Chapter 1

Introduction to
Corporate Finance

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Key Concepts and Skills
• Know the basic types of financial
management decisions and the role of the
financial manager
• Know the financial implications of the
different forms of business organization
• Know the goal of financial management
• Understand the conflicts of interest that can
arise between owners and managers
• Understand the various types of financial
markets

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 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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What Is Corporate Finance?
• Corporate finance provides answers
to some important questions:
– What long-term investments should the
firm take on?
– Where will the firm get the long-term
financing to pay for the investments?
– How will the firm manage its everyday
financial activities?

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 The 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 much should the firm borrow to pay for its
assets?
• What is the best mixture of debt and equity?
• The least expensive sources of funds?
• 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

– Sole Proprietorship
– Partnership
• General
• Limited
– Corporation
• Limited Liability Company
• Limited Liability Partnerships

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

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

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 Corporation
• Advantages • Disadvantages
– Limited liability – Separation of
– Unlimited life ownership and
management
– Separation of
– May involve double
ownership and
taxation in some
management
countries (income
– Transfer of taxed at the
ownership is easy corporate rate and
– Easier to raise then dividends taxed
capital at the personal rate)

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 Summary of
3 Business Forms

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Goal of Financial Management
• What should be the goal of a corporation?
– Maximize profits?
– Minimize costs?
– Maximize market share?
– Maximize the current value of the company’s
stock?

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Maximizing Shareholders’ Wealth
• Maximizing the share price is equivalent
to maximizing shareholders’ wealth
• Why is this a valid goal?
– Decisions are made in shareholders‘
best interest
– Considers cash flows not profits
– Incorporates time dimension
– Does not consider profitability but also
risk
 The Agency Problem
• Agency relationship
– The relationship exists when a principal
hires an agent to represent his/her interests
– Stockholders (principals) hire managers
(agents) to run the company
• Agency problem
– Conflict of interest between principal and
agent
• Agent may not work in the best interest of the
principal

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 Management Goals
• Management goals may be different
from shareholder s’ goals
– Management may be more interested in:
• Consuming expensive perks
• It’s own survival
• It’s independence
• Management may focus on increased
growth and size rather than increasing
shareholders’ wealth
 Agency Costs
• Costs due to the conflict of interest between
shareholders and management
– Direct
• Corporate expenditure that benefits management but
costs shareholders, e.g. country club
membership
• Costs to monitor management actions, e.g.
auditor costs
– Indirect
• Lost opportunity due to management forgoing
profitable but risky projects for fear of losing job if
project fails

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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
• Primary market
– A market where the firm sells its securities
to public for the first time
• Secondary markets
– A market in which the securities issued by
firms are traded
• Listed securities trade in an organized
exchange, e.g. the stock market (NYSE)
• Over-the-counter securities are bought from or
sold to a dealer

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 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?

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 Ethics Issues
• Is it ethical for tobacco companies to sell a product
that is known to be addictive and a danger to the
health of the user? Is it relevant that the product is
legal?
• Should boards of directors consider only price
when faced with a buyout offer?
• Is it ethical to concentrate only on shareholder
wealth, or should stakeholders as a whole be
considered?
• Should firms be penalized for attempting to improve
returns by stifling competition (e.g., Microsoft)?

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