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Introduction To Corporate Finance

McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Key Concepts and Skills

Know the basic types of financial management decisions and the role of the financial manager Know the financial implications of the different forms of business organization Know the goal of financial management Understand the conflicts of interest that can arise between owners and managers Understand the various types of financial markets

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Chapter Outline
Corporate Finance and the Financial Manager Forms of Business Organization The Goal of Financial Management The Agency Problem and Control of the Corporation Financial Markets and the Corporation 1-2

Corporate Finance or Business Finance?

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Fundamental Propositions
Internal Consistency Integrated whole Matters to everybody Corporate finance is fun Best practice involve application of theories to real world problems
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Corporate Finance
Some important questions that are answered using finance
What long-term investments should the firm take on? Where will we get the long-term financing to pay for the investment? What proportion f earnings should be paid as dividend related decisions How will we manage the everyday financial activities of the firm? 1-5

Financial Manager
Financial managers try to answer some or all of these questions The top financial manager within a firm is usually the Chief Financial Officer (CFO)
Treasurer oversees cash management, credit management, capital expenditures, and financial planning Controller oversees taxes, cost accounting, financial accounting and data processing
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Financial Management Decisions

Capital budgeting
What long-term investments or projects should the business take on? New Product line, Expanding into new market Mergers and acquisitions Techniques Cash flow estimation
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Financial Management Decisions

Capital structure
How should we pay for our assets? Should we use debt or equity? Or both? What are the regulatory and real world impediments? What is the optimal financing mix? What about matching of funds? What tax implications exist? External monitor considerations e.g rating agencies.
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Financial Management Decisions

Working capital management
How do we manage the day-to-day finances of the firm?

Operating cycle Cash Conversion cycle Cash, debtors, and creditors mgt

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Financial Management Decisions

consider the options available to a firm How to return assets to its owners dividends, stock buybacks and spinoffsand investigate ? how to pick between these options?

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Forms of Business Organization

Three major forms in the United States
Sole proprietorship Partnership
General Limited

Corporation
S-Corp Limited liability company
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Sole Proprietorship
Advantages
Easiest to start Least regulated Single owner keeps all the profits Taxed once as personal income

Disadvantages
Limited to life of owner Equity capital limited to owners personal wealth Unlimited liability Difficult to sell ownership interest

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Partnership
Advantages
Two or more owners More capital available Relatively easy to start Income taxed once as personal income

Disadvantages
Unlimited liability
General partnership Limited partnership

Partnership dissolves when one partner dies or wishes to sell Difficult to transfer ownership

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Corporation
Advantages
Limited liability Unlimited life Separation of ownership and management Transfer of ownership is easy Easier to raise capital

Disadvantages
Separation of ownership and management Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)

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Goal Of Financial Management

Specific: Increasing growth in the long run Measurable: Maximizing customer utility Achievable: A branch in Mars! Realistic Timing Non-counterproductive

In most cases, the objective is stated in terms of maximizing some function or variable, such as profits or growth, or minimizing some function or variable, such as risk or costs
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Goal Of Financial Management

What should be the goal of a corporation?
Maximize profit? Minimize costs? Maximize market share? Maximize the current value of the companys stock?

Does this mean we should do anything and everything to maximize owner wealth?
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Maximize firm value

The link between the corpfin decisions and firm value can be made by recognizing that the value of a firm is the present value of its expected cash flows, discounted back at a rate that reflects both the riskiness of the projects of the firm and the financing mix used to finance 1-17 them.

 To maximize value.
The managers of the firm put aside their own interests and focus on maximizing stockholder wealth. The lenders to the firm are fully protected from expropriation by stockholders. The managers of the firm do not attempt to mislead or lie to financial markets about the firms future prospects, and there is sufficient information for markets to make judgments about the effects of actions on long-term cash flows and value. There are no social costs or social benefits.
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The Agency Problem

Agency relationship
Principal hires an agent to represent his/her interests Stockholders (principals) hire managers (agents) to run the company

Agency problem
Conflict of interest between principal and agent

Management goals and agency costs

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The Agency Problem

Constituencies of the company who have a vested interest in the way the firm is operated and include

Stockholders Employees Customers Community Management Creditors Suppliers

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Corporate Governance in the US and EU

Independent Board of Directors Transparency in accounting Independent Assessors Regulators Rating agencies

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Hypothetical Organization Chart

Board of Directors Chairman of the Board and Chief Executive Officer (CEO) President and Chief Operating Officer (COO) Vice President and Chief Financial Officer (CFO)

Treasurer

Controller

Cash Manager
Capital Expenditures

Credit Manager Financial Planning

Tax Manager
Financial Accounting

Cost Accounting Data Processing

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 Corporate Governance Managerial compensation

Managing Managers

Incentives can be used to align management and stockholder interests Corporate Governance: Alan Mulaly, Ford Motors Job prospects: Larry Ellison, Oracle The incentives need to be structured carefully to make sure that they achieve their goal

Corporate control
Proxy fight e.g HP and Compaq The threat of a takeover may result in better management: carl Icahn, Motorola

Other stakeholders

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Regulation
Sarbanes Oxley Act 2004
Protects investors from corporate abuses Increase corporate audit Companies going dark Implication for access to finance Cross border listing due to high cost of complying with Sarbox

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Ethics
Case study of WorldCom Get the photocopy material on the minicase from Achik photocopying shop.

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Work the Web Example

The Internet provides a wealth of information about individual companies One excellent site is finance.yahoo.com Click on the web surfer to go to the site, choose a company and see what information you can find!

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Financial Markets
Cash flows to the firm Primary vs. secondary markets
Dealer vs. auction markets Listed vs. over-the-counter securities
NYSE NASDAQ

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Quick Quiz
What are the three types of financial management decisions and what questions are they designed to answer? What are the three major forms of business organization? What is the goal of financial management? What are agency problems and why do they exist within a corporation? What is the difference between a primary market and a secondary market?
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End of Chapter
McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.