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Fundamentals of Corporate Finance

The document discusses fundamentals of corporate finance including forms of business organization like sole proprietorships, partnerships, and corporations. It describes the four basic areas of finance and financial management decisions around capital budgeting, capital structure, and working capital management. The goal of financial management is maximizing shareholder wealth. Agency problems can arise between shareholders and managers due to conflicting interests. Financial markets play an important role in raising capital for corporations.

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48 views24 pages

Fundamentals of Corporate Finance

The document discusses fundamentals of corporate finance including forms of business organization like sole proprietorships, partnerships, and corporations. It describes the four basic areas of finance and financial management decisions around capital budgeting, capital structure, and working capital management. The goal of financial management is maximizing shareholder wealth. Agency problems can arise between shareholders and managers due to conflicting interests. Financial markets play an important role in raising capital for corporations.

Uploaded by

usman
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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FUNDAMENTALS OF CORPORATE FINANCE

Stephen A. Ross
Randolph W. Westerfield
Bradford D. Jordan
Introduction to Corporate Finance
 Chapter Organization
 1.1 Corporate Finance and the Financial
Manager
 1.2 Forms of Business Organization
 1.3 The Goal of Financial Management
 1.4 The Agency Problem and Control of the
Corporation
 1.5 Financial Markets and the Corporation
 1.6 Summary and Conclusions
The Four Basic Areas of Finance
 Corporate Finance
 What, Where and how.
 Investments
 Financial Institutions
 International Finance
Financial Management Decisions
 Capital budgeting
 The process of planning and managing a firms long
term investments
 E.g. should a retailer as Walmart open a new outlet or
should Unilever develop a new product.
 Capital Structure
 The mixture of debt and equity maintained by a firm.
 Working Capital Management.
 A firms short term assets and liabilities.
Forms of Business Organization
 Organizational Forms
 Sole Proprietorship
 Partnership
 General Partnership / Limited Partnership

 Corporation
Limited Liability Company

 Economic Considerations
 Why are corporations generally larger than other forms
of business?
Sole Proprietorship
 Advantages  Disadvantages

 Inexpensively formed  Unlimited personal


 Few government liability.
regulations  Transferring
 Taxed once. ownership is difficult.
 Difficult to obtain large
some of funds.
Partnership
General Partnership / Limited Partnership
 Advantages  Disadvantages

 Inexpensively formed  Unlimited liability.


 Few government  Limited life of the
regulations organization.
 Taxed like an  Transferring
individual. ownership of a general
partner is difficult.
 Difficult to obtain large
some of funds.
Partnership
 General Partnership: At least two owners and
no more than twenty.
 Commonly the number of partners lies between
two and four.
 The Limited Partnership: A partners invest
capital into the business but do not participate in
running and managing the business.
 Such partners are limited partners.
 There must be at least one partner that has
limited liability and at least one partner that has
unlimited liability.
 The law allows this type of partnership to have
more than 20 owners.
Corporation
 Corporation is a “legal” person and distinct from
its owners.
 Corporations can sue and can be sued.
 Corporations can own stocks in another
corporation.
 In a corporation the stockholders and managers
are separate.
 Forming a corporation involves preparing articles
of incorporation and set of By Laws.
Corporation (Created by a State)
 Advantages  Disadvantages

 Unlimited life.  Time consuming and


 Easily transferable. difficult to set up.
 Limited Liability.  Double Taxation.
 Can obtain large Earning of the
funds. corporation.
Dividends paid to
the stockholders.
The Goal of Financial Management
 The Goal of Financial Management
 What are firm decision-makers hired to do?
 “General Motors is not in the business of making
automobiles. General Motors is in the business of
making money.”
Alfred P. Sloan
 Possible goals
Three equivalent goals of financial management:
 Maximize shareholder wealth
 Maximize share price
 Maximize firm value
Session 2
Agency Relationships

Delegates
Stockholder Managers

Principals Agents
Important Agency Relationships

 Stockholders and managers


 Stockholders and creditors.
Agency Problem
 Def: “Potential conflict of interest between shareholders
and the managers / creditors”
 It arises when managers own less than 100% of the
firms common stocks.
 Potential of agency problem is greatest in large
organizations.
 Managers since they hold less % of shares may peruse
different goals.
 Agency costs
 Direct agency costs
Methods to Motivate Managers.

Managerial Compensation (tie compensation


with performance).
Threat of firing
The threat of takeover
Shareholders’ Intervention (Many institutional
investors routinely monitor top corporations).

 BUSINESS ETHICS:
Financial Markets and the Corporation

Since money can be raised easily from financial


markets thus:
What is the role of financial markets in
corporate finance?
 Cash flows to and from the firm (Ref: Fig)
 Primary vs. secondary markets
Primary Vs Secondary Markets
 Primary market: “Original sale of securities by
corporations and governments”
 Public Offerings (need to be registered with SEC).
 Private placements (involving a specific buyer).

 Secondary Market: “Market where securities are bought


and sold after the original sale”
 Dealer Market
 Auction Market.
Kinds of Secondary Markets
Dealer Market Auction Market.
• Buy and sell for • Buy and sell for others.
themselves. • It has a physical location.
• They own the commodity. • They do not own the
• Buying and selling is commodity.
done by dealer. • They match who wish to
sell with those who wish
to buy.
Questions …….!!!
Chapter 1 Quick Quiz
 Quick Quiz

 1. Who performs the financial management


function in the typical corporation?

 2. What are the major advantages and


disadvantages of the corporate form of
organization?
 3. Why is shareholder wealth maximization a
more appropriate goal than profit
maximization?

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