Finall, Spring 2011 Zero Growth: A lack of increase in the output of a business or economy between one period, such as one quarter, and the next.

Partnerships:

A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it "passes through" any profits or losses to its partners. Each partner includes his or her share of the partnership's income or loss on his or her tax return.

Corporations:

In a general sense, a corporation is a business entity that is given many of the same legal rights as an actual person. Corporations may be made up of a single person or a group of people, known as sole corporations or aggregate corporations, respectively.

Corporations exist as virtual or fictitious persons, granting a limited protection to the actual people involved in the business of the corporation. This limitation of liability is one of the many advantages to incorporation, and is a major draw for smaller businesses to incorporate; particularly those involved in highly litigated trade.

Primary Market - Definition:

The primary markets deal with the trading of newly issued securities. The corporations, governments and companies issue securities like stocks and bonds when they need to raise capital. The investors can purchase the stocks or bonds issued by the companies.

Money thus earned from the selling of securities goes directly to the issuing company. The primary markets are also called New Issue Market (NIM). Initial Public Offering is a typical method of issuing security in the primary market. The functioning of the primary market is crucial for both the capital market and economy as it is the place where the capital formation takes place.

OR

Markets that involve the issue of new securities by the borrower in return for cash from investors (Capital formation occurs)

Secondary Market - Definition:

The secondary market is that part of the capital market that deals with the securities that are already issued in the primary market.

The investors who purchase the newly issued securities in the primary market sell them in the secondary market. The secondary market needs to be transparent and highly liquid in nature as it deals with the already issued securities. In the secondary market, the value of a particular stock also varies from that of the face value. The resale value of the securities in the secondary market is dependant on the fluctuating interest rates.

ORMarkets that involve buyers and sellers of existing securities. Funds flow from buyer to seller. Seller becomes the new owner of the security. (No capital formation occurs)Primary vs. Secondary Market:

Primary vs. secondary market says that the primary market deals with the newly issued securities while the secondary market deals with already traded securities. When the companies issue securities in the primary market, they collect funds directly from the investors through the securities sales. But, in the secondary market the money earned from selling a security does not go to the company. The money thus earned goes to the investor who sells the security.

Ordinary annuity is a series of fixed payments made at the end of each period over a fixed amount of time.

An annuity due is an annuity whose payment is to be made immediately, rather than at the end of the period.

Marketable Securities:

Very liquid securities that can be converted into cash quickly at a reasonable price.

Marketable securities are very liquid as they tend to have maturities of less than one year. Furthermore, the rate at which these securities can be bought or sold has little effect on their prices.

Examples of marketable securities include commercial paper, banker's acceptances, Treasury bills and other money market instruments.

Characteristics of Marketable securities

Can be traded between or among investors after their original issue in public markets and before they mature or expire

Capital rationing

Placing limits on the amount of new investment undertaken by a firm, either by using a higher cost of capital, or by setting a maximum on the entire capital budget or parts of it.

The act or practice of limiting a company's investment. That is, capital rationing occurs when a company's management places a maximum amount on new investments it can make over a given period of time. The two methods of capital rationing are forbidding investments over a certain amount or

increasing the cost of capital for such investments. Capital rationing is most common when a company's previous investments have not performed well.

Types of Working Capital Policies

The policy is basically about how much capital the company should maintain. Should they go in for a zero-risk arrangement, or can they try a bit of daredevilry in their working capital management? Here are the different working capital policies, their advantages and disadvantages.

Matching Policy

Simple and straightforward, this policy works in an arrangement where the current assets of the business are used perfectly to match the current liabilities. It is a medium risk proposition and requires a good amount of attention. For example, if the creditor is due to be paid 8 months from today, the company will ensure that there is cash to pay the creditor 8 months hence. Today the company may or may not keep the cash on hand.

Sounds risky? Yes. Then why would companies opt for this policy? Because, by keeping as little cash, as they can, unemployed and sitting in the banks. They can reinvest it in purchasing more goods, more machinery, which will increase production and, should the sales go according to plan, so will the profit. Hence keeping low levels of working capital means that you can employ your funds more productively elsewhere.

Aggressive Policy

High risk, and often high return, the aggressive working capital policy sees the company keep a really low amount of current assets. The idea here is very simple. Collect payments on time, leaving no debtors and invest that amount in the business. And pay the creditors as late as possible. This means that the business uses very little of its own cash, paying the creditors as late as it possibly can.

