Sole Proprietorship

Business owned by one individual

Sole Proprietorship Pros

- Sole Decision Maker - Fewer Regulations - Single Taxation - Easy to Form

Sole Proprietorship Cons

- Unlimited Personal Liability - Difficult to Raise Capital - Ends with life of the owner

Guiding Principles of Finance

1. Maximization of Wealth 2. Time Value of Money 3. Risk and Return 4. Leverage 5. Diversification

Areas of Finance

1. Financial Intermediation 2. Investments 3. Corporate Finance

Partnership

Business owned by two or more people

Partnership Pros

- Limited Decision Makers - Fewer Negotiations - Single Taxation - Easy to Form

Partnership Cons

- Unlimited Personal Liability - Difficult to Raise Capital - Ends with the life of the owner - Partnership issues

Corporation

Legal entity created by a state, separate and distinct from its owners (shareholders)

Corporation Pros

- Limited Liability - Easy to raise capital - Easy to transfer ownership - Unlimited Life

Corporation Cons

- Many decision makers - More regulations - Double taxation - Can be complicated to form

Public Corporation

Have shares owned by the general public. Firms sell shares to the public with help from investment banks

Private Corporation

Raise money through private equity and venture capital. Typically, more expensive, but less regulated

Capital

An asset used to generate future value. In finance, typically referred to as the cash used to purchase these assets

Primary Market

Firm transacts directly with investors

Secondary Market

Investors transact with themselves

Types of Capital: Debt

- Legally binding contract between borrower and lender - Lender loans principal, Borrower promises repay principal with interest - In general: no voting rights, highest priority in bankruptcy, "fixed income"

Types of Capital: Equity

- Represents ownership claim on firm - Investor only earns return if firm succeeds - In general: voting rights, ownership position, "residual claim"

Balance Sheet

Provides a snapshot of firm's position at end of fiscal period

Income Statement

Summarize firm's revenues and expenses during fiscal period

Statement of Cash Flows

Summarizes firm's cash transactions during fiscal period and is divided into 3 sections 1) Operating Activities 2) Investing Activities 3) Financing Activities

Book Value

Value shown in the financial statements; Only reflect past transactions

Market Value

Current value investors are willing to pay for an asset; Reflects past transactions but also future expectations

Liquidity Ratios

Help us understand if firm has sufficient case, liquid assets to pay its bills

Efficiency Ratios

Help us understand how well a firm manage various assets

Leverage

Firm's use of debt

Leverage Ratios

Help us understand how the firm financed its assets, whether firm has sufficient funds to cover interest expenses

Profitability Ratios

Help us understand how effective firm is at generating profits

Market Value Ratios

Help us understand how the market values firm's earnings and assets

Return Ratios

Help us understand return earned by shareholders

Time Value of Money

A dollar today is worth more than a dollar tomorrow

Simple Interest

Earn interest only on your principal investment

Compound Interest

Interest on your principal and prior interest

Effective Annual Rate

Annual rate that incorporates effects of compounding

Annuity

Cash flow stream where equal cash flow occurs every period for N periods

Perpetuity

Cash flow stream that goes on forever

Ordinary Annuity

Payments occur at the end of each period

Annuity Due

Payments occur at the beginning of each period

Growing Perpetuity

Stream of cash flows received forever, where every cash flow is g% larger/smaller than the last

Amortized Loan

Loan repaid in equal payments over the loan's life

Paying Down Principal

Making extra payments on an amortized loan