Chapter 1: Introduction to

corporate finance

Nasrat ullah
Outline

Introduction to Corporate Finance:

 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
Corporate Finance and the
Financial Manager

 What Is Corporate Finance?

 Corporate finance, broadly speaking, is the
study of ways to answer these three
questions
Cont..

 1. What long-term investments should you

take on?
 2. Where will you get the long-term financing
to pay for your investment?
 3. How will you manage your everyday
financial activities such as collecting from
customers and paying suppliers
Financial Manager

 Frequently, financial managers try to address

these tasks.
 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.
capital budgeting

 The process of planning and managing a

firm’s long-term investments

 So the financial Manager will go for investing

in such capital which worth more than the
cost.
capital structure

 The mixture of debt and equity maintained by

a firm.

 So the financial manager find out how much

should the firm borrow?
 what are the least expensive sources of
funds for the firm.
working capital

 A firm’s short-term assets and liabilities.

 So the financial manager finds out

-How much cash and inventory should we keep on
hand
- Should we sell on credit
-How will we obtain any needed short-term financing?
Will we purchase on credit or will we borrow
FORMS OF BUSINESS
ORGANIZATION

 sole proprietorship
A business owned by a single individual.
 partnership

A business formed bytwo or more individuals or

entities.
 Corporation

A business created as a distinct legal entity

composed of one or more individuals or entities.
THE GOAL OF FINANCIAL
MANAGEMENT

 Survive.
 Avoid financial distress and bankruptcy.
 Beat the competition.
 Maximize sales or market share.
 Minimize costs.
 Maximize profits.
 Maintain steady earnings growth
The financial manager in a
corporation

 The goal of financial management in

corporation is to maximize the current
value per share of the existing stock.
THE AGENCY PROBLEM AND
CONTROL OFTHE CORPORATION

 Agency Relationships
The relationship between stockholders and
management is called an agency relationship

– Principals (citizens) hire an agent (the president) to

represent their interest.
– Principles (stockholders) hire agents (managers) to run the
company.
THE AGENCY PROBLEM AND
CONTROL OFTHE CORPORATION

 Agency problem
The possibility of conflict of interest between
the stockholders and management of a firm.

– Conflict of interest between principals and agents.

– This occurs in a corporate setting whenever the agents do
not hold 100% of the firm’s shares.
– The source of agency problems is the separation of
(owners’) control and management.
Agency costs

 Direct costs: (1) unnecessary expenses,

such as a corporate jet, and (2) monitoring
costs.
 Indirect costs. For example, a manager
may choose not to take on the optimal
investment. She/he may prefer a less risky
project so that she/he has a higher
probability keeping her/his tenure.
Managerial incentives

 Managerial goals are frequently different

from shareholders’ goals.
– Expensive perks.
– Survival.
– Independence.
 Growth and size (related to compensation)
may not relate to shareholders’ wealth.
Control of the Firm

Control of the firm ultimately rests with

stockholders. They elect the board of
directors, who, in turn, hire and fire
management.
FINANCIAL MARKETS AND THE
CORPORATION

 The primary advantages of the corporate

form of organization are that ownership can
be transferred more quickly and easily than
with other forms and that money can be
raised more readily.
The interplay between the
corporation and the financial
markets
Primary Markets

 In a primary market transaction, the

corporation is the seller, and the transaction
raises money for the corporation.
Secondary Markets

 A secondary market transaction involves one

owner or creditor selling to another.
End-of-chapter