 Lecturer: Joao Madeira

 Office Hours: Wednesday 11:30-13:30 or by

appointment
 Email: joao.madeira@york.ac.uk
 Office: A/EC/009 in the DERS building
 Google Meet Id:meet.google.com/kyh-goxq-nvt

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The recommended textbook is (we will go over the first three
chapters):
Corporate Finance: Core Principles and Applications by Ross,
Westerfield, Jordan and Jaffe.

A customized edition is available:

https://www.mheducation.co.uk/introduction-to-accountancy-97
81307737783-emea
Print Book

https://www.mheducation.co.uk/introduction-to-accountancy-97
81307735550-emea
E Book
The module will cover the following topics:

1: Introduction (Ch.1)

2: Financial Statements and Cash Flow (Ch. 2)
3: Financial Statements Analysis and Financial
Models (Ch. 3)
Feedback will be given in the following ways:

onlineassignments with solutions provided

upon completion
answering of questions during seminars
model solutions to quantitative questions of
seminars made available online
one-to-one help given throughout the term
during office hours
 Chapter 1
Introduction

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
 Know the three main concerns of
corporate financial management
 Grasp the goal of financial management
 Enumerate the financial benefits and
drawbacks of differing forms of business
organization
 Understand the conflicts of interest that
can arise between owners and managers
 Comprehend that corporate
organizations are enhanced by financial
markets

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1.1 What is Corporate Finance?
1.2 The Corporate Firm
1.3 The Importance of Cash Flows
1.4 The Goal of Financial Management
1.5 Separation of Ownership and Management
1.6 Financial Markets
1.7 Regulation
1.8 Institutions

1-7
 Economic resources are required to
establish and maintain a firm:
◦ Funds enable materials and processes for
delivering salable goods and services
◦ Funds are essential for assembling a
workforce
◦ Funds are required to purchase long-lived
assets such as equipment and buildings
 The Balance Sheet offers insight into the
array of decisions, activities and
objectives of the Financial Manager

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Total Value of Assets: Total Firm Value to Investors:
Current
Liabilities
Current
Assets Long-Term
Debt

Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity

1-99
…the top three concerns of
corporate finance:
1. What long-term investments should the firm
choose?
2. How should the firm raise funds for the selected
investments?
3. How should current assets be managed and
financed?

1-10
◦ A security is a fungible, negotiable instrument
representing financial value.
◦ A share of stock (also referred to as equity share)
represents a share of ownership in a corporation
(company).
◦ A bond is a formal contract to repay borrowed
money with interest at fixed intervals.
◦ Bonds and stocks are both securities, but the major
difference between the two is that stockholders have
an equity stake in the company (i.e., they are
owners), whereas bondholders have a creditor stake
in the company (i.e., they are lenders).
 Current
Liabilities
Current
Assets Long-Term
Debt

Fixed Assets
What long-term
1 Tangible investments
Shareholders’
should the firm
2 Intangible choose? Equity

1-12
12
 Current
Liabilities
Current
Assets Long-Term
How should the Debt
firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible Shareholders’
2 Intangible Equity

1-13
13
 Current
Liabilities
Current
Net
Assets Working Long-Term
Capital Debt

How should
Fixed Assets
short-term assets
1 Tangible be managed and
financed? Shareholders’
2 Intangible Equity

1-14
14
◦ all firms (including highly profitable ones) that do
not pay sufficient attention to working capital
management may be seriously damaged by the
resulting loss of investor and creditor confidence
 delayed in investment schedules
 sub-optimal temporary finance
 unscheduled sale of the firms assets
The firm’s 3 main financial concerns are
usually handled by a top officer and aides:
◦ V.P. or Chief Financial Officer
 Strategist, coordinator, authority
◦Treasurer
 Cash flow, capital expenditure, capital structure
◦ Controller
 Accounting, information systems, taxes

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 Board of Directors

Chairman of the Board and

Chief Executive Officer (CEO)

President and Chief

Operating Officer (COO)

Vice President and

Chief Financial Officer (CFO)

Treasurer Controller

Cash Manager Credit Manager Tax Manager Cost Accounting

Capital Expenditures Financial Planning Financial Accounting Data Processing

1-17
 First company problem: raise funds
 The corporate form of business is the

standard method for solving the problems

encountered in raising large amounts of cash.
 However, businesses can take other forms.

