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Introduction To Corporate Finance

Here are the key points covered in the document: - The three basic questions of corporate finance are: 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? - The three major forms of business organization are sole proprietorships, partnerships, and corporations. - The goal of financial management is to maximize shareholder wealth. - Agency problems exist because managers' goals may differ from shareholders' goals of wealth maximization, since managers are agents of the shareholders. - Primary markets involve the initial issuance of securities, while secondary markets involve subsequent trading of existing securities.

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Kshitij Vijayvergia
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© © All Rights Reserved
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23 views

Introduction To Corporate Finance

Here are the key points covered in the document: - The three basic questions of corporate finance are: 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? - The three major forms of business organization are sole proprietorships, partnerships, and corporations. - The goal of financial management is to maximize shareholder wealth. - Agency problems exist because managers' goals may differ from shareholders' goals of wealth maximization, since managers are agents of the shareholders. - Primary markets involve the initial issuance of securities, while secondary markets involve subsequent trading of existing securities.

Uploaded by

Kshitij Vijayvergia
Copyright
© © All Rights Reserved
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Introduction to Corporate Finance

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
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
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?
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
The Capital Budgeting Decision

Current
Liabilities
Current Assets
Long-Term
Debt

Fixed Assets
What long-term
1 Tangible investments Shareholders’
should the firm
2 Intangible Equity
choose?
The Capital Structure Decision

Current
Liabilities
Current Assets
Long-Term
How should the Debt
firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible Shareholders’
2 Intangible Equity
Short-Term Asset Management

Current
Liabilities
Current Assets
Net
Working Long-Term
Capital Debt

How should
Fixed Assets
short-term assets
1 Tangible be managed and
financed? Shareholders’
2 Intangible Equity
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 the pie.

If how you slice the pie affects the size of the pie,
then the capital structure decision matters.
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
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


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

Taxes (D)

Ultimately, the firm The cash flows from


the firm must exceed
must be a cash Government
the cash flows from
generating activity.
the financial markets.
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.
Forms of Business Organization
 The Sole Proprietorship
 The Partnership
 General Partnership
 Limited Partnership*

 The Corporation
Sole Proprietorship

 Sole proprietorship is the cheapest business to form


 Life is Limited
 No formal charter, and few government regulations
must be satisfied for most industries
 Pay no corporate income taxes
 All profits of the business is taxed as individual
income, unlimited liability,
 No distinction between personal and business
assets
 Equity Is limited by the proprietors personal wealth
A Comparison
Corporation Partnership

Liquidity Shares can be easily Subject to substantial


exchanged restrictions

Voting Rights Usually each share gets one General Partner is in charge;
vote limited partners may have
some voting rights

Taxation Double Partners pay personal taxes


on Partnership profits
Reinvestment and Broad latitude All net cash flow is
dividend payout distributed to partners

Liability Limited liability General partners may have


unlimited liability; limited
partners enjoy limited
liability
Continuity Perpetual life Limited life
Public and Private Limited Companies

 Private Limited  Public Limited


Companies: 2 to 50 Companies:
Members and it prohibits  Minimum Seven are required to
form a public limited company
invitation to public for
with no upper limit.
capital issues.
 Shares are easily transferable.
 Restriction on transfer of  The taxation are lower and there
shares is a wider coverage of companies
act

The main differences relate to certain provisions of the companies act that are not
Applicable to private limited companies. Ex: Voting rights and issues of shares wit
Disproportionate rights, Provisions restricting the power of the board of directors,
Further issues of share capital .
1.3 The Goal of Financial Management

 What is the correct goal?


 Maximize profit?

 Minimize costs?

 Maximize market share?

 Maximize shareholder wealth?


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
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
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
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


Financial Markets

Stocks and
Investors
Bonds
Firms securities
Money Bob Sue
money

Primary Market
Secondary
Market
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?

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