Chap001

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved

CHAPTER

1 Introduction to Corporate Finance

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Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved

McGraw-Hill/Irwin

Key Concepts and SkillsKnow the basic types of financial

management decisions and the role of the Financial Manager

Know the financial implications of the various forms of business organization

Know the goal of financial managementUnderstand the conflicts of interest that can

arise between owners and managersUnderstand the various types of financial

markets

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Chapter Outline

1.1 What is Corporate Finance?

1.2 The Corporate Firm

1.3 The Goal of Financial Management

1.4 The Agency Problem and Control of the Corporation

1.5 Financial Markets

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1.1 What is Corporate Finance?

Corporate Finance addresses the following three questions:1. What long-term investments should the firm

choose?

2. How should the firm raise funds for the selected investments?

3. How should short-term assets be managed and financed?

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Balance Sheet Model of the Firm

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Total Value of Assets:

Shareholders’ Equity

Current Liabilities

Long-Term Debt

Total Firm Value to Investors:

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The Capital Budgeting Decision

Current Assets

Fixed Assets

1 Tangible

2 IntangibleShareholders’

Equity

Current Liabilities

Long-Term Debt

What long-term investments should the firm choose?

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The Capital Structure Decision

How should the firm raise funds for the selected investments?

Current Assets

Fixed Assets

1 Tangible

2 IntangibleShareholders’

Equity

Current Liabilities

Long-Term Debt

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Short-Term Asset Management

How should short-term assets be managed and financed?

Net Working Capital

Shareholders’ Equity

Current Liabilities

Long-Term Debt

Current Assets

Fixed Assets

1 Tangible

2 Intangible

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Capital Structure

The value of the firm can be thought of as a pie.

The goal of the manager is to increase the size of the pie.

The Capital Structure decision can be viewed as how best to slice the pie.

If how you slice the pie affects the size of the pie, then the capital structure decision matters.

50% Debt

50% Equity

25% Debt

75% Equity

70% Debt

30% Equity

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The Financial Manager

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

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Hypothetical Organization Chart

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

Capital Expenditures

Credit Manager

Financial Planning

Tax Manager

Financial Accounting

Cost Accounting

Data Processing

Board of Directors

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Cash flowfrom firm (C)

The Firm and the Financial Markets

Tax

es (D)

Government

Retained cash flows (F)

Investsin assets(B)

Dividends anddebt payments (E)

Current assetsFixed assets

Short-term debt

Long-term debt

Equity shares

Ultimately, the firm must be a cash generating activity.

The cash flows from the firm must exceed the cash flows from the financial markets.

Invests in assets

Current assetsFixed assets

Firm Firm issues securities (A)

Short-term debtLong-term debtEquity shares

Financialmarkets

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Identification of Cash Flows

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Forms of Business Organization

• The Sole Proprietorship• The Partnership• The Corporation

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1.3 The Goal of Financial Management

• What is the correct goal?– Maximize profit?– Minimize costs?– Maximize market share?– Maximize shareholder wealth?

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The goal of financial management is to

• Maximize the current value per share of the existing stock.

• Maximize the market value of the existing owners’ equity. (A more general goal)

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The most important job of a financial manager:

To create value from the firm’s capital budgeting, financing, and net working-capital activities.

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Corporate Finance

• The study of the relationship between business decisions and the value of the stock in the business.

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1.4 The Agency Problem

• 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

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Managerial Goals

• Managerial goals may be different from shareholder goals– Expensive perquisites– Survival– Independence

• Increased growth and size are not necessarily equivalent to increased shareholder wealth

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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 intended goal

• Corporate control– The threat of a takeover may result in better

management

• Other stakeholders

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1.5 Financial Markets

• 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

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Financial Markets

FirmsInvestors

Secondary Market

money

securitiesSueBob

Stocks and Bonds

Money

Primary Market

Chap001

Economy & Finance

goal of financial management

shortterm assets

financial implications

corporate firm

financial markets cash

assets b dividends

longterm investments

corporate finance