Corporate Finance Assignment

Corporate Finance Assignment Words: 10091

FUNDAMENTALS OF Corporate Finance Jonathan Berk Stanford University Peter DeMarzo Stanford University Jarrad Harford University of Washington ISBN 0-558-65200-X Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. Editor in Chief: Donna Battista Sr.

Development Editor: Rebecca Ferris Market Development Manager: Dona Kenly Assistant Editors: Sara Holliday, Kerri McQueen Managing Editor: Jeff Holcomb Senior Production Supervisor: Meredith Gertz Digital Asset Manager: Marianne Groth Supplements Editor: Heather McNally Director of Media: Susan Schoenberg Senior Media Producer: Bethany Tidd MyFinanceLab Content Lead: Miguel Leonarte Marketing Assistant: Ian Gold Senior Manufacturing Buyer: Carol Melville Manager, Rights and Permissions: Zina Arabia Manager, Research Development: Elaine Soares Image Permission Coordinator: Annette Linder Rights and Permissions Advisor: Shannon Barbe Photo Researcher: Beth Anderson Senior Author Support/Technology Specialist: Joe Vetere Project Management: Nancy Freihofer Production Coordination: Janette Krauss Composition, Illustrations, and Alterations: Nesbitt Graphics/Thompson Steele Cover and Text Designer: Gillian Hall, The Aardvark Group Publishing Services Cover image: ??Getty Images/ David McNew Library of Congress Cataloging-in-Publication Data Berk, Jonathan B. , 1962Fundamentals of corporate finance/Jonathan Berk, Peter DeMarzo, Jarrad Harford. p. cm. Includes bibliographical references and index. ISBN 978-0-201-74159-9 (pbk. : alk. paper) 1. Corporations???Finance. I. DeMarzo, Peter M. II. Harford, Jarrad V. T. III. Title. HG4026. B464 2008 658. 15???dc22 2008032455 ISBN-13: 978-0-201-74159-9 ISBN-10: 0-201-74159-8

Don’t waste your time!
Order your assignment!


order now

Copyright ?? 2009 Pearson Education, Inc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. For information on obtaining permission for use of material in this work, please submit a written request to Pearson Education, Inc. , Rights and Contracts Department, 501 Boylston Street, Suite 900, Boston, MA 02116, fax your request to 617-671-3447, or e-mail at http://www. pearsoned. com/legal/permissions. htm. 2 3 4 5 6 7 8 9 10???CRK???12 11 10 09 08 Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. ISBN 0-558-65200-X PART 1 Chapter 1 Corporate Finance and the Financial Manager Introduction Valuation Principle Connection. What is Corporate Finance? No matter what your role in a corporation, an understanding of why and how financial decisions are made is essential. The focus of this book is how to make optimal corporate financial decisions. In this part of the book, we lay the foundation for our study of corporate finance. In Chapter 1, we begin by introducing the corporation and related business forms.

We then examine the role of financial managers and outside investors in decision making for the firm. To make optimal decisions, a decision maker needs information. As a result, in Chapter 2 we review and analyze an important source of information for corporate decision making???the firm’s accounting statements. These chapters will introduce us to the role and objective of the financial manager and some of the information the financial manager uses in applying the Valuation Principle to make optimal decisions. Then, in the next section of the book, we will introduce and begin applying the Valuation Principle. Chapter 2 Introduction to Financial Statement Analysis ISBN 0-558-65200-X 1

Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. 1 Corporate Finance and the Financial Manager ? Grasp the importance of financial information in both your personal and business lives LE ARNING OBJEC TIVES ? Know how a corporation is managed and controlled, the financial manager’s place in it, and some of the ethical issues financial managers face ? Understand the important features of the four main types of firms and see why the advantages of the corporate form have led it to dominate economic activity ? Understand the importance of inancial markets, such as stock markets, to a corporation and the financial manager’s role as liaison to those markets ? Explain the goal of the financial manager and the reasoning behind that goal, as well as understand the three main types of decisions a financial manager makes ISBN 0-558-65200-X 2 Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. INTERVIEW WITH Leslie Tillquist, PA Consulting Group Leslie Tillquist, who received a B. S. in Business Administration in Finance and Marketing from the University of Colorado, Boulder in 2007, wasn’t sure what she wanted to do after graduation. I enjoyed marketing’s focus on understanding human motivations and interactions, but I realized that finance provides a real-world understanding and skill set that leads to incredibly diverse career paths,” she explains. “It is hard to make credible decisions in business or nonprofit organizations without financially supporting and defending them. Understanding financial techniques allows individuals in all careers to pursue opportunities and solve problems in business situations. ” She joined the Denver office of PA Consulting Group, Inc. , an international consulting firm based in London with offices in more than 35 countries. “I wanted a high-energy, project-based environment where I could interact with the decision makers in a rapidly changing industry and also have the opportunity to work abroad,” she says.

Her finance degree gave her that opportunity within PA Consulting’s Global Energy Practice. “Within seven months, I have joined in projects for international banks, government, and a Fortune 500 company. Work has taken me across the United States as well as to England and South Africa. ” Her responsibilities include performing financial analysis and energy research that support client business analysis and the resulting strategic recommendations. For example, she uses different metrics to value assets, contracts, and companies, and creates company financial statements used in acquiring financing and evaluating opportunities. Leslie encourages students not to be intimidated by the rigor of finance courses. They give you essential fundamentals for business analysis in whatever area interests you, as well as the work ethic for further on-the-job learning,” she says. “Although it is sometimes hard to appreciate at the time, these classes provide the tools you need to resolve complex financial problems??? whether your career is in finance or not. ” She adds that she was very hesitant to study and work in finance. “I could not be more grateful for the opportunities available to me because I stuck with it. The work pays off immensely when I can communicate ideas eloquently and thoughtfully in business discussions. ” University of Colorado, 2007 “Finance classes provide the tools you need to resolve complex financial problems???whether your career is in finance or not. ” ISBN 0-558-65200-X 3

Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. 4 Part 1 Introduction This book focuses on how people in corporations make financial decisions. Despite its name, much of what we discuss in corporate finance applies to the financial decisions made within any organization, including not-for-profit entities such as charities and universities. In this chapter, we introduce the four main types of firms. We stress corporations, however, because they represent 85% of U. S. business revenue. We also highlight the financial manager’s critical role inside any business enterprise.

