
37
Partnership
A business formed by two or more co-owners.
38
general partnership
all the partners share in gains or losses, and all have unlimited liability for all partnership debts, not just some particular share
39
The way partnership gains (and losses) are divided is described in the _________
partnership agreement.
40
partnership agreement
This agreement can be an informal oral agreement or a lengthy, formal written document.
41
limited partnership
one or more general partners has unlimited liability and runs the business for one or more limited partners who do not actively participate in the business
42
A limited partner’s liability for business debts is limited to the amount contributed to the partnership
Invest 1 million, you are liable for 1 million
Examples: Real estate ventures
43
Advantages of partnerships
Same as sole proprietorship
Easy and inexpensive to form
44
When does the partnership terminate?
When a general partner wishes to sell dies
45
How is the income taxed for a partnership?
All income is taxed as personal income to the partners, and the amount of equity that can be raised is limited to the partners’ combined wealth
46
What are the primary disadvantages of sole proprietorship and partnership as forms of business organization
(1) unlimited liability for business debts on the part of the owners,
(2) limited life of the business, and
(3) difficulty of transferring ownership. These three disadvantages add up to a single, central problem—the ability of such businesses to grow can be seriously limited by an inability to raise cash for investment.
47
Corporation
A business created as a distinct legal entity owned by one or more individuals or entities.
48
In terms of size, the _________ is the most important form of business organization in Canada
corporation
49
Corporations can borrow _____ and own ______, can sue and be sued, and can enter into _________
money
property
Contracts
50
Forming a corporation involves preparing _________ (or a charter) and a __________
articles of incorporation
set of bylaws
51
The articles of incorporation
contain a number of things, including the corporation’s name, its intended Page 7life (which can be forever), its business purpose, and the number of shares that can be issued
52
Canadian firms can be incorporated under either the ____________________________ or _________________________
federal Canada Business Corporation Act or provincial law
53
The bylaws of a corporation
rules describing how the corporation regulates its own existence.
For example, the bylaws describe how directors are elected. These bylaws may be a very simple statement of a few rules and procedures, or they may be quite extensive for a large corporation.
54
In a large corporation, the___________ and the __________ are usually separate groups
shareholders and the management
55
IN a corporation, The shareholders elect the ___________, which then selects the managers
board of directors
56
Advantages to a corporation
Ownership (represented by shares of stock) can be readily transferred, and the life of the corporation is therefore not limited.
The corporation borrows money in its own name.
Ability to raise capital
As a result, the shareholders in a corporation have limited liability for corporate debts.
The most they can lose is what they have invested
SPERATE LEGAL ENTITY
57
While limited liability makes the corporate form attractive to ______, lenders sometimes view the limited liability feature as a ________
equity investors
disadvantage
58
Disadvantages to a corporation (corporate form)
1) federal and provincial governments tax corporate income
2) Corporate dividends received by shareholders are also taxable
3) The risk of managers not doing what is best for shareholders
59
Double taxation
1) federal and provincial governments tax corporate income
| 2) Corporate dividends received by shareholders are also taxable
60
Income Trust facets
- Starting in 2001, the income trust, a non-corporate form of business organization, grew in importance in Canada
- provincial legislation extended limited liability protection, which was previously limited to corporate shareholders, to trust unit holders
- Along the same lines, at the end of 2005, the TSX began to include income trusts in its benchmark S&P/TSX Composite Index
61
Income Trust definition
Income funds
hold the debt and equity of an underlying business and distribute the income generated to unit holders
THEY ARE NOT CORPORATIONS
62
Co-operative (Co-op)
an enterprise that is equally owned by its members, who share the benefits of co-operation based on how much they use the co-operative’s services
63
Four types of co-operatives
1) Consumer Co-op
2) Producer Co-op
3) Worker Co-op
4) Multi-Stakeholder Co-op
64
1) Consumer Co-op
This provides products or services to its members (such as a retail co-op, housing, health-care or child-care co-op).
65
2) Producer Co-op
This processes and markets the goods or services produced by its members, and supplies products or services necessary to the members’ professional activities (such as independent entrepreneurs, artisans, or farmers).
