Assignments: Check Your Understanding: (5 points each) 1.

Why should a financial manager have an integrated understanding of the 5 basic finance functions? Why is the corporate governance function considered a finance function?

A financial manager needs to know all five basic finance areas because they all impact his or her job. While the managers primary responsibilities may be in raising money or choosing investment projects for capital budgeting, the manager also needs to know about capital markets and debt/equity optimal levels, be able to manage risks of the business and governance of the corporation. Stake holders and the shareholders are the core contributors to the financial industry and the total financial market can collapse if there are no governing principals or ethics around it. Corporate governance is a function because a finance manager must act in the best interest of its shareholders. New methods of managing risk have been developed in recent years, and a manager must be aware of these in order to maximize shareholder value. Enron and AIG are good examples that made headlines recent years because of the lack of proper corporate governance.

2. What role does the Sarbanes-Oxley Act of 2002 play in financial reporting? Are there possible shortcomings to relying solely on financial statement analysis to value companies? Sarbanes-Oxley Act of 2002 was a result of recent failures in corporate governance such as financial collapses of large corporations like Enron and AIG. Bad accounting practices resulting from greed went out of control in these situations. These events revealed the lack of governance in place to protect the share holders and as a result congress passed Sarbanes-Oxley Act of 2002 to impose a host of new rules and regulations. The Act also required firms to provide documentation of internal controls to protect the investors, new requirements on board membership, executive compensation, and relationships with auditors. 3. What are the advantages/disadvantages of the different legal forms of business organizations? Advantages of Proprietorships and Partnerships 1. Easy to form 1. Few regulations 2. No corporate income taxes 3. Being ones own boss Disadvantages 1. Limited life Unstable in nature due to conflicts among partners. Partners can decide to end the partnership at their will. 2. Unlimited liability Partners are subject to the liabilities that resulting from this partnership. 3. Hard to raise capital Capital is limited and governed by what partners can raise. Advantages of Corporations 1. Unlimited life

2. 3. 4.

Easy to transfer ownership Limited liability Easier to raise capital

Disadvantages 1. Double taxation 2. Costly set up 3. Costly period reports required 4. Considering the financial information in the various financial statements, which statements provide information on a company's performance over a reporting period? Which present data on a company's current position?

Exercises: (10 points each) 1. Enter the home page of the Jobs in the Money web site (http://www.jobsinthemoney.com/index.php?action=adv_search) and page through the finance positions listed. If the salaries are listed, what skill sets or job characteristics lead to the variation in salaries? Describe some of the requirements for prior work experience (if any) as they relate to the position and required skill sets. 2. A particular business deal allows you the choice of receiving $1,000 today or receiving $2,000 ten years from today. How would your choice change based on your ability to invest money at a very low rate of interest or a very high rate of interest? Investors expect returns for their investment according to the risk they have to take. In this situation the 1000$ received today may be more attractive because of the theory of time value of the money. The investment decision is entirely depends on the risk I have to take to gain that return. If I could invest money at a very low rate of interest your risks are lower because over 10 years of period I only risk the low rate of interest over a 10 year period. On the other hand if I have to pay higher interest for my investment it is a higher risk that I take a longer period of time to get the additional reward and it may look very unattractive to do so. 3. What happens to the present value of a cash flow stream when the discount rate increases? Place this in the context of an investment. If the required return on an investment goes up but the expected cash flows do not change, would you be willing to pay the same price for the investment or would you pay more or less for this investment than before interest rates changed? 4. Could a limited liability advantage of a corporation also lead to an agency problem? Why?

Agency cost or agency conflict refers to any time a decision is made that does not maximize shareholder wealth. For example, managers may want excessive benefit, such as a fleet of company planes, that maximize their person satisfaction, but conflict with maximizing shareholder wealth. These costs can be minimize by, for example, tying managements compensation to stock price so they have an incentive to work to maximize stock price. Such contracts can be effective if structured properly, although they have been criticized as providing excessive gains to managers when the entire market was rising.

Professional Development: (10 points) Suppose a supplier allows payment for inventory 30 days from delivery, and the firm is able to sell all of the inventory within 15 days of delivery. How does this affect free cash flow? Back to top

Discussion Question: (10 points) Describe the differences between businesses in the U.S. and those in foreign countries with respect to taxation, financial disclosure, and ownership structure. Is privatization reducing or increasing these differences? In US the state owned enterprises are nonexistent while around the world many of the governments have corporations run buy the government. France run many state owned corporations such as Renault Automobile group and many other in railway and transportations sectors. However even in USA all the preferred stocks of such corporations as AMTRACK are owned by US government. Unlike many governments around the world in US the corporations are taxed twice at corporate level and the personal income level as share holders. This problem is substantially reduced in USA because of the jobs and growth tax relief reconciliation Act. Still the partnership enjoys better tax advantages that a corporation. And also for small companies there is the S-corporation entity that carries the same advantages as a partnership.

Tax rules are more punitive in US and public disclosure requirement in US is very much greater than other countries. U.S. has one of the strictest set of accounting rules imposed by the Securities and Exchange Commission (SEC) and the Sarbanes-Oxley Act of 2002. Even the Foreign corporations are required to be conformant to GAAP regulations if they are to be listed on U.S. exchanges. There are also differences in corporate governance, for example, lenders and companies in Japan have closer relationships than among U.S. corporations. Most countries in Europe started to feel the need for Privatization hoping that would lead to greater efficiencies in large state run corporations. Privatization in the United Kingdom by Margaret Thatcher was what led to efficiencies in financial market in United Kingdom.
In many socialist countries like Cuba almost all corporations are run by the state government but we have seen the trend of privatization even in communist countries like China and Russia.

Privatization can level the differences and increase competitiveness but only with proper corporate governance and effective tax laws and regulations.

Module Summary: The practice of corporate finance rests on a foundation of certain core principles and involves five basic, related sets of activities: financing, capital budgeting, financial management, corporate governance, and risk management. The three key legal forms of business organization in the U.S. are sole proprietorships, partnerships, and corporations. A new, fourth form, the limited liability company, has recently become popular due to its flexibility and the favorable tax

treatment. The goal of a firm's managers should be to maximize shareholder wealth rather than maximize profits. Maximizing profits focuses on the past, not the future, ignores the timing of profits, relies on accounting values rather than future cash flows, and ignores risk. Shareholderwealth maximization is socially optimal because shareholders are residual claimants who profit only after all other claims are paid in full. The four key financial statements are 1) the balance sheet, 2) the income statement, 3) statement of retained earnings, 4) statement of cash flows. Companies typically include with these statements detailed notes describing the technical aspects of the financial statements. A firm's total cash flows can be divided into operating flows, investments flows, and financing flows. Operating cash flow measures the amount of cash flow the firm generates from its operations. It is calculated by added any noncash charges to the firm's net operating profits after taxes. More important to financial analysts is free cash flow, the amount of cash flow available to investors. The statement of cash flows summarizes the firm's cash flows over a specified period, typically one year. It presents operating, investment, and financing cash flows. When interpreting the statement, an analyst typically looks for unusual change in either the major categories of cash flow or in specific items to find clues to problems that the firm may be experiencing. To compare decision alternatives, financial managers use future value and present value techniques to equate cash flows occurring at different times. Managers rely on present value techniques and commonly use financial calculators or spreadsheet programs to streamline their computations. Some special applications of time value include compounding interest more frequently than annually, stated and effective annual of interest, deposits needed to accumulate a future sum, loan amortization, implied interest or growth rates, and number of compounding periods. The more frequently interest is compounded at a stated annual rate, the larger the future amount that will be accumulated and the higher the effective annual rate.