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FUNDAMENTALS

of Corporate
FINANCE

SECOND EDITION

Stephen A. Ross
Randolph W. Westerfield
Bradford D. Jordan
Joseph Lim
Ruth Tan

Copyright © 2016 by McGraw-Hill Education. All rights reserved.


CHAPTER 1
I N T R O D U C T I O N T O C O R P O R AT E F I N A N C E

Copyright © 2016 by McGraw-Hill Education. 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

• Understand the conflicts of interest that can arise


between owners and managers

• Understand the various types of financial markets

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Copyright © 2016 by McGraw-Hill Education. All rights reserved
CHAPTER OUTLINE
• 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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Copyright © 2016 by McGraw-Hill Education. All rights reserved
CORPORATE FINANCE

• Some important questions that are answered


using 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 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
• Capital budgeting
 What long-term investments or projects
should the business take on?

• Capital structure
 How should we pay for our assets?
 Should we use debt or equity?

• Working capital management


 How do we manage the day-to-day
finances of the firm?
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FORMS OF BUSINESS
ORGANIZATION

• Three major forms:

 Sole Proprietorship

 Partnership
• General
• Limited

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

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

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

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INTERNATIONAL CORPORATIONS

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A COMPARISON OF THE DIFFERENT
FORMS OF BUSINESS ORGANIZATION

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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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WORK THE WEB EXAMPLE

• The Internet provides a wealth of information


about individual companies
• One excellent site is finance.yahoo.com
• Click on the web surfer to go to the site,
choose a company and see what information
you can find!

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FINANCIAL MARKETS

• Cash flows to and from the firm

• Primary vs. secondary markets


 Dealer vs. auction markets
 Listed vs. over-the-counter securities
• NYSE
• NASDAQ

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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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Copyright © 2016 by McGraw-Hill Education. All rights reserved
ETHICS ISSUES
• Is it ethical for tobacco companies to sell a product
that is known to be addictive and a danger to the
health of the user? Is it relevant that the product is
legal?

• Should boards of directors consider only price when


faced with a buyout offer?

• Is it ethical to concentrate only on shareholder


wealth, or should stakeholders as a whole be
considered?

• Should firms be penalized for attempting to


improve returns by stifling competition (e.g.,
Microsoft)?

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END OF CHAPTER
CHAPTER 1

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Copyright © 2016 by McGraw-Hill Education. All rights reserved