Chapter

One

Introduction To Corporate
Finance

Michele Vincenti, Ph.D, MBA, M.A. (HOS), CIM,

FCSI, STI, CFP, CMC, C.I.M., F.CIM

© 2003 The McGraw-Hill Companies, Inc. All rights reserved.

1.2 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
• Financial Institutions
• Trends in Financial Markets and Financial
Management
1.3 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?
1.4 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, capital
expenditures and financial planning
– Controller – oversees taxes, cost accounting,
financial accounting and data processing
1.5 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?
1.6 Forms of Business Organization

• Three major forms in Canada

– Sole proprietorship
– Partnership
• General
• Limited
– Corporation
• In other countries, corporations are also called joint stock
companies, public limited companies and limited liability
companies
1.7 Sole Proprietorship
• Advantages • Disadvantages
– Easiest to start – Unlimited liability
– Least regulated – Limited to life of owner
– Single owner keeps all – Equity capital limited to
the profits owner’s personal wealth
– Taxed once as personal – Difficult to sell
income ownership interest
1.8 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
1.9 Corporation
• Advantages • Disadvantages
– Limited liability – Separation of ownership
– Unlimited life and management
– Separation of ownership – Double taxation (income
and management is taxed at the corporate
– Transfer of ownership is rate and then dividends
easy are taxed at the personal
rate)
– Easier to raise capital
1.11 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?
1.12 Primary Goal of Financial Management

• Three equivalent goals of financial

management:
– Maximize shareholder wealth
– Maximize share price
– Maximize firm value
1.13 The Agency Problem

• Agency relationship
– Principal hires an agent to represent their interests
– Stockholders (principals) hire managers (agents) to
run the company
• Agency problem
– Conflicts of interest can exist between the principal
and the agent
• Agency costs
– Direct agency costs
– Indirect agency costs
1.14 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
• Conflicts with other stakeholders
1.16 What is the role of financial markets in corporate finance?

• Cash flows to and from the firm

• Money vs. capital markets
• Primary vs. secondary markets

• How do financial markets benefit society?

1.17 Cash Flows to and from the Firm
1.19 Trends in Financial Markets and Management

• Financial Engineering
• Derivative Securities
• Advances in Technology – i.e. E-business
• Deregulation
• Corporate Governance Reform
1.19

• No Class next Friday

1.20 Quick Quiz
• What are the three types of financial
management decisions and what questions are
they designed to answer?
• What are the three major forms of business
organization?
• What is the goal of financial management?
• What are agency problems and why do they
exist within a corporation?
• What is the difference between a primary
market and a secondary market?
1.21 Summary 1.9

• You should know:

– The advantages and disadvantages between a sole
proprietorship, partnership and corporation
– The primary goal of the firm
– What an agency relationship and cost are
– The role of financial markets