Chapter One

1-1

IntroductionCorporate
to
Finance
Ross Westerfield Jaffe
Corporate Finance

Sixth Edition

Instructor: AJAB KHAN BURKI

For Download: tinyurl.com/burki09

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Chapter Outline
1.1 What is Corporate Finance?
1.2 Corporate Securities as Contingent Claims on Total
Firm Value
1.3 The Corporate Firm
1.4 Goals of the Corporate Firm
1.5 Financial Institutions, Financial Markets, And The
Corporation
1.6 Trends in Financial Markets and Management
1.7 Outline of the Text
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What is Corporate Finance?

Corporate Finance addresses the following
three questions:
1. What long-term investments should the firm
engage in?
2. How can the firm raise the money for the
required investments?
3. How much short-term cash flow does a
company need to pay its bills?
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The Balance-Sheet Model of the Firm

Total Value of Assets:

Current Assets

Total Firm Value to Investors:

Current
Liabilities
Long-Term
Debt

Fixed Assets
1 Tangible
2 Intangible

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Shareholders
Equity

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The Balance-Sheet Model of the Firm

The Capital Budgeting Decision
Current
Liabilities

Current Assets

Long-Term
Debt
Fixed Assets
1 Tangible
2 Intangible

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What longterm
investments
should the
firm engage
in?

Shareholders
Equity

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The Balance-Sheet Model of the Firm

The Capital Structure Decision
Current Assets

How can the firm

raise the money
for the required
Fixed Assets
investments?
1 Tangible
2 Intangible

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Current
Liabilities
Long-Term
Debt

Shareholders
Equity

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The Balance-Sheet Model of the Firm

The Net Working Capital Investment Decision

Current Assets

Fixed Assets
1 Tangible
2 Intangible

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Current
Liabilities
Net
Working
Capital

How much shortterm cash flow

does a company
need to pay its
bills?

Long-Term
Debt

Shareholders
Equity

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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 up the pie.

70%50%30%
25%
DebtDebt
Equity
75%
50%
Equity

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

Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
President and Chief
Operating Officer (COO)
Vice President Finance

Treasurer

Controller

Cash Manager

Credit Manager

Tax Manager

Cost Accounting

Capital Expenditures

Financial Planning

Financial Accounting

Data Processing

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The Financial Manager

To create value, the financial manager
should:
1. Try to make smart investment decisions.
2. Try to make smart financing decisions.

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The Firm and the Financial Markets

Firm

Firm issues securities (A)

Invests
in assets
(B)

Retained
cash flows (D)
Short-term debt
Cash flow
from firm (C)

Dividends and
debt payments (F)
Taxes (E)

Current assets
Fixed assets

Ultimately, the firm

must be a cash
generating activity.
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Financial
markets

Government

Long-term debt
Equity shares

The cash flows from

the firm must exceed
the cash flows from
the financial markets.
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1.2 Corporate Securities as Contingent Claims on

Total Firm Value
The basic feature of a debt is that it is a
promise by the borrowing firm to repay a
fixed dollar amount by a certain date.
The shareholders claim on firm value is the
residual amount that remains after the
debtholders are paid.
If the value of the firm is less than the
amount promised to the debtholders, the
shareholders get nothing.
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1.3 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
Advantages and Disadvantages

Liquidity and Marketability of Ownership

Control
Liability
Continuity of Existence
Tax Considerations

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A Comparison of Partnership and Corporations

Corporation

Partnership

Liquidity

Shares can easily be

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 with dividend tax

credit

Partnership income is
taxable.

Reinvestment

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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1.4 Goals of the Corporate Firm

What are firm decision-makers hired to do?
The traditional answer is that the managers of
the corporation are obliged to make efforts to
maximize shareholder wealth.

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Financial Markets
Money versus Capital Markets
Money Markets
For short-term debt instruments
Capital Markets
For long-term debt and equity

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Financial Markets
Primary versus Secondary Markets
Primary Market
When a corporation issues securities, cash flows
from investors to the firm.
Usually an underwriter is involved

Secondary Markets
Involve the sale of used securities from one
investor to another.
Securities may be exchange traded or trade overthe-counter in a dealer market.
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Financial Markets

Firms

Stocks and
Bonds
Money

Investors
Bob

securities

Sue

money
Primary Market
Secondary
Market

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1.6 Trends in Financial Markets and

Management

Integration and globalization

Increased volatility
Financial Engineering reduces costs related to
Risk
Taxes
Fnancing costs
Improved computer technology allows
Economies of scale and scope
Regulatory dialectic

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