What products to launch, how to pay to develop those products, what profits to keep and how to return profits to investors???all of these decisions and many more fall within corporate finance. The financial manager makes these decisions with the goal of maximizing the value of the business, which is determined in the financial markets. In this chapter and throughout the book, we will motivate this goal, provide you with the tools to make financial management decisions, and show you how the financial markets provide funds to a corporation and produce market prices that are key inputs to any financial manager’s investment analysis. 1. 1 Why Study Finance?

Finance and financial thinking are everywhere in our daily lives. Consider your decision to go to college. You surely weighed alternatives, such as starting a full-time job immediately, and then decided that college provided you with the greatest net benefit. More and more, individuals are taking charge of their personal finances with decisions such as: ? ? ? ? When to start saving and how much to save for retirement. Whether a car loan or lease is more advantageous. Whether a particular stock is a good investment. How to evaluate the terms for a home mortgage. Our career paths have become less predictable and more dynamic. In previous generations, it was common to work for one employer your entire career.

Today, that would be highly unusual. Most of us will instead change jobs, and possibly even careers, many times. With each new opportunity, we must weigh all the costs and benefits, financial and otherwise. Some financial decisions, such as whether to pay $2. 00 for your morning Americano, are simple, but most are more complex. In your business career, you may face such questions as: ? ? ? ? ? Should your firm launch a new product? Which supplier should your firm choose? Should your firm produce a part of the product or outsource production? Should your firm issue new stock or borrow money instead? How can you raise money for your start-up firm? ISBN 0-558-65200-X

In this book, you will learn how all of these decisions in your personal life and inside a business are tied together by one powerful concept, the Valuation Principle. The Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. Chapter 1 Corporate Finance and the Financial Manager 5 Valuation Principle shows how to make the costs and benefits of a decision comparable so that we can weigh them properly. Learning to apply the Valuation Principle will give you the skills to make the types of comparisons???among loan options, investments, and projects???that will turn you into a knowledgeable, confident financial consumer and manager.

Finally, in each chapter you will hear from a former student???someone who opened a book like this one not that long ago???who talks about his or her job and the critical role finance plays in it. Whether you plan to major in finance or simply take this one course, you will find the fundamental financial knowledge gained here to be essential in your personal and business lives. 1. 2 The Four Types of Firms We begin our study of corporate finance by examining the types of firms that financial managers run. There are four major types of firms: sole proprietorships, partnerships, limited liability companies, and corporations. We explain each organizational form in turn, but our primary focus is on the most important form???the corporation. Sole Proprietorships ole proprietorship A business owned and run by one person. A sole proprietorship is a business owned and run by one person. Sole proprietorships are usually very small with few, if any, employees. Although they do not account for much sales revenue in the economy, they are the most common type of firm in the world. In 2007, an estimated 71% of businesses in the United States were sole proprietorships, although they generated only 5% of the revenue. 1 We now consider the key features of a sole proprietorship. 1. Sole proprietorships have the advantage of being straightforward to set up. Consequently, many new businesses use this organizational form. 2.

The principal limitation of a sole proprietorship is that there is no separation between the firm and the owner???the firm can have only one owner who runs the business. If there are other investors, they cannot hold an ownership stake in the firm. 3. The owner has unlimited personal liability for any of the firm’s debts. That is, if the firm defaults on any debt payment, the lender can (and will) require the owner to repay the loan from personal assets. An owner who cannot afford to repay a loan for which he or she is personably liable must declare personal bankruptcy. 4. The life of a sole proprietorship is limited to the life of the owner. It is also difficult to transfer ownership of a sole proprietorship.

For most growing businesses, the disadvantages of a sole proprietorship outweigh the advantages. As soon as the firm reaches the point at which it can borrow without the ISBN 0-558-65200-X This information, as well as other small business statistics, can be found at www. bizstats. com/ businesses. htm. The on-site disclosures page includes a description of their methodology. 1 Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. 6 Part 1 Introduction owner agreeing to be personally liable, the owners typically convert the business into another form.

Conversion also has other benefits that we will consider as we discuss the other forms below. Partnerships partnership A business owned and run by more than one owner. A partnership is a business owned and run by more than one owner. Key features include the following: 1. All partners are liable for the firm’s debt. That is, a lender can require any partner to repay all the firm’s outstanding debts. 2. The partnership ends in the event of the death or withdrawal of any single partner. 3. Partners can avoid liquidation if the partnership agreement provides for alternatives such as a buyout of a deceased or withdrawn partner. Some old and established businesses remain as partnerships or sole proprietorships.

Often these firms are the types of businesses in which the owners’ personal reputations are the basis for the businesses. For example, law firms, medical practices, and accounting firms are frequently organized as partnerships. For such enterprises, the partners’ personal liability increases the confidence of the firm’s clients that the partners will strive to maintain the firm’s reputation. A limited partnership is a partnership with two kinds of owners, general partners and limited partners. In this case, the general partners have the same rights and privileges as partners in any general partnership???they are personally liable for the firm’s debt obligations.

Limited partners, however, have limited liability???that is, their liability is limited to their investment. Their private property cannot be seized to pay off the firm’s outstanding debts. Furthermore, the death or withdrawal of a limited partner does not dissolve the partnership, and a limited partner’s interest is transferable. However, a limited partner has no management authority and cannot legally be involved in the managerial decision making for the business. limited partnership A partnership with two kinds of owners, general partners and limited partners. limited liability When an investor’s liability is limited to her investment. Limited Liability Companies imited liability company (LLC) A limited partnership without a general partner. A limited liability company (LLC) is like a limited partnership without a general partner. That is, all the owners have limited liability, but unlike limited partners, they can also run the business. The LLC is a relatively new phenomenon in the United States. The first state to pass a statute allowing the creation of an LLC was Wyoming in 1977; the last was Hawaii in 1997. Internationally, companies with limited liability are much older and established. LLCs first rose to prominence in Germany over 100 years ago as a Gesellschaft mit beschrankter Haftung (GmbH) and then in other European and Latin American countries.

