introduction to corporate finance. corporate finance and the financial manager

1Introduction to

Corporate Finance

1.1Corporate Finance and the Financial Manager

FinanceFinance consists of three interrelated

areas:Money and capital marketsInvestmentsCorporate finance

Corporate FinanceThree main areas of concern:

What long-term investments should the firm take?

Where will the firm get the long-term financing to pay for its investments?

How should the firm manage its everyday financial activities?

Financial Management DecisionsCapital budgeting

Strategic long-term investment decisionWhat long-term investments or projects should the firm

take?Capital structure

Strategic long-term financing decisionHow should the firm get the long-term financing to pay

for its investments? What is the mixture of a firm’s debt and equity

financing?Working capital management

Short-term financial planning and managementHow should the firm manage its everyday financial

activities?

The Role of the Financial ManagerForecasting and planningMaking major investments and financing

decisionsCapital budgeting Capital structure Working capital management

Coordination and controlInteraction with money and capital markets

The primary task is to make decisions about sources and uses of funds so as to maximize the value of the firm.

The Financial ManagersThe top financial manager in a firm is usually the

Chief Financial Officer (CFO)Treasurer – cash management, credit management,

capital expenditures, and financial planning, etc.Controller – taxes, cost accounting, financial

accounting and data processing, etc.

Which of the following questions are addressed by financial managers?A. How should a product be marketed?B. Should customers be given 30 or 45 days

to pay for their credit purchases?C. Should the firm borrow more money?D. Should the firm acquire new equipment?

Which one of the following is a capital budgeting decision? A. determining how many shares of stock to

issueB. deciding whether or not to purchase a new

machine for the production lineC. deciding how to refinance a debt issue that

is maturingD. determining how much inventory to keep

on handE. determining how much money should be

kept in the checking account

1.2Forms of Business Organization

Forms of Business OrganizationSole Proprietorship

Partnership Corporation

Owner of the business

Are managers and owners separate?

What is the owner’s liability?

Are the owner and business taxed separately?

Forms of Business OrganizationSole Proprietorship

Partnership Corporation

How is it formed?

How about raising large sums of capital?

What is the life of the business?

How about transferring ownership?

Forms of Business OrganizationSole Proprietorship

Partnership Corporation

Owner of the business

One person Two or more partners

The shareholders

Are managers and owners separate?

No No Yes

What is the owner’s liability?

Unlimited Unlimited Limited

Are the owner and business taxed separately?

No No Yes

Forms of Business OrganizationSole Proprietorship

Partnership Corporation

How is it formed?

Easy Easy Complex and time-consuming

How about raising large sums of capital?

Difficult Difficult Easy

What is the life of the business?

Limited Limited Unlimited

How about transferring ownership?

Difficult Difficult Easy

The Value of the CorporationThe value of a business will probably be

maximized if it is organized as a corporation.Limited liability reduces the firm’s risk. The

lower the firm’s risk, the higher the value.A firm’s value depends on its growth

opportunities. The greater the ability to raise capital, the more its growth opportunities.

The value of the asset depends on its liquidity. The easier the ability to sell the asset and convert it to cash, the higher the value.

1.3The Goal of Financial Management

Possible GoalsMaximize sales?Minimize costs?Maximize profits?Maximize growth?Maximize market share?Maximize stockholder wealth?Maximize stakeholder wealth?

Stakeholders and Their GoalsStakeholder Goal

Owners Dividend or stock appreciation

Managers High salary and perquisites

Creditors Low risk and return of principal and interest

Employees High salary and job security

Customers Low price and high quality

Suppliers High price and long-term relationship

Government Taxes

Society Good citizenship

The Goal of Financial ManagementModern Finance Theory usually assumes that the

objective of the firm is to maximize stockholder wealth.

The goal of financial management in a for-profit business is to make decisions that increase the value of the stock or increase the market value of the equity. Is it good for other stakeholders of the company? Is it good for society?

If the primary goal is appropriately defined, the other goals which are not mutually exclusive can also be accomplished.

1.4Agency Problem

The Agency ProblemAgency relationship

Principal hires an agent to represent his/her interests.

Stockholders (principals) hire managers (agents) to run the company.

Agency problemConflict of interest between principal and

agent.Conflict of interest between stockholders and

managers.

Agency costsThe costs of the conflicts of interest between

stockholders and management.Direct agency costs

Expenditures to monitor managerial actions.Expenditures that benefit the management but

cost the stockholders.Indirect agency costs

Opportunity costs

Managing ManagersProper structuring of managerial incentives

Managerial compensationJob prospects

Control of the firmThe threat of firingThe threat of takeover

1.5Financial Markets

Financial MarketsThe advantages of the corporate form are

enhanced by the existence of financial markets.Easy to transfer ownershipEasy to raise large amounts of capital

Functions Source of fundingInvestor liquidityRisk management Source of information

Primary vs. Secondary MarketsPrimary markets

The original sale of securitiesSecondary markets

The resale of securities after the original sale