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Finance Theory I - Week 1 - Complete

Chapter 1 - Value - Goals and Governance of the Firm

Corporations invest in real assets
-generate cash inflows and income
-tangible - machinery, buildings
-intangible - brand names, patents

Financial manager faces two questions
-what investments should the corporation make - involves spending money
-how should it pay for those investments - involves raising money

Secret of success is to increase value of the corporation and stock price
-how to do it?
-how well all managers and employees work to increase value
-identify risks and make sure they are managed properly

Corporation can
-invest in new assets
-or give cash back to shareholders

Opportunity cost of capital that shareholder contribute
-can the corporation add value and earn a higher return than shareholders can earn for themselves

Reoccurring themes
-Maximizing value
-Opportunity cost of capital
-Crucial importance of incentives and governance

Financial asses or securities
-corporation sells claims on the assets and on the cash flow that they will generate
-a bank loan is not a security because it is held by the bank - not sold and traded
-a bond is because it can be held and traded in financial markets

Investment decision = purchase of real assets
-capital budgeting or capital expenditure (CAPEX)
-today's capital investments generate future returns - wait for cash to flow back - must pay attention to the timing, not just cumulative amount - rarely certain
-also involves managing assets already in place and deciding when to shut down and dispose of assets if profits decline
-manage and control the risks of its investments
-raising cash today
-meet obligations to banks, bondholders, and stockholders

Financing decision = sale of financial assets
-shareholders are equity investors who contribute equity financing
-capital structure decision - choice between debt and equity financing
-raise equity financing either by issuing new shares of stock or reinvest cash raised from existing assets

Financing are somewhat less important than investment decisions
Value comes mainly from the asst side of the balance sheet

-legal entity, a legal person owned by its shareholders (but legally distinct from them)
 -shareholders have limited liability - cannot be held responsible for corporation's debts
-can make contracts, carry on a business, borrow or lend money, and sue or be sued
-pay taxes but cannot vote
-formed under state law, based on articles of incorporation that set out the purpose of the business and how it is to be governed an operated
-board of directors - choose and advise top management and sign off on some corporate actions
-closely held - privately held shares
-public companies -shares traded in public markets
-separation of ownership and control - hundreds of thousands of shareholders who own the business but couldn't possibly manage or control it
 -gives the corporation permanence - can sell shares without disrupting operations
-Chief financial officer (CFO) oversees the work of all financial staff - deeply involved in financial policy and financial planning - in constant contact with CEO - explains earnings results and forecasts to investors and the media
-Treasurer is responsible for short-term cash management, currency trading, financing transactions, and bank relationships
-Controller manages company's internal accounting systems, oversees preparation of financial statements and tax returns

Flow of money from investors to the corporation and back again
1)cash raised by selling financial assets to investors
2)cash invested in firm's operations and purchase real assets
3)cash generated by firm's operations
4a)cash reinvested or 4b)cash returned to investors

As long as investments offer higher rates of return than its shareholder can earn in the stock market
Hurdle rate or cost of capital - minimum rate of return - opportunity cost of capital because it depends on the investment other opportunities available - estimating this is one of the hardest tasks
Maximize profits - which years profits?

Stakeholders - employees, customers, suppliers, and community 
US and UK believe dividends should come first
Japanese, German, and French - job security should come first

Separation of ownership and control
-stockholders may not agree with management decisions - creates agency problems
-Agency costs - managers do not attempt to maximize value and shareholders incur costs to monitor managers - occur when managers do not act in their own interests instead of shareholders
-Corporate governance compensation schemes designed to align managers and shareholders interests
-Managers have a legal duty to act responsibly and in the interest of investors - prohibits insider trading, purchase or sale based on information not available publicly 
-Compensation plans - huge personal stake in the success of the firm
-Board of Directors - elected by shareholders - required to have independent directors that are not managers or affiliated with management
-Monitoring - security analysts that advise investors to buy, hold, or sell 
-Takeovers - consistently fail to maximize value - common in industries with slow growth and excess capacity
-Shareholder pressure - Wall Street Walk - when enough share holder bail out, the stock price goes down


Add words to blank spaces 1)Companies usually buy real assets. These include both tangible assets such as airplanes and intangible assets such as brand names. To pay for these assets, they sell financial assets such as bonds. The decision about which assets to buy is usually termed the capital budgeting or investment decision. The decision about how to raise the money is usually termed the financing decision.

2)Which of the following are real assets, and which are financial?
A share of stock - financial
A personal IOU - financial
A trademark - real
A factory - real
Undeveloped land - real
The balance in firm's checking account - real
An experienced and hardworking sales force - real
A corporate bond - financial

3)Explain the difference between
Real assets - generate income
Financial assets - claims on assets

4)Which of these always apply to corporations?
Unlimited liability
Limited life
Ownership can be transferred without affecting operations
Managers can be fired with no effect on ownership

5)Which of the following statements more accurately describe the treasurer than the controller?
Responsible for investing the firm's spare cash
Arranging any issue of common stock
Tax affairs


If you're reading this than you can empathize with my sorrow of losing my notes from the lecture. I used ctrl + c to move them from another page, but did not ctrl + v before I replaced them on the computer's clipboard by copying the link to the lecture (hyperlinked above). 
I've just spent an inordinate amount of time trying to recover the notes, but I can't find a way. I've, at least, installed an extension to my Chromebook that will keep a history of my clipboard to prevent future catastrophes.
I could listen to the lecture again to recreate the notes, but unless someone insists, I am not going to do that. I usually add my notes as a verification that I have watched and learned from the lecture but this time you'll have to take my word. Above are the notes from chapter 1 and if you watch the lecture you will find that it is an overview from the textbook.


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