An LLC is known in France as a Societe a responsabilite limitee (SAR), and by similar names in Italy (SRL) and Spain (SL). Corporations corporation A legally defined, artificial being, separate from its owners. A corporation is a legally defined, artificial being (a legal entity), separate from its owners. As such, it has many of the legal powers that people have. It can enter into contracts, acquire assets, incur obligations, and it enjoys protection under the U. S. Constitution against the seizure of its property. Because a corporation is a legal entity separate and distinct from its owners, it is solely responsible for its own obligations.

Consequently, the owners of a corporation (or its employees, customers, etc. ) are not liable for any obligations the corporation enters into. Similarly, the corporation is not liable for any personal obligations of its owners. ISBN 0-558-65200-X Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. Chapter 1 Corporate Finance and the Financial Manager 7 FIGURE 1. 1 Growth in Number of U. S. Corporations The figure shows the rapid growth in corporations during the nineteenth century, particularly after the Supreme Court established legal protection for a corporation’s property in 1819. 1800 Year 1830* 890 0 10,000 30,000 20,000 Number of Corporations 40,000 50,000 *For New England In the same way that it is difficult to imagine modern business life without e-mail and cell phones, the corporation revolutionized the economy. On February 2, 1819, the U. S. Supreme Court established the legal precedent that the property of a corporation, similar to that of a person, is private and entitled to protection under the U. S. Constitution. As shown in Figure 1. 1, this decision led to dramatic growth in the number of U. S. corporations. Today the corporate structure is ubiquitous, not only in the United States (where they are responsible for 85% of business revenue), but all over the world.

Formation of a Corporation. A corporation must be legally formed, which means that the state in which it is incorporated must formally give its consent to the incorporation by chartering it. Setting up a corporation is therefore considerably more costly than setting up a sole proprietorship. The state of Delaware has a particularly attractive legal environment for corporations, so many corporations choose to incorporate there. For jurisdictional purposes, a corporation is a citizen of the state in which it is incorporated. Most firms hire lawyers to create a corporate charter that includes formal articles of incorporation and a set of bylaws.

The corporate charter specifies the initial rules that govern how the corporation is run. Ownership of a Corporation. There is no limit on the number of owners a corporation can have. Because most corporations have many owners, each owner owns only a fraction of the corporation. The entire ownership stake of a corporation is divided into shares known as stock. The collection of all the outstanding shares of a corporation is known as the equity of the corporation. An owner of a share of stock in the corporation is known as a shareholder, stockholder, or equity holder. Shareholders are entitled to dividend payments; that is, payments made at the discretion of the corporation to its equity holders.

Shareholders usually receive a share of the dividend payments that is proportional to the amount of stock they own. For example, a shareholder who owns 25% of the firm’s shares will be entitled to 25% of the total dividend payment. stock The ownership or equity of a corporation divided into shares. equity The collection of all the outstanding shares of a corporation. shareholder (also stockholder or equity holder) An owner of a share of stock or equity in a corporation. ISBN 0-558-65200-X dividend payments Payments made at the discretion of the corporation to its equity holders. Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall.

Copyright ?? 2009 by Pearson Education, Inc. 8 Part 1 Introduction A unique feature of a corporation is that there is no limitation on who can own its stock. That is, an owner of a corporation need not have any special expertise or qualification. This feature allows free trade in the shares of the corporation and provides one of the most important advantages of organizing a firm as a corporation rather than as sole proprietorship, partnership, or LLC. Corporations can raise substantial amounts of capital because they can sell ownership shares to anonymous outside investors. The availability of outside funding has enabled corporations to dominate the economy.

Let’s look at one of the world’s largest firms, Microsoft Corporation, as an example. Microsoft reported annual revenue of $51. 1 billion over the 12 months from July 2006 through June 2007. The total value of the company (the wealth in the company the owners collectively owned) as of October 2007 was $291. 0 billion. The company employed 78,565 people. Putting these numbers into perspective, the $51. 1 billion in gross domestic product (GDP) in 2006 would rank Microsoft (ahead of Libya and behind the Slovak Republic) as the sixtieth richest country (out of more than 200). 2 Libya has almost 6 million people, about 75 times as many people as employees at Microsoft.

Indeed, if the number of Microsoft employees were used as the “population” of the corporation, Microsoft would rank just above Andorra as the thirteenth least populous country on earth! Tax Implications for Corporate Entities An important difference between the types of corporate organizational forms is the way they are taxed. Because a corporation is a separate legal entity, a corporation’s profits are subject to taxation separate from its owners’ tax obligations. In effect, shareholders of a corporation pay taxes twice. First, the corporation pays tax on its profits, and then when the remaining profits are distributed to the shareholders, the shareholders pay their own personal income tax on this income.

This system is sometimes referred to as double taxation. EXAMPLE 1. 1 Taxation of Corporate Earnings Problem You are a shareholder in a corporation. The corporation earns $5. 00 per share before taxes. After it has paid taxes, it will distribute the rest of its earnings to you as a dividend (we make this simplifying assumption, but should note that most corporations retain some of their earnings for reinvestment). The dividend is income to you, so you will then pay taxes on these earnings. The corporate tax rate is 40% and your tax rate on dividend income is 15%. How much of the earnings remains after all taxes are paid? Solution ? Plan Earnings before taxes: $5. 0 Corporate tax rate: 40% Personal dividend tax rate: 15% We first need to calculate the corporation’s earnings after taxes by subtracting the taxes paid from the pre-tax earnings of $5. 00. The taxes paid will be 40% (the corporate tax rate) of $5. 00. Since all of the after-tax earnings will be paid to you as a dividend, you will pay taxes of 15% on that amount. The amount leftover is what remains after all taxes are paid. ISBN 0-558-65200-X World Development Indicators database, July 15, 2005. For quick reference tables on GDP, go to http:// www. worldbank. org/data/quickreference. html. 2 Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc.

Chapter 1 Corporate Finance and the Financial Manager 9 ? Execute $5. 00 per share 0. 40 $2. 00 in taxes at the corporate level, leaving $5. 00 $2. 00 $3. 00 in after-tax earnings per share to distribute. You will pay $3. 00 0. 15 $0. 45 in taxes on that dividend, leaving you with $2. 55 from the original $5. 00 after all taxes. ? Evaluate As a shareholder, you keep $2. 55 of the original $5. 00 in earnings; the remaining $2. 00 $0. 45 $2. 45 is paid as taxes. Thus, your total effective tax rate is 2. 45/5 49%. S corporations Those corporations that elect subchapter S tax treatment and are allowed, by the U. S. Internal Revenue Tax code, an exemption from double taxation.