66
3) Worker Co-op
This provides employment for its members. In this co-op, the employees are members and owners of the enterprise.
67
4) Multi-Stakeholder Co-op
This serves the needs of different stakeholder groups, such as employees, clients, and other interested individuals and organizations (examples include health, home care, and other social enterprises).
68
There are more than _____ million co-op members in Canada
18
69
There are various key benefits of co-ops
such as helping producers compete effectively in the marketplace, serving rural and remote communities, developing community leadership, building social capital, and promoting local ownership and control.
70
The goal of financial management is to (vague)
Make money or add value to the owners
71
Possible financial goals
```
Survive in business.
Avoid financial distress and bankruptcy.
Beat the competition.
Maximize sales or market share. - Big one
Minimize costs. - Big one
Maximize profits. - Big one
Maintain steady earnings growth.
```
72
What is the most cited goal?
Profit maximization
73
Goals generally fall into two classes, these are?
1) Goals related to profitability
| 2) Goals involving bankruptcy avoidance, stability, safety, relate in some way to avoiding risk
74
1) Goals related to profitability
The goals involving sales, market share, and cost control all relate, at least potentially, to different ways of earning or increasing profits
75
The appropriate goal for the financial manager can thus be stated quite easily:
The goal of financial management is to maximize the current value per share of existing stock.
76
Residual owners
By this we mean that the shareholders are entitled to only what is left after employees, suppliers, and creditors (and anyone else with a legitimate claim) are paid their due
77
efficient capital market
In an efficient capital market, security prices fully reflect available information. The market sets the stock price to give the firm an accurate report card on its decisions
78
The total value of the stock in a corporation is simply equal to?
the value of the owners’ equity
79
Owner's equity can be measured how?
This market value can be measured by a business appraiser or by investment bankers if the firm eventually goes public.
80
Finally, our goal does not imply that the financial manager should take illegal or unethical actions in the hope of increasing the ____________ in the firm
value of the equity
81
Agency Relationships
The relationship between shareholders and management
82
When does an agency relationship happen?
Such a relationship exists whenever someone (the principal) hires another (the agent) to represent his or her interests
83
Agency problem
The possibility of conflicts of interest between the shareholders and management of a firm.
84
Example of agency problem
Hiring someone to sell a car that you own and them appraising it to a lower value after you had a poor ice breaker
85
Agency Cost example
The owners of the firm may wish to take the investment because the stock value will rise, but management may not because of the possibility that things will turn out badly and management jobs will be lost. If management does not take the investment, the shareholders may have lost a valuable opportunity
86
Agency cost definition (not blue)
The cost of conflict of interest between shareholders and management
87
Agency costs can be ______ or ________
direct or indirect
88
Direct agency costs come in two forms, these are:
1) Corporate expenditure that benefits management but not the shareholders (ex: buying a luxury unneeded corporate jet)
2) An expense that arises from the need to monitor management actions or the incentive fee paid to managers
89
Do Managers Act in the Shareholders’ Interests?
This is dependent on two factors
1) How closely are management goals aligned with shareholder goals
2) Can managers be replaced if they do not pursue shareholder goals
90
1) How closely are management goals aligned with shareholder goals
This question relates to the way managers are compensated
91
2) Can managers be replaced if they do not pursue shareholder goals
This issue relates to control of the firm.
92
Management frequently has a significant economic incentive to increase share value for two reasons
First, managerial compensation, particularly at the top, is usually tied to financial performance in general and often to the share value in particular.
The second incentive managers have relates to job prospect
93
First, managerial compensation, particularly at the top, is usually tied to financial performance in general and often to the share value in particular. Expand on this idea with an example
For example, managers are frequently given the option to buy stock at current prices. The more the stock is worth, the more valuable this option becomes
94
The second incentive managers have relates to job prospect, expand on this, why?
Better performers within the firm get promoted. More generally, those managers who are successful in pursuing shareholder goals are in greater demand in the labour market and thus command higher salaries
95
The ____________________________________ encourages performance-based compensation based on key business metrics
Canadian Coalition of Good Governance
96
What are some of the measures in the Canadian Coalition of Good Governance
These include financial ratios as well as non-financial measures, such as environmental, social, governance, and corporate sustainability metrics.