1-18
 The Sole Proprietorship
 The Partnership
◦ General Partnership
◦ Limited Partnership
 The Corporation

1-19
19
 Sole Proprietorship
◦ a firm owned by an individual or family
◦ the assets and liabilities are the personal assets and
liabilities of the proprietor
◦ unlimited liability
◦ low administrative costs
 Partnership
◦ A firm with  2 owners sharing the equity. A
partnership agreement usually stipulates how
decisions and profits (losses) are shared
 General partners  1 (unlimited liability)
 Limited partners  0 (don’t manage business)
◦ Changes in ownership involve dissolving the old
partnership and forming a new one
 Corporation
◦ a legal entity, distinct from its ownership
◦ may own property, borrow, sue, be sued, and
enter into legal contracts
◦ not dissolved when shares are transferred
◦ shareholders elect directors, who appoint
management
◦ pays corporate taxes, resulting in double taxation
of owner
◦ limited liability
 Corporation Partnership

Liquidity and Shares can be easily Subject to substantial

marketability exchanged restrictions

Voting Rights Usually each share gets one General Partner is in charge;
vote limited partners may have
some voting rights

Taxation Double Partners pay taxes on

distributions
Reinvestment and dividend Broad latitude All net cash flow is
payout distributed to partners

Liability Limited liability General partners may have

unlimited liability; limited
partners enjoy limited
liability
Continuity Perpetual life Limited life

1-23
23
 The corporate form of organization is not
unique to the United States:

1-24
 If the firm is to prosper, it must:
◦ Buy assets that generate more cash than they cost
◦ Sell financial instruments that raise more cash than
they cost

 The successful firm generates more cash than

it uses

1-25
 Firm Firm issues securities (A) Financial
markets
Invests
Retained
in assets cash flows (F)
(B)
Short-term debt
Current assets Cash flow Dividends and Long-term debt
Fixed assets from firm (C) debt payments (E)
Equity shares

Taxes (D)
Ultimately, the firm The cash flows from
must be a cash the firm must exceed
generating activity. the cash flows from
the financial markets.
1-26
 Do not confuse cash flow and accounting
income
◦ Non-Cash expense example: Depreciation
◦ Non-Cash revenue example: Sales on Account

1-27
 What is the correct goal?
◦ Maximize profit?
◦ Minimize costs?
◦ Maximize market share?
◦ Maximize shareholder wealth?

1-28
The Financial Manager’s primary goal is to
increase the value of the firm by:
1. Selecting value creating projects
2. Making smart financing decisions
 Owners delegate management if agency
conflicts have a cost-effective resolution
◦ professional managers have specialized skills
◦ efficiencies of scale
◦ diversification of owner’s portfolio
◦ savings in the cost of information gathering
◦ learning curve/going concern issues
 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

1-31
 Cost of Conflict of Interest
 Example:
◦ Large investment positions firm for long term
positive cash flow but has risk in short run
 Owners want this investment – Increases firm value
 Managers object – Risk may have personal cost
◦ If managers prevail, foregone long term cash flow is
the Agency Cost

1-32
 Managerial goals may be different from
shareholder goals
◦ Expensive perquisites
◦ Survival
◦ Independence
 Increased growth and size
◦ Often lead to management reward
◦ Not necessarily in best interest of shareholders

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 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 intended goal
 Corporate control
◦ The threat of a takeover may result in better
management
 Influence of other stakeholders

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 Primary Market
◦ Issuance of a security for the first time
 Secondary Markets
◦ Buying and selling of previously issued securities
◦ Securities may be traded in either a dealer or
auction market
 NYSE
 NASDAQ
 http://www.londonstockexchange.com/en-gb/
 Stocks and Investors
Firms Bonds
securities
Money Bob Sue
money

