Introduction to Corporate FinanceChapter 1Copyright 2015 by the McGraw-Hill Education (Asia). All rights reserved.

1-*

Key Concepts and SkillsKnow the basic types of financial management decisions and the role of the Financial ManagerKnow the financial implications of the various forms of business organizationKnow the goal of financial managementUnderstand the conflicts of interest that can arise between owners and managersUnderstand the various regulations that firms face

1-*

Chapter Outline1.1 What is Corporate Finance?1.2 The Corporate Firm1.3 The Importance of Cash Flows1.4 The Goal of Financial Management1.5 The Agency Problem and Control of the Corporation1.6 Regulation

1-*

1.1 What Is Corporate Finance?Corporate Finance addresses the following three questions:What long-term investments should the firm choose?How should the firm raise funds for the selected investments?How should short-term assets be managed and financed?

1-*

Balance Sheet Model of the Firm

1-*

The Capital Budgeting Decision

Current Assets

Fixed Assets1 Tangible 2 Intangible

Shareholders Equity

Current LiabilitiesLong-Term Debt

What long-term investments should the firm choose?

1-*

The Capital Structure DecisionHow should the firm raise funds for the selected investments?

Current Assets

Fixed Assets1 Tangible 2 Intangible

Shareholders Equity

Current LiabilitiesLong-Term Debt

1-*

Short-Term Asset ManagementHow should short-term assets be managed and financed?

Net Working Capital

Shareholders Equity

Current LiabilitiesLong-Term Debt

Current Assets

Fixed Assets1 Tangible 2 Intangible

1-*

The Financial ManagerThe Financial Managers primary goal is to increase the value of the firm by: Selecting value creating projects Making smart financing decisions

1-*

Hypothetical Organization Chart

1-*

1.2 The Corporate FirmThe 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.

1-*

Forms of Business OrganizationThe Sole ProprietorshipThe PartnershipGeneral PartnershipLimited PartnershipThe Corporation

1-*

A Comparison

1-*

International Corporations

1-*

Cash flow from firm (C)1.3 The Importance of Cash FlowTaxes (D)Retained cash flows (F)Invests in assets (B)Dividends and debt payments (E)Current assets Fixed assetsShort-term debtLong-term debtEquity sharesUltimately, the firm must be a cash generating activity.The cash flows from the firm must exceed the cash flows from the financial markets.Firm issues securities (A)

1-*

1.4 The Goal of Financial ManagementWhat is the correct goal?Maximize profit?Minimize cost?Maximize market share?Maximize shareholder wealth?

1-*

1.4 Goal of Finance Maximizing profit?Maximizing profit is not a suitable goal because:Profits can be increased by reducing cost. This is discussed in the next slide.Profits are not cash flowsRisk is not taken into account

1-*

1.4 Goal of Finance- Minimizing cost?Minimizing cost is not a suitable goal because:Minimizing costs may increase current profits but the future well-being of the company may be affected, for example,Reducing maintenance costs may result in machines breaking down earlier in the futureReducing R&D expenditures may cause the products to be less competitiveReducing headcount may reduce the quality of service

1-*

1.4 Goal of Finance- Maximizing market share?Maximizing market share is not a suitable goal because:In order to increase market the firm may large amounts in advertising and promotionHaving a large market share may not translate into higher profits if the firm cannot increase revenue much more by increasing prices

1-*

1.4 Goal of Finance- Maximizing shareholder wealth? This is the right goal of finance because:It avoids the problems of the other goals by taking risk into consideration, as well as the impact on future cash flows of the firms actions An investment may promise high returns, but if the risks involved are too high, then the investment may not be viable.As the share price depends not only on current cash flows but future cash flows as well, any action taken by the firm would consider not just the short term effects but the long term effects to the firm

1-*

1.5 The Agency ProblemAgency relationshipPrincipal hires an agent to represent his/her interestStockholders (principals) hire managers (agents) to run the companyAgency problemConflict of interest between principal and agent

1-*

Managerial GoalsManagerial goals may be different from shareholder goalsExpensive perquisitesSurvivalIndependenceIncreased growth and size are not necessarily equivalent to increased shareholder wealth

1-*

Managing ManagersManagerial compensationIncentives can be used to align management and stockholder interestsThe incentives need to be structured carefully to make sure that they achieve their intended goalCorporate controlThe threat of a takeover may result in better managementOther stakeholders

1-*

1.6 RegulationSecurities ActsEach country has its own securities acts to govern the operations of the securities markets in relation toTrading of securitiesIssue of new securitiesCorporate disclosure and insider tradingSarbanes-Oxley (Sarbox)Increased reporting requirements and responsibility of corporate directors

1-*

Corporate GovernanceCorporate governance relates to the rights and responsibilities of various stakeholders in the firmA firm with good corporate governance wouldRespect the rights of the shareholders and other stakeholdersEnsure that the board of directors represent the best interests of shareholdersOperate in a transparent manner

1-*

Quick QuizWhat 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 major regulations impact public firms?

************************