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Principles of

CORPORATE FINANCE

Richard A Brealey Franklin Allen

Stewart C Myers Pitabas Mohanty

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Topics Covered
Corporate Investment and Financing Decisions The Role of the Financial Manager and the Opportunity Cost of Capital Goals of the Corporation Agency Problems and Corporate Governance

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Investment and Financing Decisions


Common Finance Terminology
Real assets Financial assets / Securities Capital markets and financial markets Investment / capital budgeting Financing

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Investment and Financing Decisions


Real Assets
Assets used to produce goods and services.

Financial Assets
Financial claims to the income generated by the firms real assets.

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Investment and Financing Decisions


Investment decision
purchase of real assets

Financing decision
sale of financial assets

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Investment and Financing Decisions


Capital Budgeting Decision
Decision to invest in tangible or intangible assets.

also called the Investment Decision also called Capital Expenditures or (CAPEX)

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Investment and Financing Decisions


Capital Budgeting

Tangible Assets Expand Stores @ Rs.800 million

Intangible Assets New Drug R&D @ Rs.800 million

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Investment and Financing Decisions


Company (revenue in billions for 2007 or 2008) Recent Investment Decision Began production of its 787 Dreamliner aircraft, at a forecast cost of more than $10 billion. Recent Financing Decision The cash flow from Boeings operations allowed it to repay some of its debt and repurchase $2.8 billion of stock. In 2008 returned $13.1 billion of cash to its stockholders by buying back their shares. Boeing ($61 billion)

Royal Dutch Shell ($458 billion)

Invests in a $1.5 billion deepwater oil and gas field in the .

(26,289 billion)

In 2008 opened new engineering and safety testing facilities in


. Spent 3.7 billion in 2008 on research and development of new drugs. In 2008 announced plans to invest over a billion dollars in 90 new stores in . Acquired 315 new locomotives in 2007.

Returned 443 billion to shareholders in the form of


dividends. Financed R&D expenditures largely with reinvested cash flow generated by sales of pharmaceutical products. In 2008 raised $2.5 billion by an issue of 5-year and 30-year bonds. Largely financed its investment in locomotives by long-term leases. Financed the acquisition by an exchange of shares. Issued a 6-year bond in 2007, raising 300 million Swiss francs. Borrowed $400 million for 5 years from a group of banks

GlaxoSmithKline (24 billion)

Wal-Mart ($379billion)

Union Pacific ($18 billion)

Wells Fargo ($52 billion)

Acquired Wachovia Bank in 2008 for $15.1 billion.

LVMH (17 billion )

Acquired the Spanish winery, Bodega Numanthia Termes.

Lenovo ($16 billion)

Expanded its chain of retail stores to cover over 2,000 cities.

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Role of The Financial Manager


(2)
Firm's operations Financial manager

(1)
Financial

(4a)

markets

(3)
(1) Cash raised from investors (2) Cash invested in firm

(4b)

(3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors
Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Who is The Financial Manager?


Chief Financial Officer

Treasurer

Controller

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

The Investment Trade-off

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The Investment Trade-off


Hurdle rate Cost of capital Opportunity cost of capital

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Goals of The Corporation


Each stockholder wants three things:
1. To be as rich as possible, that is, to maximize his or her current wealth. 2. To transform that wealth into the most desirable time pattern of consumption either by borrowing to spend now or investing to spend later. 3. To manage the risk characteristics of that consumption plan.

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Goals of The Corporation


Profit maximization is not a well-defined financial objective, for at least two reasons: 1. Maximize profits? Which years profits? A corporation may be able to increase current profits by cutting back on outlays for maintenance or staff training, but that may add value. Shareholders will not welcome higher short-term profits if long-term profits are damaged.

2. A company may be able to increase future profits by cutting this years dividend and investing the freed-up cash in the firm. That is not in the shareholders best interest if the company earns less than the opportunity cost of capital. Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Whose Company Is It?


** Survey of 378 managers from 5 countries
Japan Germany France United Kingdom United States
0
The Shareholders All Stakeholders
Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

3 17 22 71 76 40 60 80

97 83 78 29 24 20

100

120

% of responses

Dividends vs. Jobs


** Survey of 399 managers from 5 countries. Which is more important...jobs or paying dividends?
Japan Germany France United Kingdom United States
0
Dividends Job Security
Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

3 40 41

97 60 59 89 89 40 60 80 100 120

11 11 20

% of responses

Goals of The Corporation


Shareholders desire wealth maximization Do managers maximize shareholder wealth? Mangers have many constituencies stakeholders Agency Problems represent the conflict of interest between management and owners
Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Agency Problem
Ownership vs. Management

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Agency Problem
Agency costs are incurred when:
1. managers do not attempt to maximize firm value and 2. shareholders incur costs to monitor the managers and constrain their actions.

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Agency Problem
Agency Problems
Managers, acting as agents for stockholders, may act in their own interests rather than maximizing value.

Stakeholder
Anyone with a financial interest in the firm.

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Agency Problem
Tools to Ensure Management Pays Attention to the Value of the Firm
Mangers actions are subject to the scrutiny of the board of directors. Shirkers are likely to find they are ousted by more energetic managers. Financial incentives such as stock options

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Agency Problem
Agency Problem and Corporate Governance Solutions 1. Legal and Regulatory Requirements 2. Compensation plans 3. Board of Directors 4. Monitoring 5. Takeovers 6. Shareholder pressure
Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Web Resources
Click to access web sites Internet connection required

www.corpgov.net www.thecorporatelibrary.com

www.riskmetrics.com

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.