C corporations Corporations that have no restrictions on who owns their shares or the number of shareholders; therefore, they cannot qualify for subchapter S treatment and are subject to direct taxation. S Corporations. The corporate organizational structure is the only organizational structure subject to double taxation. However, the U. S. Internal Revenue Code allows an exemption from double taxation for certain corporations. These corporations are called S corporations because they elect subchapter S tax treatment. Under subchapter S tax regulations, the firm’s profits (and losses) are not subject to corporate taxes, but instead are allocated directly to shareholders based on their ownership share. The shareholders must include these profits as income on their individual tax returns (even if no money is distributed to them).

However, after the shareholders have paid income taxes on these profits, no further tax is due. C Corporations. The government places strict limitations on the qualifications for subchapter S tax treatment. In particular, the shareholders of such corporations must be individuals who are U. S. citizens or residents, and there can be no more than 100 of them. Because most corporations have no restrictions on who owns their shares or the number of shareholders, they cannot qualify for subchapter S treatment. Thus, most corporations are C corporations, which are corporations subject to corporate taxes. EXAMPLE 1. 2 Taxation of S Corporation Earnings Problem Rework Example 1. , assuming the corporation in that example has elected subchapter S treatment and your tax rate on non-dividend income is 30%. Solution ? Plan Earnings before taxes: $5. 00 Corporate tax rate: 0% Personal tax rate: 30% In this case, the corporation pays no taxes. It earned $5. 00 per share. In an S corporation, all income is treated as personal income to you, whether or not the corporation chooses to distribute or retain this cash. As a result, you must pay a 30% tax rate on those earnings. ? Execute Your income taxes are 0. 30 after-tax earnings. $5. 00 $1. 50, leaving you with $5. 00 $1. 50 $3. 50 in ISBN 0-558-65200-X ? Evaluate The $1. 50 in taxes that you pay is substantially lower than the $2. 5 you paid in Example 1. 1. As a result, you are left with $3. 50 per share after all taxes instead of $2. 55. However, note that in a C corporation, you are only taxed when you receive the income as a dividend, whereas in an S corporation, you pay taxes on the income immediately regardless of whether the corporation distributes it as a dividend or reinvests it in the company. Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. 10 Part 1 Introduction Corporate Taxation around the World In most countries, there is some relief from double taxation.

Thirty countries make up the Organization for Economic Co-operation and Development (OECD), and of these countries, only Ireland and Switzerland offer no relief from double taxation. The United States offers some relief by having a lower tax rate on dividend income than on other sources of income. As of 2007, dividend income is taxed at 15%, which, for most investors, is significantly below their personal income tax rate. A few countries, including Australia, Finland, Mexico, New Zealand, and Norway, offer complete relief by effectively not taxing dividend income. As we have discussed, there are four main types of firms: sole proprietorships, partnerships (general and limited), limited liability companies, and corporations (“S” and “C”). To help you see the differences among them, Table 1. compares and contrasts the main characteristics of each. TABLE 1. 1 Characteristics of the Different Types of Firms Sole Proprietorship Partnership Number of Owners One Unlimited Liability for Firm’s Debts Yes Owners Manage the Firm Yes Ownership Change Dissolves Firm Taxation Yes Yes Personal Personal Yes; each Yes partner is liable for the entire amount GP-Yes LP-No Limited Partnership One general GP-Yes partner (GP), LP-No no limit on limited partners (LP) Unlimited No GP-Yes LP-No Personal Limited Liability Company S Corporation C Corporation Yes No* Personal At most 100 Unlimited No No No (but they No legally may) No (but they No legally may)

Personal Double *However, most LLCs require the approval of the other partners to transfer your ownership. ISBN 0-558-65200-X Concept Check 1. What is a limited liability company (LLC)? How does it differ from a limited partnership? 2. What are the advantages and disadvantages of organizing a business as a corporation? Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. Chapter 1 Corporate Finance and the Financial Manager 11 1. 3 The Financial Manager As of March 2007, Apple, Inc. had more than 864 million shares of stock held by 29,861 owners. Because there are many owners of a corporation, each of whom can freely trade their stock, it is often not feasible for the owners of a corporation to have direct control of the firm. It falls to the financial manager to make the financial decisions of the business for the stockholders. Within the corporation, the financial manager has three main tasks: 1. Make investment decisions. 2. Make financing decisions. 3. Manage cash flow from operating activities. We will discuss each of these in turn, along with the financial manager’s overarching goal. Making Investment Decisions The financial manager’s most important job is to make the firm’s investment decisions.

The financial manager must weigh the costs and benefits of each investment or project and decide which of them qualify as good uses of the money stockholders have invested in the firm. These investment decisions fundamentally shape what the firm does and whether it will add value for its owners. For example, it may seem hard to imagine now, but there was a time when Apple’s financial managers were evaluating whether to invest in the development of the first iPod. They had to weigh the substantial development and production costs against uncertain future sales. Their analysis indicated that it was a good investment, and the rest is history. In this book, we will develop all the tools necessary to make these investment decisions. Making Financing Decisions

Once the financial manager has decided which investments to make, he or she also decides how to pay for them. Large investments may require the corporation to raise additional money. The financial manager must decide whether to raise more money from new and existing owners by selling more shares of stock (equity) or to borrow the money instead (debt). In this book, we will discuss the characteristics of each source of money and how to decide which one to use in the context of the corporation’s overall mix of debt and equity. Managing Short-Term Cash Needs The financial manager must ensure that the firm has enough cash on hand to meet its obligations from day to day.

This job, also commonly known as managing working capital,4 may seem straightforward, but in a young or growing company, it can mean the 3 Apple, Inc. , Definitive Proxy Statement, April 26, 2007. ISBN 0-558-65200-X Working capital refers to things such as cash on hand, inventories, raw materials, loans to suppliers and payments from customers???the grease that keeps the wheels of production moving. We will discuss working capital in more detail in the next chapter and devote all of Chapter 18 to working capital management. 4 Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. 12 Part 1 Introduction difference between success and failure.

