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Introduction To
Corporate Finance

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter Outline
 The Field of Finance
 Corporate Finance and the Financial
Manager
 Forms of Business Organization
 The Goal of Financial Management
 The Agency Problem and Control of the
Corporation
 Financial Markets and the Corporation
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 The Field of Finance
1. Financial Management
 Analyze and forecast a firm’s
performance
 Evaluate investment opportunities
2. Financial Markets and Institutions
 The flow of funds through institutions
 Markets in which financial assets are sold
 Impact of interest rates on that flow of
funds
3. Investments
 Locate, select, and manage money
producing assets. 1-2
 Corporate Finance

 Some important questions that are

answered using finance
1. What long-term investments should the
firm take on?
2. Where will we get the long-term
financing to pay for the investment?
3. How will we manage the everyday
financial activities of the firm?
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 Financial Manager
 Financial managers try to answer some or
all of these questions
 The top financial manager within a firm is
usually the Chief Financial Officer (CFO)
 Treasurer – oversees cash management, credit
management, capital expenditures, and
financial planning
 Controller – oversees taxes, cost accounting,
financial accounting and data processing
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Financial Management Decisions
1. Capital budgeting
 What long-term investments or projects
should the business take on?
2. Capital structure
 How should we pay for our assets?
 Should we use debt or equity?
3. Working capital management
 How do we manage the day-to-day
finances of the firm?
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 Financial Management

ST Assets ST Liabilities

LT
LT Assets
Assets LT Liabilities
Equity

 Capital Budgeting
 Deals with the firm’s investment
in long-term real assets
 e.g., in what projects should the
firm invest?
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 Financial Management

ST Assets ST Liabilities

LT Assets LT Liabilities
Equity

 Capital Structure Policy

 Deals with long-term financing of
the firm’s activities
 e.g., what mix of long term debt
and equity will the firm use?
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Financial Management

Assets
ST Assets ST Liabilities

LT Assets LT Liabilities
Equity

 Working Capital Management

 Deals with management of short-term
(current) assets.
 e.g., will the firm purchase supplies on
credit or pay cash? 1-8
Forms of Business Organization

1. Sole proprietorship
2. Partnership
3. Corporation

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 Sole Proprietorship

 Advantages  Disadvantages
 Easiest to start  Limited to life of
 Least regulated owner
 Single owner keeps  Equity capital limited
all the profits to owner’s personal
 Taxed once as wealth
personal income  Unlimited liability
 Difficult to sell
ownership interest

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 Partnership

 Advantages  Disadvantages
 Two or more owners  Unlimited liability
 More capital available  General partnership
 Relatively easy to  Limited partnership
start  Partnership dissolves
 Income taxed once as when one partner dies
personal income or wishes to sell
 Difficult to transfer
ownership

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 Corporation

 Advantages  Disadvantages
 Limited liability  Separation of
 Unlimited life ownership and
 Separation of management
ownership and  Double taxation
management (income taxed at the
 Transfer of ownership corporate rate and
is easy then dividends taxed
at the personal rate)
 Easier to raise capital

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 Goal Of Financial Management

 What should be the goal of a corporation?

 Maximize profit?
 Minimize costs?
 Maximize market share?
 Maximize the current value of the company’s
stock?
 Does this mean we should do anything
and everything to maximize owner wealth?

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 The Agency Problem
 Agency relationship
 Principal hires an agent to represent his/her
interests
 Stockholders (principals) hire managers
(agents) to run the company
 Agency problem
 Conflict of interest between principal and agent
 Management goals and agency costs

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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 goal

 Corporate control
 The threat of a takeover may result in better
management

 Other stakeholders
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 Financial Markets

 Cash flows to the firm

 Primary vs. secondary markets

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Cash flows between the firm & the financial market

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