chap001.ppt Introduction to Corporate Finance

Corporate Finance

1. McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
CHAPTER
1
Introduction to Corporate
Finance

2. Slide 2
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
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 various
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

3. Slide 3
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
Chapter Outline
1.1 What is Corporate Finance?
1.2 The Corporate Firm
1.3 The Goal of Financial Management
1.4 The Agency Problem and Control of the
Corporation
1.5 Financial Markets

4. Slide 4
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
1.1 What is Corporate Finance?
Corporate Finance addresses the
following three questions:
1.What long-term investments should the firm
choose?
2.How should the firm raise funds for the
selected investments?
3.How should short-term assets be managed
and financed?

5. Slide 5
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
Balance Sheet Model of the
Firm
Current
Assets
Fixed Assets
1 Tangible
2 Intangible
Total Value of Assets:
Shareholders’
Equity
Current
Liabilities
Long-Term
Debt
Total Firm Value to Investors:

6. Slide 6
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
The Capital Budgeting Decision
Current
Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders’
Equity
Current
Liabilities
Long-Term
Debt
What long-term
investments
should the firm
choose?

7. Slide 7
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
The Capital Structure Decision
How should the
firm raise funds
for the selected
investments?
Current
Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders’
Equity
Current
Liabilities
Long-Term
Debt

8. Slide 8
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
Short-Term Asset Management
How should
short-term assets
be managed and
financed?
Net
Working
Capital
Shareholders’
Equity
Current
Liabilities
Long-Term
Debt
Current
Assets
Fixed Assets
1 Tangible
2 Intangible

9. Slide 9
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
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 the pie.
If how you slice the pie affects the size of the
pie, then the capital structure decision matters.
50%
Debt
50%
Equity
25%
Debt
75%
Equity
70%
Debt
30%
Equity

10. Slide 10
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
The Financial Manager
The Financial Manager’s primary goal is to
increase the value of the firm by:
1. Selecting value creating projects
2. Making smart financing decisions

11. Slide 11
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
Hypothetical Organization Chart
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
Capital Expenditures
Credit Manager
Financial Planning
Tax Manager
Financial Accounting
Cost Accounting
Data Processing
Board of Directors

12. Slide 12
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
Cash flow
from firm (C)
The Firm and the Financial
Markets
T
a
x
e
s

(
D
)
Government
Retained
cash flows (F)
Invests
in assets
(B)
Dividends and
debt payments (E)
Current assets
Fixed assets
Short-term debt
Long-term debt
Equity shares
Ultimately, the firm
must be a cash
generating activity.
The cash flows from
the firm must exceed
the cash flows from
the financial markets.
Firm Firm issues securities (A) Financial
markets

13. Slide 13
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
1.2 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.

14. Slide 14
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
Forms of Business Organization
•The Sole Proprietorship
•The Partnership
–General Partnership
–Limited Partnership
•The Corporation

15. Slide 15
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
A Comparison
 
Corporation Partnership
Liquidity Shares can be easily
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 Partners pay taxes on
distributions
Reinvestment and
dividend payout
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

16. Slide 16
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
1.3 The Goal of Financial
Management
•What is the correct goal?
–Maximize profit?
–Minimize costs?
–Maximize market share?
–Maximize shareholder wealth?

17. Slide 17
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
1.4 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

18. Slide 18
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
Managerial Goals
•Managerial goals may be different from
shareholder goals
–Expensive perquisites
–Survival
–Independence
•Increased growth and size are not
necessarily equivalent to increased
shareholder wealth

19. Slide 19
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
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 intended goal
•Corporate control
–The threat of a takeover may result in better
management
•Other stakeholders

20. Slide 20
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
1.5 Financial Markets
•Primary Market
–Issuance of a security for the first time
•Secondary Markets
–Buying and selling of previously issued
securities
–Securities may be traded in either a dealer or
auction market
•NYSE
•NASDAQ

21. Slide 21
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
Financial Markets
Firms
Investors
Secondary
Market
money
securities
SueBob
Stocks and
Bonds
Money
Primary Market

22. Slide 22
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin
Quick Quiz
•What are the three basic questions
Financial Managers must 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?