Even companies with great products require a lot of money to develop and bring those products to market. Consider the costs to Apple of launching the iPhone, which included developing the technology and creating a huge marketing campaign, or the costs to Boeing of producing the 787???billions of dollars were spent before the first 787 left the ground. A company typically burns through a significant amount of cash before the sales of the product generate income. The financial manager’s job is to make sure that access to cash does not hinder the firm’s success. The Goal of the Financial Manager All of these decisions by the financial manager are made within the context f the overriding goal of financial management???to maximize the wealth of the owners, the stockholders. The stockholders have invested in the corporation, putting their money at risk to become the owners of the corporation. Thus, the financial manager is a caretaker of the stockholders’ money, making decisions in their interests. Many corporations have thousands of owners (shareholders). These shareholders vary from large institutions to small first-time investors, from retirees living off their investments to young employees just starting to save for retirement. Each owner is likely to have different interests and priorities. Whose interests and priorities determine the goals of the firm?

You might be surprised to learn that the interests of shareholders are aligned for many, if not most, important decisions. Regardless of their own personal financial position and stage in life, all the shareholders will agree that they are better off if the value of their investment in the corporation is maximized. For example, suppose the decision concerns whether to develop a new product that will be a profitable investment for the corporation. All shareholders will very likely agree that developing this product is a good idea. Returning to our iPod example, by the end of 2007, Apple shares were worth 18 times as much as they were in October 2001, when the first iPod was introduced.

All Apple shareholders at the time of the development of the first iPod are clearly much better off because of it, whether they have since sold their shares of Apple to pay for retirement, or are still watching those shares appreciate in their retirement savings account. Even when all the owners of a corporation agree on the goals of the corporation, these goals must be implemented. In the next section, we discuss the financial manager’s place in the corporation and how owners exert control over the corporation. Concept Check 3. What are the main types of decisions that a financial manager makes? 4. What is the goal of the financial manager? 1. 4 The Financial Manager’s Place in the Corporation We’ve established that the stockholders own the corporation but rely on financial managers to actively manage the corporation. The board of irectors and the management team headed by the chief executive officer possess direct control of the corporation. In this section, we explain how the responsibilities for the corporation are divided between these two entities and describe conflicts that arise between stockholders and the management team. ISBN 0-558-65200-X Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. Chapter 1 Corporate Finance and the Financial Manager 13 The Corporate Management Team board of directors A group of people elected by shareholders who have the ultimate decisionmaking authority in the corporation. hief executive officer (CEO) The person charged with running the corporation by instituting the rules and policies set by the board of directors. The shareholders of a corporation exercise their control by electing a board of directors, a group of people who have the ultimate decision-making authority in the corporation. In most corporations, each share of stock gives a shareholder one vote in the election of the board of directors, so investors with more shares have more influence. When one or two shareholders own a very large proportion of the outstanding stock, these shareholders might either be on the board of directors themselves, or they may have the right to appoint a number of directors.

The board of directors makes rules on how the corporation should be run (including how the top managers in the corporation are compensated), sets policy, and monitors the performance of the company. The board of directors delegates most decisions that involve the day-to-day running of the corporation to its management. The chief executive officer (CEO) is charged with running the corporation by instituting the rules and policies set by the board of directors. The size of the rest of the management team varies from corporation to corporation. In some corporations, the separation of powers between the board of directors and CEO is not always distinct.

In fact, the CEO can also be the chairman of the board of directors. The most senior financial manager is the chief financial officer (CFO), often reporting directly to the CEO. Figure 1. 2 presents part of a typical organizational chart for a corporation, highlighting the positions a financial manager may take. FIGURE 1. 2 The Financial Functions Within a Corporation The board of directors, representing the stockholders, controls the corporation and hires the top management team. A financial manager might hold any of the green-shaded positions, including the Chief Financial Officer (CFO) role. The controller oversees accounting and tax functions.

The treasurer oversees more traditional finance functions, such as capital budgeting (making investment decisions), risk management (managing the firm’s exposure to movements in the financial markets), and credit management (managing the terms and policies of any credit the firm extends to its suppliers and customers). Board of Directors Chief Executive Officer Chief Financial Officer Controller Accounting Tax Department Chief Operating Officer Treasurer Capital Budgeting Risk Management Credit Management ISBN 0-558-65200-X Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. 14 Part 1 Introduction Ethics and Incentives in Corporations A corporation is run by a management team, separate from its owners. How can the owners of a corporation ensure that the management team will implement their goals? Agency Problems.

Many people claim that because of the separation of ownership and control in a corporation, managers have little incentive to work in the interests of the shareholders when this means working against their own self-interest. Economists call this an agency problem???when managers, despite being hired as the agents of shareholders, put their own self-interest ahead of the interests of those shareholders. Managers face the ethical dilemma of whether to adhere to their responsibility to put the interests of shareholders first, or to do what is in their own personal best interests. This problem is commonly addressed in practice by minimizing the number of decisions managers make that require putting their self-interest against the interests of the shareholders.

For example, managers’ compensation contracts are designed to ensure that most decisions in the shareholders’ interest are also in the managers’ interests; shareholders often tie the compensation of top managers to the corporation’s profits or perhaps to its stock price. There is, however, a limitation to this strategy. By tying compensation too closely to performance, the shareholders might be asking managers to take on more risk than they are comfortable taking. As a result, the managers may not make decisions that the shareholders want them to, or it might be hard to find talented managers willing to accept the job. For example, biotech firms take big risks on drugs that fight cancer, AIDS, and other widespread diseases. The market for a successful drug is huge, but the risk of failure is high.

Investors who put only some of their money in biotech may be comfortable with this risk, but a manager who has all of his or her compensation tied to the success of such a drug might opt to develop a less risky drug that has a smaller market. Further potential for conflicts of interest and ethical considerations arise when some stakeholders in the corporation benefit and others lose from a decision. Shareholders and managers are two stakeholders in the corporation, but others include the regular employees and the communities in which the company operates, for example. Managers may decide to take the interests of other stakeholders into account in their decisions, such as keeping a loss-generating factory open because it is the main provider of jobs in a small town, paying above local market wages to factory orkers in a developing country, or operating a plant at a higher environmental standard than local law mandates. In some cases, these actions that benefit other stakeholders may also benefit the firm’s shareholders by creating a more dedicated workforce, generating positive publicity with customers, or other indirect effects. In other instances, when these decisions benefit other stakeholders at shareholders’ expense, they represent a form of corporate charity. Indeed, many if not most corporations explicitly donate (on behalf of their shareholders) to local and global causes. Shareholders often approve of such actions, even though they are costly and so reduce their wealth.