It is a high risk arrangement though, because, should your creditor come asking for money, and for some reason, you don't have enough money to pay them off, you might end up having to sell a costly asset to pay off your debt to them.

Conservative Policy

And if this above eventuality seems unpalatable to you, perhaps you would be better off opting for the conservative policy. In this policy, you not only match the current assets and the current liabilities, but you also keep a little safety net just in case of any uncertainty. Undoubtedly, this is the policy with the lowest risk, but it reduces the money used in increasing the production.

Financial Market, in very crude terms, is a place where the savings from various sources like households, government, firms and corporates are mobilized towards those who need it. Alternatively put, financial market is an intermediary which directs funds from the savers (lenders) to the borrowers.

In other words, financial market is the place where assets like equities, bonds, currencies, derivatives and stocks are traded.

Some of the salient features of financial market are:

Transparent pricing

Basic regulations on trading

Low transaction costs

Market determined prices of traded securities

Basic Functions of Financial Market:

Financial market has emerged as one of the biggest markets in the world. It is engaged in a wide range of activities that cater to a large group of people with diverse needs.

Six key functions of Financial Market OR Role of financial market in grooming of business

Borrowing & Lending: Financial market transfers fund from one economic agent (saver/lender) to another (borrower) for the purpose of either consumption or investment.

Determination of Prices: Prices of the new assets as well as the existing stocks of financial assets are set in financial markets.

Assimilation and Co-ordination of Information: It gathers and co-ordinates information regarding the value of financial assets and flow of funds in the economy.

Liquidity: The asset holders can sell or liquidate their assets in financial market.

Risk Sharing: It distributes the risk associated in any transaction among several participants in an enterprise.

Efficiency: It reduces the cost of transaction and acquiring information.

Cost of capital:

The opportunity cost of an investment; that is, the rate of return that a company would otherwise be able to earn at the same risk level as the investment that has been selected. For example, when an investor purchases stock in a company, he/she expects to see a return on that investment. Since the individual expects to get back more than his/her initial investment, the cost of capital is equal to this return that the investor receives, or the money that the company misses out on by selling its stock.

Cost of capital refers to the opportunity cost of making a specific investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk. Thus, the cost of capital is the rate of return required to persuade the investor to make a given investment.

Cost of Debt

What Does Cost of Debt Mean?

The effective rate that a company pays on its current debt; it can be measured as either before-tax or after-tax returns; however, because interest expense is deductible, the after-tax cost is seen most often. This is one part of the company's capital structure, which also includes the cost of equity.

Cost of Debt

Companies use bonds, loans, and other forms of debt for capital; this measure is useful because it indicates the overall rate being

used for debt financing. It also gives investors an idea of how risky a company can be; riskier companies generally have a higher cost of debt. To get the after-tax rate, multiply the before-tax rate by 1 minus the marginal tax rate (before-tax rate × (1 - marginal tax)). For example, if a company's only debt was a single bond in which it paid 5%, the before-tax cost of debt would be 5%. If, however, the company's marginal tax rate was 40%, the company's after-tax cost of debt would be only 3% (5% × (1 -40%)).

marginal cost of capital:

The cost associated with raising one additional dollar of capital. The marginal cost will vary according to the type of capital used. For example, raising funds through the use of unsecured or subordinated debt, or through debt that requires higher interest rates to offset risk, will be more expensive than debt that is backed by collateral, such as a secured bond.

OR

The cost of financing for the next dollar of capital raised. Some sources of capital are more expensive than others; for example, low-grade subordinated debt would be more expensive to raise (require a higher interest rate) than unsubordinated debt. Because capital must be raised to finance a new project, the mar- ginal cost of capital should be the hurdle rate used in discounted cash flow present value analysis, not the average cost of capital.

'Weighted Average Cost of Capital - WACC'

A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk.

The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing:

Where: Re = cost of equity ,Rd = cost of debt ,E = market value of the firm's equity ,D = market value of the firm's debt ,V = E + D ,E/V = percentage of financing that is equity ,D/V = percentage of financing that is debt &Tc = corporate tax rate

Broadly speaking, a company’s assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances.

A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm.

Calculating WACC:

The proportion of each component in the firm’s target capital structure is what should be used to calculate the WACC.

WACC Example: Full-O-Vit Inc.’s cost of equity is 14%.It is before-tax cost of debt is 8% and its marginal tax rate is 40%. The stock sells at book value. Using the following balance sheet, calculate Full-O-Vit’s after tax WACC.

wD=PSValue

wD=EquityValue

wD=DebtValue