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Corporate Finance, 7/e

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CHAPTER
1
Introduction to Corporate
Finance

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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 Markets
1.6 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: Total Firm Value to Investors:
Current
Liabilities
Current Assets
Long-Term
Debt

Fixed Assets
1 Tangible Shareholders’
2 Intangible 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 What long-

term
1 Tangible investments Shareholders’
2 Intangible should the Equity
firm engage
in?
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The Balance-Sheet Model

of the Firm
The Capital Structure Decision
Current
Liabilities
Current Assets

Long-Term
How can the firm Debt
raise the money
for the required
Fixed Assets
investments?
1 Tangible Shareholders’
2 Intangible Equity

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The Balance-Sheet Model

of the Firm
The Net Working Capital Investment Decision
Current
Liabilities
Current Assets
Net
Working
Capital
Long-Term
Debt

How much short-

Fixed Assets
term cash flow
1 Tangible does a company
need to pay its Shareholders’
2 Intangible bills? 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 70%50%30%

25%
to increase the size of the DebtDebt
Equity
pie.
75%
50%
The Capital Structure Equity
decision can be viewed as
how best to slice up a the
pie.
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 and

Chief Financial Officer (CFO)

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) Financial
markets
Invests
Retained
in assets cash flows (F)
(B)
Short-term debt
Current assets Cash flow Dividends and Long-term debt
Fixed assets from firm (C) debt payments (E)
Equity shares

Ultimately, the firm
must be a cash
generating activity.
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Corporate Finance, 7/e
Taxes (D)
The cash flows from
the firm must exceed
the cash flows from the
Government
financial markets.
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1.4 Goals of the Corporate Firm

The traditional answer is that the managers of the
corporation are obliged to make efforts to
maximize shareholder wealth.

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Separation of Ownership and Control

Board of Directors

Debtholders

Shareholders
Management

Debt
Assets
Equity

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1.5 Financial 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 over-the-
counter in a dealer market.
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Financial Markets

Stocks and
Investors
Bonds
Firms securities
Money Bob Sue
money

Primary Market
Secondary
Market

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