Corporate Finance

Prof. dr. Anamaria Ciobanu

What the Module is About...

Covers the information in the area of

financial management and investment

decisions analysis.

This module will be a support for the

International Corporate Finance module,

Investment and Business Valuation

modules.

Lectures themes

Introduction to Corporate Finance

Balance sheet analysis

Income statements analysis

Operating risk and financial risk

Cash flow statement analysis

Working capital management

Ratio analysis

Time value of money

Investment Valuation

Analysis of long term financing decisions

The final exam and the final mark

you can get 60% of the final mark at the final exam

.and 40% depends on the marks youll get at seminar (20%: attendance and home works) and 20%: 1 test at the seminar)

Introduction to Corporate Finance

Key activities of the Financial

Manager:

1. Financial Analysis and Planning

2. Investment Decisions

3. Financing Decisions

Key Activities of the Financial

Manager

Corporate Organization

Overview of Finance

Finance and Accounting functions are closely-

related and overlapping.

In smaller firms, the financial manager generally

performs both functions.

Relationship to Accounting

Overview of Finance

Finance and accounting differ with respect to

decision-making.

While accountant - is primarily concerned with the

preparation and presentation of financial data,

the financial manager - is primarily concerned with

analyzing and interpreting this information for decision-

making purposes.

Relationship to Accounting

What is Corporate Finance?

Corporate Finance is the study of decisions that firms make regarding the capital used in their

business

What is a firm?

Any business in any area of economic activity, large or small, private or publicly traded

Firms own assets that generate earnings and seek to invest and grow

Legal Forms of Business Organization

Three key legal forms

Sole Proprietorship

Partnership

Corporation

The principles of finance apply to all three forms of the business organizations.

Sole Proprietorship

Advantages

Easiest to start

Least regulated

Single owner keeps all the profits

Taxed once as personal income

Disadvantages

Limited to life of owner

Equity capital limited to owners personal wealth

Unlimited liability

Limited access to capital

Proprietorship is a business that is owned by one person

No distinction between business & person

Partnership

Advantages

Two or more owners

More capital available

Relatively easy to start

Income taxed once as personal income

Disadvantages

Unlimited liability

General partnership

Limited partnership

Partnership dissolves when one partner dies

or wishes to sell

Difficult to transfer ownership

A Partnership has two or more business owners Partners are liable for every other partners actions

Corporation

Advantages

Limited liability

Unlimited life

Separate contracting Transfer of ownership

is easy

Easier to raise capital

Disadvantages

Separation of ownership and

management

Double taxation (income taxed at the

corporate rate and

then dividends taxed

at personal rate)

A corporation is a separate legal entity with all the economic rights & responsibilities of a person

Corporation

The manager Partners Shareholders

No No Usually

Unlimited

Sole Proprietorship Partnership

Who owns the business?

Are managers and owner separate?

What is the owners

liability?

No

Unlimited Limited

Are the owners & business

taxed separately? No Yes

Corporate Finance

Which are the four important questions a CFO should answer regarding the management of

invested capital in a business?

Brainstorm session: 5 minutes!

Corporate Finance

By studying corporate finance we get answers to these four important questions for a financial manager:

In which projects we should invest the money of the company?

How we should finance the investment projects and the whole company?

What means for the company we run a efficient working capital management?

How much of annual companys profit we should distribute as dividends?

Corporate Finance means common sense!

Make good investments!

Find the right resources to finance your business!

Distribute well the companys profits!

Manage efficiently your assets!

Corporate finance is about

common sense in managing the

companys capital In which investment projects we should invest?

How we substantiate our investment decision?

Brainstorm session: 5 minutes!

Corporate finance is about

common sense in managing the

companys capital

Investment Principle: Invest in projects that yield a return greater than the minimum acceptable

hurdle rate (required rate of return)

Returns on projects should be measured in terms of cash flows generated and the timing of these cash

flows

The hurdle rate should be higher for riskier projects and reflect the financing mix used (debt or equity)

Corporate finance is about

common sense in managing the

companys capital

Buy real assets that are worth more than they cost

Investment return have to be higher than the cost of funds we use to finance them!