While it is the manager’s job to make decisions that maximize shareholder value, shareholders???who own the firm???also want the firm’s actions to reflect their moral and ethical values. Of course, shareholders may not have identical preferences in these matters, leading to potential sources of conflict. The CEO’s Performance. Another way shareholders can encourage managers to work in the interests of shareholders is to discipline them if they do not. If shareholders are unhappy with a CEO’s performance, they could, in principle, pressure the board to oust the CEO. Disney’s Michael Eisner (shown in photo during happier times), Hewlett Packard’s Carly Fiorina, and Home Depot’s Robert Nardelli were all forced to resign by their boards.

Despite these high-profile examples, directors and top executives are rarely replaced through a grassroots shareholder uprising. Instead, dissatisfied investors often choose to sell their shares. Of course, somebody must be willing to buy the shares from agency problem When managers, despite being hired as the agents of shareholders, put their own self-interest ahead of the interests of those shareholders. ISBN 0-558-65200-X Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. Chapter 1 Corporate Finance and the Financial Manager 15 Shareholder Activism and Voting Rights

In reaction to poor stock market performance and several accounting scandals, the number of shareholder initiatives (when shareholders request that a specific firm policy or decision be put to a direct vote of all shareholders) has increased dramatically in recent years. According to the Investor Responsibility Research Center, the number of shareholder proposals increased from about 800 during 2002 to over 1200 during 2007. Shareholder initiatives have covered a range of topics, including shareholder voting rights, takeovers and anti-takeover provisions, election of members of the board of directors, and changes in the time or location of shareholder meetings.

One of the recent trends in shareholder activism is to withhold voting support for nominees to the board of directors. In March 2004, shareholders withheld support for Michael Eisner (the Disney CEO) as chairman of the board. As a result, he lost the Disney chairmanship but retained his position as CEO for another year. The California Public Employees’ Retirement System (Calpers), the world’s largest pension fund, has withheld votes for at least one of the directors in 90% of the 2700 companies in which it invests. Source: Adapted from John Goff, “Who’s the Boss? ” CFO Magazine, September 1, 2004, pp. 56???66. Shareholder proposal data updated based on 2007 Postseason Report, Riskmetrics Group (ISS Proxy Services). ostile takeover A situation in which an individual or organization, sometimes referred to as a corporate raider, purchases a large fraction of a target corporation’s stock and in doing so gets enough votes to replace the target’s board of directors and its CEO. the dissatisfied shareholders. If enough shareholders are dissatisfied, the only way to entice investors to buy (or hold) the shares is to offer them a low price. Similarly, investors who see a well-managed corporation will want to purchase shares, which drives the stock price up. Thus, the stock price of the corporation is a barometer for corporate leaders that continuously gives them feedback on the shareholders’ opinion of their performance. When the stock performs poorly, the board of directors might react by replacing the CEO.

In some corporations, however, the senior executives might be entrenched because boards of directors do not have the independence or motivation to replace them. Often the reluctance to fire results when the board is comprised of people who are close friends of the CEO and lack objectivity. In corporations in which the CEO is entrenched and doing a poor job, the expectation of continued poor performance will cause the stock price to be low. Low stock prices create a profit opportunity. In a hostile takeover, an individual or organization???sometimes known as a corporate raider???can purchase a large fraction of the company’s stock and in doing so get enough votes to replace the board of directors and the CEO.

With a new superior management team, the stock is a much more attractive investment, which would likely result in a price rise and a profit for the corporate raider and the other shareholders. Although the words “hostile” and “raider” have negative connotations, corporate raiders themselves provide an important service to shareholders. The mere threat of being removed as a result of a hostile takeover is often enough to discipline bad managers and motivate boards of directors to make difficult decisions. Consequently, the fact that a corporation’s shares can be publicly traded creates a “market for corporate control” that encourages managers and boards of directors to act in the interests of their shareholders. 5.

How do shareholders control a corporation? 6. What types of jobs would a financial manager have in a corporation? 7. What ethical issues could confront a financial manager? ISBN 0-558-65200-X Concept Check Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. 16 Part 1 Introduction 1. 5 The Stock Market stock markets (also stock exchanges or bourse) Organized markets on which the shares of many corporations are traded. liquid Describes an investment that can easily be turned into cash because it can be sold immediately at a competitive market price. In Section 1. , we established the goal of the financial manager: to maximize the wealth of the owners, the stockholders. The value of the owners’ investments in the corporation is determined by the price of a share of the corporation’s stock. Corporations can be private or public. A private corporation has a limited number of owners and there is no organized market for its shares, making it hard to determine the market price of its shares at any point in time. A public corporation has many owners and its shares trade on an organized market, called a stock market (or stock exchange or bourse). These markets provide liquidity for a company’s shares and determine the market price for those shares.

An investment is said to be liquid if it can easily be turned into cash by selling it immediately at price at which you could contemporaneously buy it. An investor in a public company values the ability to turn his investment into cash easily and quickly by simply selling his shares on one of these markets. In this section, we provide an overview of the functioning of the major stock markets. The analysis and trading of participants in these markets provides an evaluation of the financial managers’ decisions that not only determines the stock price, but also provides feedback to the managers on their decisions. The Largest Stock Markets primary market When a corporation issues new shares of stock and sells them to investors. econdary market Markets, such as NYSE or NASDAQ, where shares of a corporation are traded between investors without the involvement of the corporation. market makers Individuals on the trading floor of a stock exchange who match buyers with sellers. specialists Individuals on the trading floor of the NYSE who match buyers with sellers; also called market makers. bid price The price at which a market maker or specialist is willing to buy a security. ask price The price at which a market maker or specialist is willing to sell a security. The best known U. S. stock market and the largest stock market in the world is the New York Stock Exchange (NYSE).

Billions of dollars of stock are exchanged every day on the NYSE. Other U. S. stock markets include the American Stock Exchange (AMEX), NASDAQ (the National Association of Security Dealers Automated Quotation), and regional exchanges such as the Midwest Stock Exchange. Most other countries have at least one stock market. Outside the United States, the biggest stock markets are the London Stock Exchange (LSE) and the Tokyo Stock Exchange (TSE). Figure 1. 3 ranks the world’s largest stock exchanges by trading volume. All of these markets are secondary markets. The primary market refers to a corporation issuing new shares of stock and selling them to investors.

