% This is lecture no. 1 of BU8201/: Business Finance.

\chapter{Maximising Value}

\begin{definition}
	Business Finance.
	It is the study of how companies conduct their business in order to maximise value.
\end{definition}

\section{Forms of Business Organisations}

\noindent
There are three forms of business organisations:

\begin{enumerate}
	\item \textbf{Proprietorship:} An unincorporated business owned by 1 individual.
	\item \textbf{Partnership:} An unincorporated business owned by two or more persons.
	\item \textbf{Corporation:} An incorporated business owned by many shareholders.
		\begin{enumerate}
			\item Legal Entity separate from owners.
			\item Ownership denoted by shares.
			\item Can be public or private.
		\end{enumerate}
\end{enumerate}

\subsection{Incorporated and unincorporated businesses}

The above mentioned business organisations can be further sub-divided into two categories.
Unincorporated businesses and incorporated businesses.
Each of these are distinct and have pros and cons.

\bigbreak
\noindent
Unincorporated Businesses:

\begin{itemize}
	\item Pros:
		\begin{itemize}
			\item Ease of formation.
			\item Subject to few regulations.
			\item No corporate income taxes.
		\end{itemize}
	\item Cons:
		\begin{itemize}
			\item Difficult to raise capital.
			\item Unlimited liability.
			\item Limited life.
		\end{itemize}
\end{itemize}

\bigbreak
\noindent
Incorporated Businesses:

\begin{itemize}
	\item Pros:
		\begin{itemize}
			\item Easy transfer of ownership.
			\item Unlimited life.
			\item Limited liability.
			\item Ease of raising capital.
		\end{itemize}
	\item Cons:
		\begin{itemize}
			\item Cost of set up and report filing.
			\item Double taxation.
		\end{itemize}
\end{itemize}

\subsection{Double taxation}

\begin{definition}
	Double taxation.
	A situation in which income taxes are paid twice on the same source of income.
\end{definition}

\bigbreak
\noindent
When a business makes \$1 in profit:

\begin{itemize}
	\item Proprietorship / Partnership:
	\begin{itemize}
		\item Profit goes to owners.
		\item Owners pay personal income tax on the \$1 (e.g. 20\%).
		\item Owners left with \$0.80 after tax.
	\end{itemize}
\end{itemize}

\begin{itemize}
	\item Corporation (U.S. system):
	\begin{itemize}
		\item Corporation pays corporate tax (e.g. 30\%).
		\item After-tax profit of \$0.70 distributed to owners as dividends.
		\item Owners pay dividend tax (e.g. 15\%).
		\item Owners left with \$0.595
	\end{itemize}
\end{itemize}

\subsection{Structure of corporations}

\begin{figure}[h]
	\centering
	\includegraphics[width=0.35\textwidth]{./figures/drawing.pdf}
	\caption{Typical Corporate Structure}
\end{figure}

\section{Goals of Financial Management}

\begin{mdframed}
The goal of financial management is to maximise shareholder wealth. This is done by maximising the \textit{intrinsic} value of the stock.
\end{mdframed}

\subsection{Stock Price \& Intrinsic Value}

A stock's \textit{intrinsic} value is based off `true' investor cash flows and `true' risk.
In contrast, the stock's market price is based off `perceived' investor cash flows and `perceived' risk.

Stock prices are set by marginal investors based on the price of the most recent transaction.
When the stock price falls below the stock's \textit{intrinsic} value, the stock is said to be \textbf{undervalued}, and vice-versa.
When they are both the same value, the stock is said to be in \textbf{Market Equilibrium}.

\subsection{Important Business Trends}

\bigbreak
\noindent
Some important business trends:

\begin{itemize}
	\item Corporate scandals have reinforced the importance of business ethics, spurring additional regulations and corporate oversight.
	\item Increased globalisation of businesses.
	\item Stockholders now have more control of corporate governance.
\end{itemize}

\section{Agency Problems}

\begin{definition}
	Agency Problems.
	Conflict between shareholders and managers.
\end{definition}

\subsection{Solving Agency Problems}

Agency Problems can be solved in the following ways:

\begin{enumerate}
	\item Threat of firing / takeover.
	\item Direct intervention by shareholders.
	\item Managerial compensation packages.
	\begin{enumerate}
		\item Reward managers based on long-run intrinsic value of the company stock.
	\end{enumerate}
\end{enumerate}

\subsection{Conflicts Between Stockholders \& Bondholders}

\begin{definition}
	Bondholder.
	A Bondholder is someone who lends money to a company with interest
\end{definition}

\bigbreak
\noindent
Stockholders and bondholders have certain conflicts of interest:

\begin{itemize}
	\item Stockholders prefer riskier projects, as they receive more upside if the project succeeds.
	\item Bondholders receive fixed payments and are interested in limiting risk.
	\item Bondholders are concerned about the use of additional debt.
	\item Bondholders protect themselves by including clauses in bond agreements to limit the use of additional debt.
\end{itemize}
