Risk and Return, Business Structures
By R. S. Miolla
Risk and Return
• Return– Cash inflows– Profits (net income)– Satisfaction
• Risk – How wide a range of outcomes– Standard deviation– Only relevant if good and bad outcomes
Risk and Return - Example
• A) $10,000 to invest– At the bank in a cd paying 5%– In the stock market: will pay between -50% and
+50 %. Mean of all possibilities is +5%.
Which investment would you choose? Why?
Risk and Return - Example
• Still $10,000 to invest.– Still a bank cd paying 5%.– Invest in the stock market: return will be between
-50% and +75%. The mean of the outcomes (expected value) is +25%.
• Which investment would you invest in? Why?
Finance Terms
• Financial Capital: Cash or “money”• Real Capital: Long term plant and equipment• Capital Structure: The mix (%) of debt and
equity used to finance the business. What your sources of capital are.
• Inflation: Increase of prices over time.• The goal of finance is to maximize shareholder
wealth.
The Flow of Business
• 1) obtain financing• 2) receive cash• 3) buy real assets• 4) produce net income in the period• 5) collect cash flows• 6) reinvest (retained earnings) or pay
dividends
Forms of Ownership
• 1) Sole Proprietorship: – Single owner– Unlimited liability– Taxed as owner’s income
• 2) Partnership:– Two or more owners, Unlimited liability– Articles of partnership: profits, withdrawal terms,
ownership %– Limited Liability Partnership (LLP): General partner and
limited partners
Forms of Ownership, con’t
• 3) Limited Liability Company (LLC):– Low reporting costs, taxed as partnership or Corp.,
limits liability• 4) Corporation:– A legal entity, limited liability– Many owners (shareholders)– Board of Directors– Profits taxed twice: corporate and dividends– Subchapter S Corp. – Income taxed once to
shareholders, maximum of 75 shareholders
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