Corporate finance is about common

sense in managing the companys capital

How we substantiate our financing decision?

Which are the factors we have to take into account we choose between various types of funds (resources)?

Brainstorm session: 5 minutes!

Corporate finance is about common

sense in managing the companys capital

The Financing Principle: Choose a financing mix that minimizes the hurdle rate (required rate of

return) and matches the assets being financed

Is there an optimal financing mix and, if so, what is it?

Debt is beneficial as long as the marginal benefits exceed the marginal costs

Corporate finance is about

common sense in managing the

companys capital

What means an efficient management of the companys assets?

Give some examples of assets for which an efficient management it is crucial for the companys activity!

Brainstorm session: 5 minutes!

Corporate finance is about

common sense in managing the

companys capital

An efficient management of the companys assets imply:

The companys resources are tide up in its current assets for a short period of time!

A higher return of the companys current assets than the cost of funds used to buy them!

Types of current assets:

Raw materials

Accounts receivables

Cash and bank accounts

Corporate finance is about common

sense in managing the companys capital

How we substantiate our dividend decision?

When we should reinvest the companys annual profit?

When we should distribute the companys annual profit to its shareholders?

Brainstorm session: 5 minutes!

Corporate finance is about

common sense in managing the

companys capital

The Dividend Principle: If there are not enough investment projects that earn the hurdle rate (the

rate of return the investors demand), return the

cash to stockholders (distribute dividends!)

Goal Of Financial Manager

What should be the goal of a corporation?

Maximize profit?

Maximize cash flows?

Minimize costs?

Maximize market share?

Maximize the current value of the companys stock?

Employee well-being?

Protect interests of all stakeholders?

Goal of Financial Manager To Maximize Shareholders Wealth!

It can also be described using the following flow chart:

Maximizing shareholder wealth vs.

maximizing profits

Maximizing shareholder wealth is better than maximizing profits for three reasons:

Maximizing profits does not take the time value of money into account (a dollar today is

worth more than a dollar tomorrow)

Maximizing profits does not take risks into account (a riskless dollar is worth more than a

risky one)

Accounting numbers, such as profits, can easily be manipulated

Goals of the Corporation

Market-oriented economies

Anglo-Saxon countries (Canada, U.S., U.K., Ireland, Australia etc.)

Emphasis on shareholder value maximization

Network-oriented economies

Emphasis on interests of all stakeholders

Goals of the Corporation

Does this mean we should do anything and

everything to maximize owner wealth?

Does a firm have responsibilities to society at

large?

Is the goal of maximizing shareholder wealth

good or bad for society at large?

Goal of Corporations What About Other Stakeholders?

Stakeholders include all groups who have a direct economic link to the firm including:

Employees - Creditors

Customers - Bankers

Suppliers

The stakeholders view that the firms should make a conscious effort to avoid actions that could be detrimental to the wealth position of its stakeholders.

Thus firms have to maintain a social responsibility towards the stakeholders.

Shareholders

The role of Financial Manager

Creditors

Management

I will get my money back?

How performing is

the investment

we made in the stocks

of this company? How performing is

the company we run?

Financial

Manager

Firm's

operation

s Investors

(1) Cash raised from investors

(1)

(2) Cash invested in firm

(2)

(3) Cash generated by operations

(3)

(4a) Cash reinvested

(4a)

(4b) Cash returned to investors

(4b)

The Role of The Financial Manager

Real assets

Capital Budgeting Financing Decisions

The Agency Issue

Within a corporation, agency relationship exists between

shareholders and managers.

In theory, managers would agree with shareholders wealth

maximization - where managers only act as an agent.

However, managers also concerned with their own personal

wealth, job security, fringe benefits, and lifestyle.

This would cause managers to act in ways that do not

always benefit the shareholders - lead to a conflict of

interest with the shareholders. For eg. managers may avoid

risk to safeguard their personal security and benefits.

The Problem

The Agency Problem

Agency problem

Conflict of interest between principal and agent

Will managers work in the shareholders best interests?

Agency costs:

Direct agency costs: Management compensation

Indirect agency costs: monitoring managers and suboptimal

decisions.

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

Questions?

Thank you for your attention!