Lecture 1 - Introduction To Corporate Finance

CORPORATE FINANCE
(FIN 3354/4124/4134)
WEEK 1
INTRODUCTION TO CORPORATE
FINANCE
© LMS SEGi education group 1

LEARNING OBJECTIVES
 Understand the:
 Basic types of financial management decision
 The three types of firms
 Ownership versus control of corporations
 The goal of the firm
 Ethics and incentives within corporations
 The financial markets environment
 Financial institutions

LEARNING OUTCOMES
Upon completion of topic, student will be able:

 Understand the basic types of financial management
decisions.
 Understand the three types of firms
 Understand the rationale for separation of ownership
and control
 Understand how companies are controlled.
 Understand who determine the goal of the firm and the
issues relating to it.

 Understand the ethics and incentives within
corporations.
 Define and understand the financial markets
environment. © LMS SEGi education group 3

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?
Last Updated: © LMS SEGi education group 4

Wednesday, April 5, 2023
Balance Sheet Model of the Firm
TOTAL FIRM VALUE TO
TOTAL VALUE OF ASSET INVESTOR
Current
Current Asset Liabilities
Long term
Debt
Fixed Asset
Shareholder’s
• Tangible Equity
• Intangible

The Capital Budgeting Decision
TOTAL FIRM VALUE TO
Current
Long term
Debt
Fixed Asset
What long-term Shareholder’s
investments
• Tangible should the firm Equity
• Intangible choose?

The Capital Structure Decision
TOTAL FIRM VALUE TO
Current
How should the Long term

firm raise funds for
the selected Debt
Fixed Asset investments?
Shareholder’s
• Tangible Equity
• Intangible

Short-Term Asset Management
TOTAL FIRM VALUE TO
Current
Current Asset Working
Capital Liabilities
Long term
Debt
Fixed Asset
How should short-
term assets be
Shareholder’s
• Tangible managed and Equity
• Intangible financed?

THE FOUR TYPES OF FIRMS
TYPES OF
FIRMS
SOLE PARTNERSHIPS LIMITED

PROPRIETORSHIPS LIABILITY
COMPANIES OR
CORPORATIONS

SOLE PROPRIETORSHIPS
• Characteristics:
• Owned and run by one person
• Straightforward to set up
• No separation between the firm and the owner
• Only one owner
• Owner has unlimited personal liability for the firm’s
debts.
• Life limited to the life of the owner.

PARTNERSHIPS
• Has more than one owner.
• All partners have unlimited liability for the firm’s debt.
• Partnership ends on death or withdrawal of a partner
unless it provides for alternatives such as buyout of a

deceased or withdrawn partner.

ADVANTAGES AND DISADVANTAGES OF
PARTNERSHIPS
• Advantages
1. Low cost and ease of formation.
2. Not subject to corporate taxation but is taxed only as
part of the partners’ personal incomes.
• Disadvantages
1. Unlimited liability
2. Limited life
3. Difficulty in ownership transfer
4. Difficulty in raising large amounts of capital

LIMITED PARTNERSHIPS
• Due to unlimited liability, partners can establish limited

partnership to limit the liability of some partners.
• Certain partners general partners
• Other partners limited partners
• Limited partners are only liable only for the amount of
their investment in the partnership.
• General partners have unlimited liability.
• Limited partners no control and their returns
limited.

LIMITED PARTNERSHIPS
• Common in real estate, oil, equipment

leasing ventures and venture capital.
• However, not used in general business
situations because no one partner is
usually willing to be the general partner
and thus, accept the majority of the
business risk and none of the others are
willing to be limited partners and give up
all control.
LIMITED LIABILITY COMPANIES OR
CORPORATIONS
• The owners’ liabilities are limited to their own
investments only.
• 2 types : private and public companies.
Private limited companies

• Owners of private limited companies are not allowed
to trade their shares on an organised exchange.

• Known as Gesellschaft mit beschranker Haftung
(GmbH) in Germany, Societe a responsabilitire

(SARL) in France, Sendirian Berhad (Sdn Bhd) in
Malaysia, Privately Limited in UK (Pty.Ltd) and
Singapore (Pte. Ltd), Company Limited (Co. Ltd) or
Incorporated (Inc) in USA.
CORPORATIONS (CONT’D)
Public limited companies
• Allow their shares to be traded on an organised
exchange.
• Called public limited companies (PLCs),
Aktiengesellschaft (AG) in Germany, Societe

Anonyme (SA) in France, Sociedade Anonima (SA) in
Spain, publicly traded companies in United States,
Berhad (Bhd) in Malaysia.

