Provides more useful information for better predicting cash flows and for evaluating the performance of the firm and its managers.
Problems with Profit Maximisation Goal
Variable definition of Profit
Does not consider the differing levels of risk between competing alternative investments
Does not consider the TVM
Determinants of Share Price
Amount of expected cash flows
Timing of expected cash flows
Risk of expected cash flows
Advantages of a Sole Proprietorship
Ease of Formation
Subject to few regulations
No corporate income tax
Profit is taxed only once as personal income
Disadvantages of a Sole Proprietorship
Limited Life
Unlimited Liability
Difficult to Raise Capital to support growth
Advantages of a Corporation
Advantages to Shareholders
Limited Liability
Easy transfer of ownership of shares
Capacity to contract withe the company
Advantages to company
Unlimited Life
Facility in Raising or increasing capital
Ease of raising capital -- issue shares to the public
Availability to use expertise of directors with technical skills
Disadvantages of a corporation
Double taxation (in the states)
Cost of setup and report filing
Penalty for officers if not compiled with the act
Agency Problem: Stockholders and Management
Agent is hired by a principal and given decision making authority
Abuse: Management may act to maximise their own welfare instead of the owners;
Managing: Monitor management via audits and tying executive compensation to stock performance
Agency Problem:Stockholders and Creditors
Abuse: If actions of the borrowing firm become rsikier than before loan, creditors are exposed to more risk, but risk taking rewards all go to the stockholders
Managing: Lenders put clauses in loan agreements to prevent this including protective covenants.
Agency Relationship
Occurs when one or more individuals (the principals) hire another individual(the agent) to perform a decision making role.
Advantages of Shareholder Wealth Maximisation Goal
It considers the timing and risk of the expected benefits
Conceptually possible to determine whether a particular financial decision is consistent with this obejective
Objective is ipersonal - shareholders can buy and sell as desired
Economic Value Added
Differences between after tax profit and totla anual cost of capital
8 Elements of a cash budget
Cash Receipts
Cash Disbursements
Net Change in Cash for the Period
Plus opening cash balance = initial closing cash balance
Note target cash Balance
New financing Needed/surplus cash for investing
Final Closing Cash Balance
Cumulative Balance of Overdraft, short term investment.