Chapter 1

Introduction To Corporate
Finance

McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 Key Concepts and Skills

Know the basic types of financial

management decisions and the role of the
financial manager
Know the financial implications of the
different forms of business organization

Know the goal of financial management

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 Key Concepts and Skills

Understand the conflicts of interest that can

arise between owners and managers

Understand the various types of financial

markets

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 What is Finance?

What is Finance?

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 What is Finance?

Finance: the art and science of managing

money.

Finance is a new branch of knowledge

established on the year 1956.

Dynamic, growing rapidly.

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 Finance is influenced by other
sciences, such as:
Accounting
Economics
Marketing
Management
Statistics
Mathematics
Engineering
Physics
Psychology
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 Finance

Financial markets International

Corporate Finance Investments
and Institutions Finance

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What is Corporate Finance?

What long-term investments should the firm

take on?
Where will we get the long-term financing to
pay for the investment?
How will we manage the everyday financial
activities of the firm?

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Financial Management Decisions

Capital budgeting

Capital structure

Working capital management

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 Capital Budgeting
What long-term investments or projects should
the business take on?

Process of planning and managing a firms

investments in fixed assets.

Financial manager tries to identify investment

opportunities that are worth more to the firm
than they cost to acquire.

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 Capital Budgeting
The types of investment opportunities that
would be typically considered depend in part
on the nature of the firms business. Two
examples:

For large retailers such as Wal-Mart deciding

whether to open another store would be an
important capital budgeting decision.

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 Capital Budgeting
For software company such as Microsoft, the
decision to develop and market a new spread
sheet program would be a major capital
budgeting decision.

The key concerns in capital budgeting are the

size, timing and riskiness of future cash flows.

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 Capital Structure
How should we pay for our assets?
Should we use debt or equity?
How much should the firm borrow?
What mixture of debt and equity is best?
Is the this mix going affect both risk and value of the
firm?
What are the least expensive sources of funds for the
firm?
Capital structure is the mixture of debt and equity
maintained by a firm
Is there an optimal mix of debt and equity?
When and where should the firm raise funds?
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Working Capital Management
How do we manage the day-to-day finances of
the firm?
How much cash and inventory should we keep in
hand?
Should we sell in credit?
If so, what terms will we offer, and to whom will
we extend them?
How we will obtain any needed short-term
financing?
Will we purchase on credit or will we borrow in
the short term and pay cash?
If we borrow in the short term, how and we 1-13
Working Capital Management

Working capital management is about

managing short-term assets and liabilities
( current assets and current liabilities)

Working Capital = Current Assets &

Current Liabilities
Net Working Capital = Current Assets
Current Liabilities
Current Ratio = Current assets / Current
Liabilities
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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 Manager

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Forms of Business Organization

Three major forms in the United States

Sole proprietorship
Partnership
General
Limited
Corporation
S-Corp
Limited liability company

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 Sole Proprietorship

Sole Proprietorship A business owned by

one person

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

Unlimited liability for business debts : creditors

can look beyond business assets to the
proprietors personal assets for payments.

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 Partnership

Partnership A business with multiple owners, but not

incorporated .

General partnership all partners share in gains or

losses; all have unlimited liability for all partnership
debts.

Limited partnership one or more general partners run

the business and have unlimited liability. A limited
partners liability is limited to his or her contribution to
the partnership and they cannot help in running the
business.

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 Partnership

Advantages Disadvantages
Two or more owners Unlimited liability
More capital available General partnership
Relatively easy to start Limited partnership

Income taxed once as Partnership dissolves

personal income when one partner dies
or wishes to sell
Difficult to transfer
ownership

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 Corporation

Corporation A distinct legal entity

composed of one or more owners.

Limited Liability Company (LLC)

is a hybrid of partnership and corporation,
the goal of this entity is to operate and be
taxed like a partnership but retain limited
liability for its owners.
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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 then
is easy dividends taxed at the
personal rate)
Easier to raise capital

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Forms of Business Organization
https://www.youtube.com/watch?v=pPVkG9krOMI

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 Goal Of Financial Management
What should be the goal of a corporation?
Survive?
Avoid financial distress and bankruptcy?
Beat the competition?

Maximize profit?
Minimize costs?
Maximize market share?
Maximize the current value of the companys 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
interest
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

Financial
Markets

Primary Secondary
Markets Markets

Private Dealer Auction

Public Offering
Placements Markets Markets

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 Financial Markets

Primary Markets: the issuer is the seller

Public offering: selling securities to the

general public

Private placements: is a negotiated sale

involving a specific buyer

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 Financial Markets

Secondary markets: one creditor or owner

selling to another

Dealer Markets: dealers buy or sell for

themselves at their own risk.

Dealer markets for stocks and long-term debt

securities are called Over The Counter
Markets OTC.
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 Financial Markets

Auction markets differ from dealer markets

in two ways:
An auction market or exchange has a
physical location.
The primary purpose of the action markets
is to mach those who wish to sell with those
who wish to buy, dealers play a limited role.

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 Listing

To be traded in the organized exchanges,

firms must meet listing requirements. such
as asset size, number of shareholders.

These requirements differ from one

exchange to another.

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 Quick Quiz

What are the three types of financial management

decisions and what questions are they designed to
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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Chapter 1
End of Chapter

McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.