7. Terminology
Ownership have shares in a firm
The right to share in a firm’s profits
decide who
Control
manage the
The right to directly manage or elect management of a firm firm/himself
Personal liability or others
The responsibility to pay a firm’s financial obligations using
personal assets when the firm cannot
Limited liability use his money to repay firm's debt
A limit that the owner can only lose the value of their
investment when the firm cannot pay its financial obligations
loose a part of his assets (investments) money already shared
in the firm but no obligation to use his personal money to
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repay firm's debt
8. CONTROL/OWNERSHIP/
Sole trader PERSONAL LIABILITY
Business owned and controlled by a single person
Sole trader is personally liable for firm’s debts
Business ceases existence with death or
withdrawal of the sole trader
Profits taxed at personal level
Also known as sole proprietorships = sole trader
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9. Partnership
Business owned by several partners
• General partners: act as a sole proprietor
Ownership, control and personal liability
• Limited partners:
Ownership, no control and limited liability
general
Profits taxed at personal level partners are
very
Business ceases to exist with death or withdrawal
of a single general partner unless other important
provisions are made
control/limited liability=good ; no control/personal liability=bad
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10. Comparison
Sole trader Partnership Limited Partnership
Type of owner N/A General partner General partner Limited partner
Number One Several One or more Several
Control Yes Yes Yes No
Liability Personal Personal Personal Limited
Taxation Personal Personal Personal Person
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11. Big organisation/ mgt
Corporations and owners different
control
Organizational structure Board of directors
• Each director is
A B C D elected by the firm’s
owners
• Hires the Chief hires CEO
Executive Officer
CEO
• Monitors firm and sets
high level strategy
CFO
• Objective is to
maximize firm value
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12. Corporations
Organizational structure Chief Executive
Officer (CEO)
A B C D • Everyday manager of
the firm
• Implements rules and
policies set by board of
CEO director
• Advised by high level
executives
CFO • Objective is to
maximize firm value
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13. Corporations
Organizational structure
Chief Financial Officer
A B C D (CFO)
• Evaluates investment
decisions for the firm
CEO • Evaluates financing
decisions for the firm
• Objective is to
maximize firm value
CFO
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14. The Financial Manager
We will focus on two primary responsibilities of the
financial manager: CFO
Investment decisions
Where to put
• Which projects should the firm pursue? money? which
Financing decisions projects
• How should the firm raise capital to finance How raise
these projects? funds/capital?
• How should the firm distribute profits to
investors? Is it beneficial to distribute money/
beneficial to put in dividends to shareholders or
the common stock 14 reinveste it?
or publick stock?
15. Corporations
Capital structure
• Describes how firm value is
split among different types of
financial securities
Total firm value
(e.g. $100 million) • Common securities include
• Equity
common stocks
• Debt
• Preference shares
= different common
financial securities
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16. Capital structure
Total Firm Value = Market Value of Equity + Market Value of Debt
Equity value
Equity value (e.g. $20 million)
(e.g. $60 million)
or
Debt value
Debt value (e.g. $80 million)
(e.g. $40 million)
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17. Capital structure
common stock=stock E+stock D
Equity owners of
+stock Prefer Shares
• Ownership of a company is divided into common stock the
• Stock owners, called shareholders, elect the Board of company
Directors have also
• Stock owners share in firm profits, which are uncertain and control and
may be zero liability
• Public stock is traded on stock exchanges
Debt
firms have to • Lender of capital to a firm hold bonds
Bond holders
repay bonds • Bond holders have no role in electing directors have no control
after; repay • Bond holders receive prescribed payments when firms
debt generate profits
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18. Capital structure
before paying dividends, have to
Absolute priority
repay debt/bonds
Requires a firm to make payment on debt
before distributing money to equity holders
Administration (bankruptcy) and liquidation
Occurs when a firm cannot pay its prescribed
payments to debt holders, an event called default
Control of the firm is given to the debt holders
firms take control when firms
bankruptcy=default have done shit!
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19. Capital structure
Example
Imagine a firm that has promised to pay bond
holders $90 million in one year. Assume the firm
will either earn $80, $100, or $120 million in
one year.
Equity Value 30
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Debt Value 80 90 90
repay debt before putting19money in the common stock
(equity)/and public stock for new exchange/new investment
20. Capital structure
depends of Equity Debt
how much
they have to Elects Board of Seizes firm on
Control
Directors default
reimburse. if
they prefer Payment amount Uncertain Prescribed
to reinvest
instead Payment order Last First
Risk High Low
I think risk must depends on debt; because of the
payment order; and the uncertained payment amount
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21. Corporations!
Key features of a corporation
It is its own legal entity, distinct from the owners
There is a separation between ownership and
management
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22. Corporations
Advantages over partnerships and sole traders
Limited liability for the owners
Business continues operation when ownership
changes
personal liability for the ceo??
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23. Agency costs
Definition
We assume that employees have their own personal objectives
These personal objectives may not always agree with the value
maximizing objective of the firm’s owners
An agency cost arises when an employee takes an action
that serves their own interests instead of maximizing firm
value
Examples
A CEO may not invest in a profitable, but risky project if they
are afraid of getting fired should the project fail
An employee may arrive late and leave early due to lack of
interest and no managerial oversight
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24. Taxation
Firm profits generate different after-tax values to owners
depending on firm structure and the tax system
Firm owner Limited partner Shareholder
Tax System Imputation Classical
credit
Firm profits $100 $100 $100
compensate income
Distribution method Dividends Dividends
the
Corporate Tax (30%) - -30 -30
corporate
Distributed Profits 100 70 70
tax!
Personal tax basis distributed profits Firm profits distributed profits
Personal tax (45%) -45 -45 -31.5
Franking credit (equal - 30 -
to corporate tax)
After-tax to owner $55 $55 $38.5
classical: tax previous amount
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imputation: tax first amount=amount before being distributed
25. Corporations
Advantages over partnerships and sole traders
Limited liability for the owners
Business continues operation when ownership
changes
Disadvantages compared to partnerships and sole
traders
Agency costs between owners and management
Taxation (in jurisdictions with “classical” tax
systems) with the previous slide, the after tax value of the
imputation is bigger than the classical.
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26. Ownership comparison
Sole trader Partnership Limited Partnership Corporation
General General Limited
Type of owner N/A Shareholder
partner partner partner
Number One Several One or more Several Many
Control Yes Yes Yes No Yes
Liability Personal Personal Personal Limited Limited
Corporate and
Personal
Taxation Personal Personal Personal Personal
(depending on
tax system)
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27. Review
Firm structures
• Characteristics of sole trader, partnerships,
corporations
Corporations
• Responsibilities of the financial manager
• Difference between equity and debt
• Advantages and disadvantages versus sole
traders and partnerships
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32. Assessments
Stock Weight
Tutorial
Participation 15%
Attendance 5
Quizzes (Lowest of the 4 quizzes dropped) 40
Final Exam 40
100%
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33. How to succeed
Tutorials
Attend
Participate
Quizzes and final exam
Practice
• Questions in tutorials and the text
• MyFinanceLab
Know strategies for Multiple Choice Questions
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