Primary Market
Secondary
Market
 The Securities Act of 1933 and the Securities
Exchange Act of 1934
◦ Issuance of Securities (1933) – companies
must disclose all relevant information to
investors and potential investors
◦ Creation of SEC (1934)-extends disclosure
requirements to securities trading after they
have been issued; covers reporting
requirements on monthly, quarterly and
annual basis; insider trading is made illegal

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To pursue its activity any firm will necessarily
deal with the following types of institutions:

Financial intermediaries
◦ Useful when services cannot be obtained more
efficiently by transacting directly in securities
markets
Supervisors and Regulators
◦ Firms face substantial supervision/regulation from
governmental agencies and other agents (such as
unions)

1-38
 Traditional Role:
◦ Clearing and settling payment
 Contemporary Role:
◦ Take Deposits

39
 Purpose is to shed specific risks
◦ Property and Causality Insurance
◦ Health and Disability Insurance
◦ Life Insurance
 Payments are Called Premiums, and these
are invested in real estate, Stock and
bonds

40
 A portfolio of stocks, bonds, or other assets
purchased in the name of a group of
investors, and managed by a professional
investment company or financial association

41
 Assist businesses and governments raise
funds by issuing securities
 Facilitate mergers and acquisitions
 Underwrite security issues

42
 Similar to investment banks, but corporate
clientele are usually start-up companies
 Help manage company until ready to go

public

43
 Advise, and often administer: mutual funds,
pension funds, and other asset pools on
behalf of individuals, firms, and governments

44
 Firms that specialize in providing financial
information
◦ Standard and Poor’s; Moody’s
◦ Best (Insurance)
◦ Bloomberg; Reuters
◦ Lipper, Morningstar, SEI

45
 The Prudential Regulation Authority (PRA), which is
a subsidiary to the Bank of England, focuses on
whether banks, insurers and investment banks
hold enough capital and are financially sound.
 The Financial Conduct Authority (FCA) looks at how
firms go about their business, including how they
interact with consumers and whether they obey
market rules.
 These authorities are complemented by the
Financial Policy Committee which looks at systemic
risks in the UK’s financial services industry.

46
 has the responsibility for the
overall institutional structure of regulation, and
the legislation that governs it
 informally The Treasury, is the United Kingdom
government department responsible for
developing and executing the British
government's public finance policy and
economic policy

47
 As a maker and enforcer of society’s laws,
government is ultimately responsible to
regulate the financial system
 Government’s use the financial system to

achieve public policy goals

48
 Fiscal policy: the size of the government deficit and the
methods it uses to finance it.
◦ Tax policy
◦ Government spending
 Monetary policy: control of the supply of money and
interest rate, in order to attain a set of objectives oriented
towards the growth and stability of the economy
 Trade policy: refers to tariffs and trade agreements

49
 The Bank of England is a state-owned
institution and the central bank of the United
Kingdom.
 It was established in 1694 to act as the English
Government's banker, and to this day it still
acts as the banker for the UK Government. The
Bank has a monopoly on the issue of
banknotes in England and Wales.

50
 Monetary stability
◦ Stable prices and confidence in the currency are the two
main criteria for monetary stability. Stable prices are
maintained by making sure price increases meet the
Government's inflation target. The Bank aims to meet this
target by adjusting the base interest rate
 Financial stability
◦ Maintaining financial stability involves protecting against
threats to the whole financial system. In exceptional
circumstances, the Bank may act as the lender of last resort
by extending credit when no other institution will

51
 Several international bodies currently exist for
the purpose of coordinating the financial
policies of national governments
◦ The European Union: designed to create uniform
trading conditions and the free movement of goods,
persons, services and capital between its member
states
◦ Bank for International settlements (BIS): promotes
uniformity of banking regulations
◦ International Monetary Fund (IMF): monitors economic
conditions of member countries, in particular those
with an impact on exchange rates and the balance of
payments. It also offers financial and technical
assistance to its members, making it an international
lender of last resort
◦ The World Bank: finances projects in developing
countries

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