Chap001corporate Finance

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

CHAPTER

1Introduction to Corporate

Finance


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

Key Concepts and Skills

Know the basic types of financialmanagement decisions and the role of theFinancial Manager

Know the financial implications of thevarious forms of business organization

Know the goal of financial management

Understand the conflicts of interest thatcan arise between owners and managers

Understand the various types of financialmarkets


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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 managedand 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-TermDebt

Total Firm Value to Investors:


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The Capital Budgeting Decision

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Shareholders

Equity

Current

Liabilities

Long-TermDebt

What long-terminvestmentsshould the firmchoose?


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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 Intangible

Shareholders

Equity

Current

Liabilities

Long-TermDebt


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Short-Term Asset Management

How should

short-term assetsbe managed andfinanced?

Net

WorkingCapital

Shareholders

Equity

Current

Liabilities

Long-TermDebt

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 Managers 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 andChief Executive Officer (CEO)

President and ChiefOperating Officer (COO)

Vice President andChief Financial Officer (CFO)

Treasurer Controller

Cash Manager

Capital Expenditures

Credit Manager

Financial Planning

Tax Manager

Financial Accounting

Cost Accounting

Data Processing

Board of Directors

Th Fi d h Fi i l


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Cash flowfrom firm (C)

The Firm and the Financial

Markets

Taxes

(D)

Government

Retainedcash flows (F)

Invests

in assets

(B)

Dividends anddebt payments (E)

Current assets

Fixed 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.

Firm Firm issues securities (A) Financial

markets


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1.2 The Corporate Firm

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.


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Forms of Business Organization

The Sole Proprietorship

The Partnership

General Partnership

Limited Partnership

The Corporation

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A ComparisonCorporation Partnership

Liquidity Shares can be easily

exchanged

Subject to substantial

restrictions

Voting Rights Usually each share gets one

vote

General Partner is in charge;

limited partners may have

some voting rights

Taxation Double Partners pay taxes on

distributions

Reinvestment and

dividend payout

Broad latitude All net cash flow is

distributed to partners

Liability Limited liability General partners may have

unlimited liability; limited

partners enjoy limited

liability

Continuity Perpetual life Limited life

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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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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 andagent

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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 makesure 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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http://www.nyse.com/http://www.nasdaq.com/http://www.nasdaq.com/http://www.nyse.com/


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Financial Markets

FirmsInvestors

Secondary

Market

money

securitiesSueBob

Stocks and

Bonds

Money

Primary Market

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C i ht 2008 b Th M G Hill C i I All i ht dM G Hill/I i

Quick Quiz

What are the three basic questionsFinancial Managers must answer?

What are the three major forms of

business organization? What is the goal of financial management?

What are agency problems, and why do

they exist within a corporation? What is the difference between a primary

market and a secondary market?

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