Chapter 1

•Introduction To Corporate
Finance
•Edited by DBH Jan 06

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 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

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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?
• How will we manage the everyday financial
activities of the firm?

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 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?
• Capital structure
• How should we pay for our assets?
• Should we use debt or equity?
• Working capital management
• How do we manage the day-to-day finances of
the firm?

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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 • Disadvantages
• Easiest to start • Limited to life of owner
• Least regulated • Equity capital limited to
• Single owner keeps all owner’s personal
the profits wealth
• Taxed once as • Unlimited liability
personal income • Difficult to sell
ownership interest

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 Partnership

• Advantages
• Two or more owners
• More capital available
• • Limited partnership
Relatively easy to start
• Income taxed once as
personal income
• Disadvantages
• Unlimited liability
• General partnership
• Partnership dissolves
when one partner dies
or wishes to sell
• Difficult to transfer
ownership

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 Corporation

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

• What should be the goal of a corporation?

• Maximize profit?
• Minimize costs?
• Maximize market share?
• Maximize the current value of the company’s
stock?
• Does this mean we should do anything and
everything to maximize owner wealth?

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 Why Shareholder Value?
Roberto Goizueta, Chairman, Coca-Cola Company, 1997

 Increasing share-owner value is the job

our economic system demands of us
 Shareholders put us in business

 Business distributes the lifeblood of

our economic system--goods and
services but also taxes, salaries,
philanthropy

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 Why Shareholder Value? (2)

• If we do our jobs, we can contribute to society

in very meaningful ways
• Companies are expected to do good deeds, but
also good work--work focused on our mission to
create value over time for owners
• Those owners include not only individual investors,
but university endowments, philanthropic
foundations, other non-profit organizations. The
more value created for them, the more good they
can do

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 Why Shareholder Value? (3)

• Focusing on creating value over the long term

keeps us from acting shortsighted
• The long haul means being of value to consumers,
customers, bottling partners, all other stakeholders
• Real conflict is not between shareholders and
stakeholders, but between the long-term and short-
term interests of both
• Coca-Cola has grown over 110 years because of
discipline to its mission (value over the long haul
for its owners)

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 Why Shareholder Value? (4)

 “A billion hours ago, human life appeared

on Earth. A billion minutes ago, Christianity
emerged. A billion seconds ago, the
Beatles changed music forever. A billion
Coca-Colas ago was yesterday morning.”
-Roberto Goizueta

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Why Shareholder Value? (5-end)

 “What must we do to make a billion Coca-

Colas ago be this morning? By asking this
question, we discipline ourselves to the long
term view...the best way to serve all our
stakeholders...is by creating value over time
for those who have hired us.”

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 The Agency Problem

• Agency relationship
• Principal hires an agent to represent his/her
interest
• 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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 Managing Managers
• Managerial compensation
• Incentives can be used to align management
and stockholder interests
• The incentives need to be structured carefully
to make sure that they achieve their goal
• Corporate control
• The threat of a takeover may result in better
management
• Other stakeholders

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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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Chapter 1
•End of Chapter

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.