Such measures are designed to align management’s compensation with the corporation’s long-term performance.
97
The Canadian Coalition of Good Governance also suggests, instead of options, executives should be required to hold some _______ of the company while employed, and ideally for a period after
equity
98
In its _________________, the Coalition argues that use of stock options allows management to participate only in upside share performance, while not suffering any consequences on the downside.
Executive Compensation Principles,
99
Using _________ as a significant component of executive compensation can encourage inappropriate risk-taking and lead to unintended rewards that are not aligned with interests of long-term shareholders.
stock options
100
Many observers believe that top executives are overpaid. This belief led to the ______________
“say on pay”
101
“say on pay”
a firm’s shareholders have the right to vote on the remuneration of executives
102
Do Canadian companies have to have "say on pay" votes to gauge shareholder support for their compensation practices?
No sir
103
Control of the firm ultimately rests with the ___________-
shareholders
104
“poison pill” provisions
to make the stock unattractive or the firm may issue non-voting stock to thwart a takeover attempt
105
Corporate governance
Rules for corporate organization and conduct; rules and practices relating to how corporations are governed by management, directors, and shareholders.
106
Asides from management and shareholder, who else has a financial interests in a firm?
Employees, customers, suppliers, and various levels of government all have financial interests in the firm.
107
Stakeholder definition
Anyone who potentially has a claim on a firm.
or
Shareholder, creditor, or other individual (or group) that potentially has a claim on the cash flows of the firm
Could include:
108
Stakeholder __________ is consistent with shareholder wealth _________.
satisfaction
maximization
109
Corporate social responsibility (CSR), AKA corporate sustainability, or the triple bottom line
a company’s commitment to operate in an economically, socially, and environmentally sustainable manner
Investor's increasingly demanding that corporations behave responsibly
110
Many investors may turn to firms like __________, a leading provider of environmental, social, and governance (ESG) research for responsible investing information
Sustainalytics
111
A formal meta-analysis of 251 studies concludes that there is no significant relationship between _____________________ and ______________________
corporate social performance and corporate financial performance
112
Cash flows to and from the firm
Figure 1.3
Suppose we start with the firm selling shares of stock and borrowing money to raise cash.
Cash flows to the firm from the financial market (A).
The firm invests the cash in current and fixed assets (B).
These assets generate some cash (C), some of which goes to pay corporate taxes (D).
After taxes are paid, some of this cash flow is reinvested in the firm (E).
The rest goes back to the financial markets as cash paid to creditors and shareholders (F).
113
A financial market, like any market, is just a way of bringing ________ and _________ together
buyers and sellers
114
Two types of financial markets
1) Money Markets
| 2) Capital Markets
115
Money markets
Financial markets where short-term debt securities are bought and sold.
Dealer market
116
Capital Markets
Financial markets where long-term debt and equity securities are bought and sold.
Toronto Stock Exchange, for example, is a capital market
117
Short-term debt securities
are often called money market instruments and are essentially IOUs
118
____________ are an IOU of the Government of Canada
Treasury bills
119
The largest money market dealers are __________________ and _____________
chartered banks and investment dealers
120
Financial markets function as both _________________ and _____________ markets for debt and equity securities
1) Primary
| 2) Secondary
121
1) Primary markets
refers to the original sale of securities by governments and corporations (i.e IPO, prvate placements)
122
2) Secondary markets
where these securities are bought and sold after the original sale (I.e TSX)
123
__________ are, of course, issued solely by corporations.
Equities
124
___________ are issued by both governments and corporations
Debt securities
125
In Canada, ___________ is conducted by investment dealers specialized in marketing securities.
underwriting
Examples are RBC Capital Markets, Scotia Capital, BMO Capital Markets, and CIBC World Markets.
126
When a public offering is underwritten
an investment dealer or a group of investment dealers (called a syndicate) typically purchases the securities from the firm and markets them to the public. The underwriters hope to profit by reselling the securities to investors at a higher price than they pay the firm.