After this initial transaction between the corporation and investors, the shares continue to trade in a secondary market between investors without the involvement of the corporation. For example, if you wish to buy 100 shares of Starbucks Coffee, you could place an order on the NASDAQ, where Starbucks trades under the ticker symbol SBUX. You would buy your shares from someone who already held shares of Starbucks, not from Starbucks itself. NYSE The NYSE is a physical place located at 11 Wall Street in New York City. On the floor of the NYSE, market makers (known on the NYSE as specialists) match buyers and sellers. They post two prices for every stock they make a market in: the price they stand willing to buy the stock at (the bid price) and the price they stand willing to sell the stock for (the ask price).

If a customer comes to them wanting to make a trade at these prices, they will honor the price (up to a limited number of shares) and make the trade even if they do not have another customer willing to take the other side of the trade. In this way, they ensure ISBN 0-558-65200-X Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. Chapter 1 Corporate Finance and the Financial Manager 17 FIGURE 1. 3 Worldwide Stock Markets Ranked by Volume of Trade The bar graph shows the 10 biggest stock markets in the world ranked by total value of shares traded on exchange in 2007. Source: www. worldexchanges. org

Hong Kong Stock Exchanges Borsa Italiana BME Spanish Exchanges Shanghai Stock Exchange Deutsche Borse Euronext Tokyo Stock Exchange London Stock Exchange NASDAQ NYSE 0 5000 10,000 15,000 20,000 25,000 30,000 35,000 Total Value of Shares Traded in $ Billion bid-ask spread The amount by which the ask price exceeds the bid price. transaction cost In most markets, an expense such as a broker commission and the bid-ask spread investors must pay in order to trade securities. that the market is liquid because customers can always be assured they can trade at the posted prices. The exchange has rules that attempt to ensure that bid and ask prices do not get too far apart and that large price changes take place through a series of small changes, rather than in one big jump. Ask prices exceed bid prices. This difference is called the bid-ask spread.

Because investors buy at the ask (the higher price) and sell at the bid (the lower price), the bidask spread is a transaction cost they have to pay in order to trade. When specialists in a physical market such as the NYSE take the other side of the trade from their customers, this transaction cost accrues to them as a profit. It is the compensation they demand for providing a liquid market by standing ready to honor any quoted price. Investors also pay other forms of transactions costs such as commissions. NASDAQ In today’s technology-driven economy, a stock market does not need to have a physical location. Stock transactions can be made over the phone or by computer network.

Consequently, some stock markets are a collection of dealers or market makers connected by computer network and telephone. The most famous example of such a market is NASDAQ. An important difference between the NYSE and NASDAQ is that on the NYSE, each stock has only one market maker. On NASDAQ, stocks can and do have multiple market makers who compete with each other. Each market maker must post bid and ask prices in the NASDAQ network where they can be viewed by all participants. The NASDAQ system posts the best prices first and fills orders accordingly. This process guarantees investors the best possible price at the moment, whether they are buying or selling.

While you may have seen coverage of the stock markets on the news, it is unlikely that you have had any exposure to the finance function within the firm. In this chapter, we provided a sense of what corporate finance is all about, what a financial manager does, and the importance of stock markets. In the coming chapters, you will learn how to make financial management decisions and how to use financial market information. We will develop the tools of financial analysis hand-in-hand with a clear understanding of when to apply them and why they work. ISBN 0-558-65200-X Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. 18 Part 1 Introduction FIGURE 1. 4

The Dow Jones Industrial Average (DJIA) In this graphic from a Wall Street Journal article in February 2008, you see the 30 stocks in the DJIA, as well as the dates they were included in the index. The article was written about changes being made to the DJIA in an attempt to have it more accurately reflect the U. S. economy. By adding Bank of America and Chevron, Dow Jones editors were hoping to better capture the economy’s move toward financial services and the growing importance of energy. To make room, Altria (formerly Phillip Morris) and Honeywell, a long-time member, were dropped. As a result, the average is less industrial and more services and technology. Company Dow-member years (trading symbol) (XOM)

Market cap (in billions) Exxon Mobil 1928-present $446. 4 General Electric 1896-98; 1899-1901; 1907-present (GE) 342. 0 Microsoft 1999-present (MSFT) AT&T 1916-28; 1939-84; 1984-2004; 1999-present Procter & Gamble 1932-present (PG) Johnson & Johnson 1997-present (JNJ) 1 238. 1 (T) 221. 8 202. 9 177. 5 153. 4 152. 3 148. 3 141. 1 134. 2 126. 1 122. 5 117. 9 112. 9 108. 0 105. 6 96. 9 67. 0 65. 5 57. 3 54. 9 51. 9 47. 0 46. 6 43. 9 40. 9 39. 6 28. 6 12. 7 1 1916-28; 1939-84; ‘new’ AT&T in 1984-2004; former SBC from 1999-present 2 Bank of America (BAC) $190. 0 billion Chevron (CVX) $169 billion IN IN OUT Altria Group 1985-2008 (MO) Pfizer 2004-present (PFE) J. P.

Morgan Chase 1991-present (JPM) IBM 1932-39; 1979-present (IBM) Citigroup 1997-present (C) Coca-Cola 1932-35; 1987-present (KO) Wal-Mart Stores 1997-present (WMT) Intel 1999-present (INTC) AIG 2004-present (AIG) Hewlett-Packard 1997-present (HPQ) Verizon Commun. 2004-present (VZ) Merck 1979-present (MRK) McDonald’s 1985-present (MCD) United Technologies 1933-34; 1939-present (UTX) Walt Disney 1991-present (DIS) Boeing 1987-present (BA) 3M 1976-present (MMM) Home Depot 1999-present (HD) American Express 1982-present (AXP) Caterpillar 1991-present (CAT) DuPont 1924-25; 1935-present (DD) OUT Honeywell Int’l. 1925-2008 Alcoa 1959-present (AA) 2 (HON) 1925-2008; joined as Allied Chemical & Dye, later AlliedSignal ISBN 0-558-65200-X

Note: ‘Float-adjusted’ market cap Figures as of Feb. 8 Source: Dow Jones Indexes General Motors 1915-16; 1925-present (GM) Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. Chapter 1 Corporate Finance and the Financial Manager 19 NYSE, AMEX, DJIA, S&P 500: Awash in Acronyms With all of these acronyms floating around, it’s easy to get confused. You may have heard of the “Dow Jones” or “Dow Jones (Industrial) Average” and the “S 500” on news reports about the stock markets. The NYSE, AMEX, and NASDAQ are all stock markets where the prices of stocks are determined through trading.

