BAF 361 INTRODUCTION TO CORPORATE

BANKING AND FINANCE

LECTURE 1- INTRODUCTION TO CORPORATE

FINANCE

Samuel Gameli Gadzo

2 Learning objectives
´What is Corporate Finance?
´Corporate finance principles
´Main task of areas of corporate finance
´Role of the Financial Manager
´Goals of corporate finance management
´Agency theory
3 What is Corporate Finance?
Imagine that you were to start your own business. No matter what type you
started, you would have to answer the following three questions in some form or
another:
´ What long-term investments should you take on? That is, what lines of business
will you be in and what sorts of buildings, machinery, and equipment will you
need?
´ Where will you get the long-term financing to pay for your investment? Will you
bring in other owners or will you borrow the money?
´ How will you manage your everyday financial activities such as collecting from
customers and paying suppliers?
These are not the only questions by any means, but they are among the most
important. Corporate finance, broadly speaking, is the study of ways to answer
these three questions.
4 Core Corporate Finance Principles

´ The Investment Principle: Invest in assets and projects that

yield a return greater than the minimum acceptable
hurdle rate.
´ The Financing Principle: Choose a financing mix (debt and
equity) that maximizes the value of the investments made
and match the financing to the nature of the assets being
financed.
´ The Dividend Principle: If there are not enough investments
that earn the hurdle rate, return the cash to the owners of
the business.
5
Main tasks/Decision areas of corporate finance

´ Capital budgeting: the process of planning and managing a

firmʼs long-term investments Þ Non- Current Assets.
´ Example: deciding whether or not to open a new restaurant.

´ Capital structure: the mixture of debt and equity maintained by

the firm Þ S-T and L-T debt and equity.

´ Working capital management: a firmʼs short-term assets and

liabilities Þ current assets and current liabilities.
6 The Financial Manager
To create value, the financial manager
should:
1. Try to make smart investment decisions.
2. Try to make smart financing decisions.
7 Role of The Financial Manager

(1)

Firm's Financial Financial

operations manager markets

(1) Cash raised from investors

8 Role of The Financial Manager

(2) (1)

Firm's Financial Financial

(4a)
operations manager markets

(3) (4b)

(1) Cash raised from investors

(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
9 Possible goals of Corporate Finance Management

´Survive
´Beat the competition
´Maximize sales
´Maximize net income
´Maximize market share
´Minimize costs
´Maximize the value of (stock) shares
10
The “appropriate” goal of Corporate
Finance
´ Maximize the (fundamental or economic) value of
(stock) shares is the right goal.
´ Why? Shareholders own shares. Managers, as
agents, ought to act in a way to benefit
shareholders; i.e., to enhance the value of the
shares.
´ A limitation of this goal is that value is not directly
observable.
11 Primary Goal of Corporate finance

The primary goal of financial management is to:

´maximize current dividends per share of the existing
stock.
´maximize the current value per share of the existing
stock.
´avoid financial distress.
´minimize operational costs and maximize firm efficiency.
´maintain steady growth in both sales and net earnings.
12
Value maximization and sustainability
´ Business sustainability: often viewed as managing the triple
bottom line - a process by which companies manage their
economic/financial, ecological, and social opportunities and
risks.
´ Sustainability and value maximization are somewhat different.
´ Three Aspects of Sustainability
´ Economic/financial –here is more about economic viability and
profitability, and not directly about value maximization.
´ Ecological – reaching your financial goals should not impose
burden on the current natural environment.
´ Social – reaching your financial goals should not damage the
well-being of the society (employees, etc.).
13 Shareholders and other stakeholders
´Customers

´Suppliers

´Employees (human capital and assets)

´Creditors (bondholders, banks, debtholders)

´Government: tax and regulations

´Community (local / global)

´Owner/shareholder
14
Agency Relationships
´ The relationship between stockholders and management is called an agency
relationship . Such a relationship exists whenever someone (the principal) hires
another (the agent) to represent his or her interests. In all such relationships, there
is a possibility of conflict of interest between the principal and the agent. Such a
conflict is called an agency problem
´ Agency problem: The possibility of conflict of interest between the stockholders
and management of a firm..
´ Agency costs refers to the costs of the conflict of interest between stockholders
and management. These costs can be indirect or direct.
´ An indirect agency cost is a lost opportunity, such as the one we have just
described.
´ Direct agency costs come in two forms. The first type is a corporate expenditure
that benefits management but costs the stockholders. The second type of
direct agency cost is an expense that arises from the need to monitor
management actions.
15 Do Shareholders Control Managerial Behaviour?

´ Shareholders vote for the board of directors, who in turn hire the
management team.

´ Contracts can be carefully constructed to be incentive compatible.

´ There is a market for managerial talent—this may provide market

discipline to the managers—they can be replaced.

´ If the managers fail to maximize share price, they may be replaced in

a hostile takeover.
16 Ethics
´ Managers are expected to behave in an ethical manner.
´ The province of ethics is to sort out what is good and bad.
´ But, what is the criterion or guideline for doing so?
´ Philosophers came up with some criteria, but none of them
makes sorting out what is good and bad an easy task.
´ Here, we introduce two of these criteria.
´ Golden rule: Do unto others as you would have others do
onto you.
´ Confucianism: Do not do to others what you do not want
done to yourself.
17

END OF
LECTURE