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Introduction to Corporate Finance

Financial Management Duties

Capital Budgeting The process of planning and managing a firms long-term

Capital Structure The specific mixture of long-term debt and equity the firm uses to
finance it operations.

Working Capital Management Managing the firms short-term assets and liabilities.

Financial Officers

Chief Financial Officer oversees the treasurer and controller and sets overall financial

Treasurer responsible for financing, cash management, and relationships with financial
markets and institutions.

Controller responsible for budgeting, accounting, and auditing.

Forms of Business Ownership

Proprietorship An unincorporated business owned by a single individual.

Easily and inexpensively formed.
Few government regulations.
Avoids corporate income taxes.

Unlimited liability for the owner.
Limited to the life of the owner.
Difficult to obtain large amounts of capital.

Partnership Business owned by tow or more persons who are personally responsible for
all its liabilities.

Easily and inexpensively formed.
Few government regulations.
Avoids corporate income taxes.

Unlimited liability for general partners.
Limited life for the organization.
Difficult to transfer ownership.
Difficult to obtain large amounts of capital.

Corporation A business that is legally distinct from its owners.

Unlimited life.
Easy to transfer ownership.
Limited liability.

Double taxation.
Complex legal requirements.

Hybrid Forms of Organization

Limited partnership Certain partners are designated general partners, who have
unlimited liability. Other owners are limited partners because their liability is limited.

Professional Corporation A type of corporation common among professionals. An S
corporation has 75 or fewer shareholders.

The Goal of Financial Management

Maximize Shareholder Wealth Mangers work on behalf of shareholders and should
pursue policies that enhance shareholder value.

Social Responsibility The concept that businesses should be actively concerned with
the welfare of society at large.

Agency Problems and Control of the Corporation

Agency Problem The conflict of interest between the firms owners and managers.

Management Goals Managers have a tendency to increase their own perks or to
increase the size of the organization in an attempt to increase their power.

Methods to Entice Managers to Act in the Best Interests of Stockholders

The threat of firing
The threat of takeovers
Managerial compensation
Direct Intervention by Shareholders

Ownership Structure outside the U.S. in some countries, ownership is more
concentrated, creating separate problems.

Lecture 2 Financial Statements, Taxes, and Cash Flow

Review the income statement, balance sheet, and cash flow statement.

Emphasize cash flows and the difference between accounting accruals.

Income Statement

Income Statement Shows how profitable a firm has been over some period of time.

GAAP Revenues appear when they accrue, not when they are collected. Expenses are
matched with the revenues that appear.

Noncash items Depreciation.

Taxes The marginal tax rate is the most relevant when evaluating projects.

Balance Sheet

Balance Sheet Presents a snapshot of the firms assets, liabilities, and owners equity.

Assets Listed in order of their liquidity on the left-hand side of the statement.

- Current Assets life of less than one year.

- Fixed Assets life longer than one year.

Liabilities and Owners Equity The claims against assets.

- Current Liabilities life of less than one year.

- Long-term Liabilities debt (financial leverage) that is not due in the next year.

- Owners Equity value of the capital supplied by common stockholders.

Book Values vs. Market Values assets must be shown on the balance sheet at their
historical cost adjusted for depreciation. These are not market values.

Cash Flow Analysis

Cash Flows Analysis shows the firms cash receipts and cash payments over a period of

Cash Flow from Operations begins with net income and adjusts for non-cash items.

Cash Used for Investments money spent on fixed assets and received from sales of
fixed assets.

Cash Flow from Financing Activities

- Cash flow to creditors interest paid minus net new borrowing.

- Cash flow to stockholders dividends paid minus net new equity.

Anyone who has spent any time employed by a public company quickly learns the phrase in the
best interests of the shareholders. It is used to justify decisions on issues including (and
certainly not limited to) strategy, resource allocation, risk, personnel, marketing and reputation.
In the best interests of the shareholders much like that booming voice in the The Wizard of
Oz always bellows forth from the walled-off chambers of upper management, conveying an
unambiguous intention that it should (or must) reverberate from top to bottom, ultimately finding
its way into every corporate message and mission statement.

Stockholders have traditionally watched the results of the stock markets as a measure of their
financial investment. Stakeholders typically watch the behavior of those corporations they
support as a measure of their interest and emotional support. The level of support a business gets
from people has a direct correlation to financial returns. Yet stockholders dont typically see the
things that influence the stakeholders support for a business.
A corporate stakeholder are those groups of people who can affect or be affected by the actions
of the business as a whole. Stakeholders are defined as those groups without whose support the
organization would cease to exist. Stakeholders include stockholders but stockholders are
influenced more by financial returns while the remaining stakeholders are influenced more by
their experience with the organization.