127
Securities regulation (of listed corporations and investment advisers) is a __________ matter
provincial
128
A ______________ transaction involves one owner or creditor selling to another.
secondary market
129
There are two kinds of secondary markets:
1) Auction markets
| 2) Dealer Markets
130
Dealer Markets in stocks and long-term debt are called _____________________
over-the-counter (OTC) markets
131
The largest stock market in Canada is an auction market called the ____________________
Toronto Stock Exchange (TSX)
132
Stocks that trade on an organized exchange are said to be ________ on that exchange.
“listed”
133
Financial institutions act as _________ between investors (funds suppliers) and firms raising funds
intermediaries
134
Individuals and households may choose to save not only in the traditional savings and chequing accounts, but also in savings plans such as a _______________________, Registered Education Savings Plan (RESP), or _____________________
Registered Retirement Savings Plan (RRSP)
Tax-Free Savings Account (TFSA)
135
Canadian financial institutions include chartered banks and other depository institutions, such as —
trust companies, credit unions, investment dealers, insurance companies, pension funds, and mutual funds
136
Big Six
```
The Big Six refers to the top six chartered banks in Canada: 1)
Royal Bank of Canada,
2) Toronto Dominion Bank,
3) Bank of Nova Scotia,
4) Bank of Montreal,
5) Brookfield Asset Management, and
6) Canadian Imperial Bank of Commerce.
```
137
Chartered banks operate under ___________, accepting deposits from suppliers of funds and making commercial loans to mid-sized businesses, corporate loans to large companies, and personal loans and mortgages to individuals
federal regulation
138
Indirect finance
The spread between the interest paid on deposits and the higher rate earned on loans
This is how banks make most their money
139
Bankers’ acceptance
This is an interest-bearing IOU stamped by a bank guaranteeing the borrower’s credit
140
Bankers’ acceptances are an example of ___________________
direct finance
141
The difference between direct finance and indirect finance
is that in direct finance funds do not pass through the bank’s balance sheet in the form of a deposit and loan. Because a security (the bankers’ acceptance) is created, this process is often called securitization
142
_________ are non-depository institutions that assist firms in issuing new securities in exchange for fee income
Investment dealers
143
Insurance companies
include property and casualty insurance and health and life insurance companies
144
Life insurance companies
engage in indirect finance by accepting funds in a form similar to deposits and making loans
145
In June 2017, the two largest categories of mutual funds were _________________ and ______________
equity funds and balanced funds
146
________ are less regulated and privately managed investment funds catering to sophisticated investors, which seek to earn high returns using financial strategies prohibited by mutual funds
Hedge funds
147
There is a _________associated with hedge funds as these are highly unregulated and subject to fraud
high risk
148
Like all markets, financial markets are experiencing rapid _______
globalization
149
Financial engineering
Creation of new securities or financial processes.
When financial managers or investment dealers design new securities or financial processes, their efforts are referred to as financial engineering
150
Successful financial engineering reduces and controls risk and _______
minimizes taxes
151
Derivative securities
Financial assets that represent claims to another financial asset.
152
Financial engineering also seeks to reduce _______ of issuing securities as well as the costs of complying with rules laid down by __________
financing costs
regulatory authorities.
153
Regulatory dialectic
The pressures financial institutions and regulatory bodies exert on each other.
154
Highest level of finance
Chief Financial Officer (CFO)
155
Sole proprietor advantages
- Ease of start-up
- Least regulated
- Owner operator keep profits
- Taxed an personal income
156
Sole proprietor disadvantages
- Unlimited liability
- Limited to life of owner
- Difficult to raise capital
- Difficult to transfer ownership interest
157
Partnership Advantages
- Ease of start-up
- Less regulated
- Access to more inputs (owners expertise and capital)
- Income taxed as personal income
158
Partnership Disadvantages
- Unlimited liability (general partnership and limited partnership
- Limited life
- Difficult to transfer ownership interest
159
Goal of financial management as per the live lecture recording
Maximize Owner's Equity
160
Corporate control (as per lecture)
The threat of a takeover may result in better management (i.e new owners may result in firing CEO)
