Fin440 Chapter 1

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Introduction To Corporate Finance
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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 different
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
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Chapter 1: Outline
 What is Finance?
 Corporate Finance and the Financial
Manager
 Forms of Business Organization
 The Goal of Financial Management
 The Agency Problem and Control of the
Corporation
 Financial Markets and the Corporation
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What is Finance?
 The art and science of managing money.
Acct. Finance Econ.
Math
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Corporate Finance
 Some important questions that are
answered using finance
 What long-term investments should the firm
take on?
 Where will we get the long-term financing to
pay for the investment?
 How will we manage the everyday financial
activities of the firm?
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Corporate Finance
 Corporate Finance, broadly speaking, is the
study of ways to answer these three
questions.
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Financial Manager
 Financial managers try to answer some or all of
these questions
 The top financial manager within a firm is usually
the Chief Financial Officer (CFO)
 Treasurer – oversees cash management, credit
management, capital expenditures, and financial
planning
 Controller – oversees taxes, cost accounting, financial
accounting and data processing
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Financial Management
Decisions
 Capital budgeting
 What long-term investments or projects should
the business take on?
 The process of planning and managing a
firm’s investments in fixed assets.
 The key concerns are the size, timing and
riskiness of future cash flows.
 To identify investment opportunities that are
worth more to the firm than they cost to
acquire.
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Decisions
 Capital structure
 How should we pay for our assets?
 Mix of debt (borrowing) and equity (ownership
interest) used by a firm.
 What are the least expensive sources of
funds?
 Is there an optimal mix of debt and equity?
 When and where should the firm raise funds?
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Decisions
 Working capital management
 How do we manage the day-to-day finances of
the firm?
 Managing short-term assets and liabilities.
 How much inventory should the firm carry?
 What credit policy is best?
 Where will we get our short-term loans?
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Forms of Business Organization
 Three major forms in the United States
 Sole proprietorship
 Partnership
• General
• Limited
 Corporation
• S-Corp
• Limited liability company
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Sole Proprietorship
 Advantages  Disadvantages
 Easiest to start  Limited to life of owner
 Least regulated  Equity capital limited to
 Single owner keeps all owner’s personal
the profits wealth
 Taxed once as  Unlimited liability
personal income  Difficult to sell
ownership interest
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Partnership
 Two or more owners  Unlimited liability
 More capital available  Limited Life
 Relatively easy to start  Partnership dissolves
 Income taxed once as when one partner dies
personal income or wishes to sell
 Difficult to transfer
ownership
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Corporation
 Limited liability  Separation of
 Unlimited life ownership and
 Separation of management
ownership and  Double taxation
management (income taxed at the
 Transfer of ownership corporate rate and then
is easy dividends taxed at the
personal rate)
 Easier to raise capital
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Goal Of Financial Management
 What should be the goal of a corporation?
 To survive?
 Avoid financial distress and bankruptcy?
 Beat the competition?
 Maximize profit?
 Minimize costs?
 Maximize sales or market share?
 Maintain steady earnings growth?
 Does this mean we should do anything and
everything to maximize owner wealth?
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Goal Of Financial Management
 To maximize the current value per share of the
existing stock.
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The Agency Problem
 Agency relationship
 Principal hires an agent to represent his/her interests
 Stockholders (principals) hire managers (agents) to run
the company
 Agency problem
 Conflict of interest between principal and agent
 Management goals and agency costs
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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
 Other stakeholders
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Work the Web Example
 The Internet provides a wealth of information about
individual companies
 One excellent site is finance.yahoo.com
 Click on the web surfer to go to the site, choose a
company and see what information you can find!
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Financial Markets
 Cash flows to the firm
 A. Firm issues securities to raise cash.
 B. Firm invests in assets.
 C. Firm’s operations generate cash flow.
 D. Cash is paid out to govt. as taxes.
 E. Cash reinvested in the firm.
 F. Dividends and debt payments are made.
 Primary vs. secondary markets
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End of Chapter
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Introduction To Corporate Finance

Acct. Finance Econ.

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