However, when commentators talk about whether stocks are up or down in general in a given day, they often refer to the Dow Jones Industrial Average (DJIA) and the Standard and Poor’s 500 (S&P 500). The DJIA and S&P 500 are simply measures of the aggregate price level of collections of pre-selected stocks???30 in the case of the DJIA and 500 in the case of the S&P 500. These stocks were selected by Dow Jones (the publisher of the Wall Street Journal ) or Standard & Poor’s as representative of the overall market. The S&P 500 consists of 500 of the highestvalued U. S. companies. While fewer in number, the 30 stocks in the DJIA include companies such as Microsoft, Wal-Mart, Boeing, and 3M, and are selected to cover the important sectors in the U. S. economy. Figure 1. shows the composition of the DJIA as of February 2008. Both the DJIA and S&P 500 include stocks that are traded on the NYSE and stocks that are traded on NASDAQ and so are distinct from the exchanges themselves. ?? www. cartoonbank. com, ID52363; The New Yorker, July 22, 2002. Concept Check 8. What advantage does a stock market provide to corporate investors? 9. What is the importance of a stock market to a financial manager? Here is what you should know after reading this chapter. MyFinanceLab will help you identify what you know, and where to go when you need to practice. Key Points and Equations 1. 1 Why Study Finance? ? Finance and financial decisions are everywhere in our daily lives. Many financial decisions are simple, but others are complex. All are tied together by the Valuation Principle???the foundation for financial decision making???which you will learn in this book. Terms Online Practice Opportunities ISBN 0-558-65200-X Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. 20 Part 1 Introduction 1. 2 The Four Types of Firms ? There are four types of firms in the United States: sole proprietorships, partnerships, limited liability companies, and corporations. ? Firms with unlimited personal liability include sole proprietorships and partnerships. Firms with limited liability include limited partnerships, limited liability companies, and corporations. ? A corporation is a legally defined artificial being (a judicial person or legal entity) that has many of the legal powers people have. It can enter into contracts, acquire assets, incur obligations, and it enjoys protection under the U. S. Constitution against the seizure of its property. ? The shareholders in a C corporation effectively must pay tax twice. The corporation pays tax once and then investors must pay personal tax on any funds that are distributed. S corporations are exempt from the corporate income tax. ? The ownership of a corporation is divided into shares of stock collectively known as equity.

Investors in these shares are called shareholders, stockholders, or equity holders. 1. 3 The Financial Manager ? The financial manager makes investing, financing, and cash flow management decisions. ? The goal of the financial manager is to maximize the wealth of the shareholders (maximize the stock price). 1. 4 The Financial Manager’s Place in the Corporation ? The ownership and control of a corporation are separate. Shareholders exercise their control indirectly through the board of directors. C corporations, p. 9 corporation, p. 6 dividend payments, p. 7 equity, p. 7 equity holder, p. 7 limited liability, p. 6 limited liability company, p. 6 limited partnership, p. 6 partnership, p. 6 S corporations, p. 9 shareholder, p. sole proprietorship, p. 5 stock, p. 7 stockholder, p. 7 MyFinanceLab Study Plan 1. 2 MyFinanceLab Study Plan 1. 3 agency problem, p. 14 board of directors, p. 13 chief executive officer (CEO), p. 13 hostile takeover, p. 15 ask price, p. 16 bid-ask spread, p. 19 bid price, p. 16 bourse, p. 16 liquid, p. 16 market makers, p. 16 primary market, p. 16 secondary market, p. 16 specialists, p. 16 stock exchange, p. 16 stock market, p. 16 transaction cost, p. 19 MyFinanceLab Study Plan 1. 4 1. 5 The Stock Market ? The shares of public corporations are traded on stock markets. The shares of private corporations do not trade on a stock market. MyFinanceLab Study Plan 1. 5

ISBN 0-558-65200-X Fundamentals of Corporate Finance, by Jonathan Berk, Peter DeMarzo, and Jarrad Harford. Published by Prentice Hall. Copyright ?? 2009 by Pearson Education, Inc. Chapter 1 Corporate Finance and the Financial Manager 21 Problems A blue box (??) indicates problems available in MyFinanceLab. The Four Types of Firms 1. What is the most important difference between a corporation and all other organization forms? 2. What does the phrase limited liability mean in a corporate context? 3. Which organizational forms give their owners limited liability? 4. What are the main advantages and disadvantages of organizing a firm as a corporation? 5.

Explain the difference between an S and a C corporation. 6. You are a shareholder in a C corporation. The corporation earns $2. 00 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. The corporate tax rate is 40% and the personal tax rate on (both dividend and non-dividend) income is 30%. How much is left for you after all taxes are paid? 7. Repeat Problem 6 assuming the corporation is an S corporation. The Financial Manager 8. What is the most important type of decision that the financial manager makes? 9. Why do all shareholders agree on the same goal for the financial manager? The Financial Manager’s Place in the Corporation 10.

Corporate managers work for the owners of the corporation. Consequently, they should make decisions that are in the interests of the owners, rather than in their own interests. What strategies are available to shareholders to help ensure that managers are motivated to act this way? 11. Think back to the last time you ate at an expensive restaurant where you paid the bill. Now think about the last time you ate at a similar restaurant, but your parents paid the bill. Did you order more food (or more expensive food) when your parents paid? Explain how this relates to the agency problem in corporations. 12. Suppose you are considering renting an apartment.

You, the renter, can be viewed as an agent while the company that owns the apartment can be viewed as the principal. What principal-agent conflicts do you anticipate? Suppose, instead, that you work for the apartment company. What features would you put into th

How to cite this assignment

Choose cite format:
Corporate Finance Assignment. (2019, Nov 07). Retrieved November 14, 2019, from https://anyassignment.com/finance/corporate-finance-assignment-57772/