CHAPTER 1.

INTRO TO CORPORATE FINANCE

1. WHAT IS CF?
Imagine you are an entrepreneur with a business idea (build and sell wood tables)
You will need to undertake some decisions:
- Capital budgeting decisions (how many machines to produces the tables and its cost).
Related to investments
- Capital structure decisions (you may need external financing such as equity or debt).
Related to financing
- Net working capital decisions (how much wood you need to buy every week given
what you sell). Related to current assets and liabilities
Corporate finance will allow us to provide efficient answers to these and many more and more
complex questions in order to determine the value of the firm

FINANCING
INVESTMENT
€ € Equity
Non-current assets
CEO Non-current liabilities
Current assets
Current liabilities
Machies, warehouses, €€€ €€
trucks… Savings, shares, bank
loans

2. THE GOAL OF FINANCIAL MANAGEMENT

Possible goals of the manager in a firm:
- Survive/avoid bankruptcy
- Outperform competition (maximize sales and market power)
- Maximize profits / minimize costs
- Maintain a constant growth
- Increase marketability of manager
The general goal of financial management show be to maximize the market value of the
firm (shareholder’s equity)
 3. AGENCY PROBLEM
There are always problems between managers and financiers (shareholders and debtholders)
due to the conflict of interest
SHAREHOLDERS DEBTHOLDERS
Earn through dividends/buybacks and Earn through interest payments and return of
increases in firm value (stock price) the principal
Do not have priority in liquidation* Do have priority in liquidation*
Do have voting rights (decision power) Do not have voting rights
Their payoff is a positive function of firm Their payoff is capped at a maximum
value
Do like risk Do not like risk

* Priority in liquidation:
1. Senior debt
2. Junior debt
3. Preferred shareholders
4. Shareholders

* Payoff – with the CFs generated by the project, the firm will (1) pay back debtholders and
(2) if there is money left, distribute the rest in dividends to shareholders

It may seem that choosing investment projects with higher risk (more expected return) is more
beneficial to shareholders.
However, this is not good for other stakeholders or even the firm:
- Debtholders – projects with more risk also have higher probability of failure or
bankruptcy
- Managers – the failure of a project send a signal to the outside world (this is not a very
good manager) and also increases the probability of being fired
Agency problem: conflict of interest between managers and shareholders. The classic agency
problem occurs between shareholders (decision power) and managers, and it is not limited to
risk choices
Solutions to agency problems
Managers get paid same way debtholders do (as long as the firm survives, the manager will
earn his salary independently of how good the company does). This doesn’t make shareholders
happy, but they still have decision power.
To align managerial incentives and shareholders incentives:
- Make the manager salary dependent on firm performance, under the market value of
the firm (accounting measures are not good measures to know the firm performance)
- Make the manager another shareholder of the firm
Now that managers incentives are completely aligned with shareholders, debtholder won’t be
happy (agency cost of debt)
4. TIME VALUE OF MONEY
There are 3 reasons why a dollar tomorrow is worth less than a dollar today:
- You prefer present consumption to future consumption
- The real value of money decreases over time due to inflation
- There is uncertainty (risk) associated with the CF (will I pay you bak?)
All other things equal, the value of receiving future CF (money) will decrease when:
- The preference for current consumption increases (pandemic)
- Expected inflation increases (central banks cutting interest rates)
- The uncertainty in the CF increases