Introduction To Corporate Finance
Key Concepts and Skills
Ø Know the basic types of financial management decisions and the role of the financial manager
Ø Know the financial implications of the different forms of business organization
Ø Know the goal of financial management
Ø Understand the conflicts of interest that can arise between owners and managers
Ø Understand the various types of financial markets
Chapter 1: Outline
Ø What is Finance?
Ø Corporate Finance and the Financial Manager
Ø Forms of Business Organization
Ø The Goal of Financial Management
Ø The Agency Problem and Control of the Corporation
Ø Financial Markets and the Corporation
What is Finance?
Ø The art and science of managing money.
Corporate Finance
Ø Some important questions that are answered using finance
l What long-term investments should the firm take on?
l Where will we get the long-term financing to pay for the investment?
l How will we manage the everyday financial activities of the firm?
Corporate Finance
Ø Corporate Finance, broadly speaking, is the study of ways to answer these three questions.
Financial Manager
Ø Financial managers try to answer some or all of these questions
Ø The top financial manager within a firm is usually the Chief Financial Officer (CFO)
l Treasurer – oversees cash management, credit management, capital expenditures, and financial planning
l Controller – oversees taxes, cost accounting, financial accounting and data processing
Financial Management Decisions
Ø Capital budgeting
l What long-term investments or projects should the business take on?
l The process of planning and managing a firm’s investments in fixed assets.
l The key concerns are the size, timing and riskiness of future cash flows.
l To identify investment opportunities that are worth more to the firm than they cost to acquire.
Financial Management Decisions
Ø Capital structure
l How should we pay for our assets?
l Mix of debt (borrowing) and equity (ownership interest) used by a firm.
l What are the least expensive sources of funds?
l Is there an optimal mix of debt and equity?
l When and where should the firm raise funds?
Financial Management Decisions
Ø Working capital management
l How do we manage the day-to-day finances of the firm?
l Managing short-term assets and liabilities.
l How much inventory should the firm carry?
l What credit policy is best?
l Where will we get our short-term loans?
Forms of Business Organization
Ø Three major forms in the United States
l Sole proprietorship
l Partnership
• General
• Limited
l Corporation
• S-Corp
• Limited liability company
Sole Proprietorship
Ø Advantages
l Easiest to start
l Least regulated
l Single owner keeps all the profits
l Taxed once as personal income
Partnership
Ø Advantages
l Two or more owners
l More capital available
l Relatively easy to start
l Income taxed once as personal income
Corporation
Ø Advantages
l Limited liability
l Unlimited life
l Separation of ownership and management
l Transfer of ownership is easy
l Easier to raise capital
Goal Of Financial Management
Ø What should be the goal of a corporation?
l To survive?
l Avoid financial distress and bankruptcy?
l Beat the competition?
l Maximize profit?
l Minimize costs?
l Maximize sales or market share?
l Maintain steady earnings growth?
Ø Does this mean we should do anything and everything to maximize owner wealth?
Goal Of Financial Management
Ø To maximize the current value per share of the existing stock.
The Agency Problem
Ø Agency relationship
l Principal hires an agent to represent his/her interests
l Stockholders (principals) hire managers (agents) to run the company
Ø Agency problem
l Conflict of interest between principal and agent
Ø Management goals and agency costs
Managing Managers
Ø Managerial compensation
l Incentives can be used to align management and stockholder interests
l The incentives need to be structured carefully to make sure that they achieve their goal
Ø Corporate control
l The threat of a takeover may result in better management
Ø Other stakeholders
Work the Web Example
Ø The Internet provides a wealth of information about individual companies
Ø One excellent site is finance.yahoo.com
Ø Click on the web surfer to go to the site, choose a company and see what information you can find!
Financial Markets
Ø Cash flows to the firm
l A. Firm issues securities to raise cash.
l B. Firm invests in assets.
l C. Firm’s operations generate cash flow.
l D. Cash is paid out to govt. as taxes.
l E. Cash reinvested in the firm.
l F. Dividends and debt payments are made.
Ø Primary vs. secondary markets