Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc. 1999
The University of Lethbridge - Faculty of Management
Management 3040 - Finance
TRANSPARENCY ACETATESto accompany
FUNDAMENTALS OFFUNDAMENTALS OFCORPORATE FINANCECORPORATE FINANCE
Fourth Canadian Edition
Stephen A. RossRandolph W. Westerfield
Bradford D. JordanGordon S. Roberts
Prepared byThomas J. Cottrell
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Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson,Ltd.
Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd.
Part I: Overview of Corporate Finance
Part II: Financial Statements and Long-Term Financial Planning
Part III: Valuation of Future Cash Flows
Part IV: Capital Budgeting
Part V: Risk and Return
Part VI: Cost of Capital and Long-Term Financial Policy
Part VII: Short-Term Financial Planning and Management
Part VIII: Topics in Corporate Finance
Part IX: Derivative Securities and Corporate Finance
Outline of the Text
Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd.
Chapter 1 Introduction to Corporate Finance
Chapter 2 Financial Statements, Taxes, and Cash Flow
Chapter 3 Working with Financial Statements
Chapter 4 Long-Term Financial Planning and Corporate Growth
Chapter 5 Introduction to Valuation: The Time Value of Money
Chapter 6 Discounted Cash Flow Valuation
Chapter 7 Interest Rates and Bond Valuation
Chapter 8 Stock Valuation
Chapter 9 Net Present Value and Other Investment Criteria
Chapter 10 Making Capital Investment Decisions
Chapter 11 Project Analysis and Evaluation
Chapter 12 Some Lessons from Capital Market History
Chapter 13 Return, Risk, and the Security Market Line
Chapter 14 Cost of Capital
Table of Contents
Chapter 15 Raising Capital
Chapter 16 Financial Leverage and Capital Structure Policy
Chapter 17 Dividends and Dividend Policy
Chapter 18 Short-Term Finance and Planning
Chapter 19 Cash and Liquidity Management
Chapter 20 Credit and Inventory Management
Chapter 21 International Corporate Finance
Chapter 22 Leasing
Chapter 23 Mergers and Acquisitions
Chapter 24 Risk Management: An Introduction to Financial Engineering
Chapter 25 Options and Corporate Securities
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Table of Contents (continued)
T1.1 Chapter Outline Chapter 1Introduction to Corporate Finance
Chapter Organization
1.1 Corporate Finance and the Financial Manager
1.2 Forms of Business Organization
1.3 The Goal of Financial Management
1.4 The Agency Problem and Control of the Corporation
1.5 Financial Markets, Financial Insts, & the Corporation
1.6 Trends in Financial Markets & Financial Mgmt.
1.7 Outline of the Text
1.8 Summary and Conclusions
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T1.2 The Four Basic Areas of Finance - Corporate Finance
Corporate Finance
Long-term investments Capital Budgeting
Long-term financing Capital Structure
Short-term financing Working Capital Management
Risk management Derivative securities
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Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc. 1999
T1.2 A Simplified Organizational Chart (Figure 1.1)
Chairman of the Board andChief Executive Officer (CEO)
Board of Directors
President and ChiefOperations Officer (COO)
Vice PresidentMarketing
Vice PresidentFinance (CFO)
Vice PresidentProduction
Treasurer Controller
Cash Manager Credit Manager Tax ManagerCost AccountingManager
CapitalExpenditures
FinancialPlanning
FinancialAccountingManager
Data ProcessingManager
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T1.3 Forms of Organization
Sole Proprietorship
Partnership
General Partnership / Limited Partnership
CorporationLimited Liability Company
Legal Considerations
How do owners’ roles differ across organizational forms?
Economic ConsiderationsWhy are corporations generally larger than other forms of business?
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T1.4 Limited Liability Companies
Limited Liability Companies (LLCs)
Created by state law
Governed by the “operating agreement” (rather than articles of incorporation)
Ownership interests - may or may not be evidenced by ownership shares
Legal and Economic Considerations
LLC “members” (i.e., owners) have limited liability
LLC is treated as a partnership for tax purposes
Source: LLCs - A Summary: by David S. Neufeld
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T1.5 The Goal of Financial Management
The Goal of Financial Management
What are firm decision-makers hired to do?
“General Motors is not in the business of making automobiles. General Motors is in the business of making money.”
Alfred P. Sloan
Possible goals
Maximize profits
Maximize shareholder wealth/value
Maximize share price
Maximize firm value
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T1.7 The Agency Problem
The Agency Problem and Control of the Firm
Agency Relationships and Management Goals potential for conflict - is their too much emphasis on
corporate survival and job security?
Do managers Act in the Shareholders’ interests? Management actions in take-over situations
Mechanisms to ensure Managers are acting in
shareholders’ interest:
Managerial compensation Proxy Contest
Board of directors Institutional Investors
Takeover activity
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T1.6 The Agency Problem Continued
Agency costs
Agency Costs - defined as the costs associated with the
conflict of interests :
Direct agency costs
Indirect agency costs
Impact of Agency Costs on Shareholder Wealth or Value direct - expenditures benefiting Management e.g. the
unneeded corporate jet or direct - monitoring costs e.g. outside auditors indirect - lost opportunity where Management is not acting in
the best interests of its shareholders e.g. costly acquisitions driven more by desire for power and prestige
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Conflict of Interest
Will Managers work in the Shareholder’s best interest?
Mechanisms to ensure Managers are acting in shareholders’ interest:
Managerial compensation Proxy Contest
Board of directors
Institutional Investors
Takeover activity
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T1.7 Financial Markets
Financial Institutions, Markets and the Corporation
Financial Institutions
Act as intermediaries between investors and firms raising funds - banks, trust companies, investment dealers, insurance companies, etc. direct finance
indirect finance
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T1.7 Financial Markets Continued
Financial Markets - brings buyers and sellers of debt and equity securities together
How do financial markets differ? Type of securities traded/how trading is conducted and
who the buyers and sellers are
Money markets and capital markets money market - short term debt securities
capital market - long term debt and equity
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T1.7 Financial Markets Continued
Primary vs. secondary markets
Primary Market- where the original sale of issue of a
security by a government or corporation occurs
• public offering - underwritten by an investment
dealer and registered with provincial securities
commissions
• private placement - debt and equity sold directly to
a buyer - typically life insurance companies and ,
pension funds
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T1.7 Financial Markets Continued
Secondary Market - trading of securities subsequent to
the initial sale - enables the transfer of ownership
• auction market - TSE
• dealer market - ‘over the counter (OTC) ‘
How do financial markets benefit society?
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Financial Markets and Society
what is the benefit to society? Channel savings into investment produce and transmit information on returns and risk provide a media and a payments system enable the shifting of the timing of consumption over a life cycle enable the management of risk enable the diversification of portfolios
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T1.9 Financial Markets and the Corporation - Cash Flows Between the Firm and the Financial Markets (Figure 1.2)
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T1.9 Chapter 1 Quick Quiz
Quick Quiz
1. Who performs the financial management function in the typical corporation?
2. What are the major advantages and disadvantages of the corporate form of organization?
3. Why is shareholder wealth maximization a more appropriate goal than profit maximization?