• It is a legally defined, artificial being (a judicial person or
legal entity), separate from its owners.
• It can enter into contracts, acquire assets, incur
obligations and enjoys property rights protection.
• Solely responsible for its own obligations.
• The owners are not liable for any obligations the
corporation enters into.
• The corporation is not liable for any personal obligations
of its owners.
• There is no limit on the number of owners.

• Must be legally formed.
• More costly to be set up.
• A corporate charter needs to be created which includes
formal articles of incorporation and a set of bylaws.
• The ownership of a corporation divided into shares
• Collective share ownership equity.
• Investors shareholders, stockholders or equity
holders.
• There is no limitation on who can own its shares.
• Can raise capital by selling ownership shares to
anonymous outside investors.
• May be subject to double taxation
• Earnings of the limited liability companies
or corporations are taxed at the corporate
level.
• Earnings paid out as dividends are taxed
again as income to the shareholders.

OWNERSHIP VERSUS CONTROL OF
CORPORATIONS
• Many owners in corporations.
• Not feasible for the owners of a
corporation to have direct control of the
firm.
• Separation of ownership and control.
• Main control goes to the Board of
Directors (BODs) and the Chief Executive
Officer (CEO).

OWNERSHIP VERSUS CONTROL OF
CORPORATIONS
• Board of directors (BODs) have the
ultimate decision-making authority in the
corporation.
• The Chief Executive Officer (CEO) runs
the corporation by instituting the rules and
policies set by the BODs.
• The financial manager make
investment decisions, make financing
decisions and manage the firm’s cash
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flow. © LMS SEGi education group 21
THE GOAL OF THE FIRM
• In theory, the goal of the firm should be

determined by its owners.
• In organization forms with multiple owners,
the appropriate goal of the firm is not as
clear.
• Different owners have different goals.
• Managers (management) have different
goals.

THE GOAL OF THE FIRM
• Ideally, all shareholders will agree that

management should make decision to
maximize the value of their shares.

ETHICS AND INCENTIVES WITHIN
CORPORATIONS
• Even if all owners agree on the goals of
the corporation, these goals must be
implemented.
• How can the owners of a corporation
ensure that the management team will
implement their goals ?
• Typically, managers have little incentive to
work in the interests of shareholders.

ETHICS AND INCENTIVES WITHIN
CORPORATIONS
• This is called agency problem.
• This problem can be reduced by the
following :
1. Proper design of compensation contracts
for the management
2. Compensation incentives such as stocks
or stock options given to management.
3. The threat of a hostile takeover by
external investors who could replace the
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management at any time.
FINANCIAL MARKETS
• When businesses want to invest or raise

capital financial markets.

FINANCIAL MARKETS
FINANCIAL MARKETS
MONEY MARKET CAPITAL DERIVATIVES FOREIGN

Less than 1 year MARKET MARKET EXCHANGE
e.g. Treasury More than 1 e.g. options, MARKET
Bills year forwards and e.g. spot and
futures forward

FINANCIAL MARKETS
• Money market
1. Channel funds usually less than 1 year.
2. Dominated by major banks and other
financial institutions
3. Eg. Certificate of Deposits (CDs),
Commercial Papers, Repurchase
Agreements, Bankers’ Acceptances, etc.

FINANCIAL MARKETS
• Capital Market
1. Long-dated securities i.e. shares and
bonds (loan stocks)
2. For shares : E.g. Bursa Malaysia (Kuala
Lumpur Stock Exchange), Dow Jones,
NASDAQ, S&P 500.
3. For bonds : E.g. the Eurobond market.

FINANCIAL MARKETS
• Derivatives Market
1. Provide hedging and speculative
opportunities against shares, currencies
and interest rate movements.
• Foreign Exchange Market
1. Market for buying and selling one
currency against another.
2. Deals : Spot (current rate) or forward
basis (forward rate).
FINANCIAL MARKETS
• Financial markets provide access to

finance and financial instruments.
• E.g. capital markets function in two ways :
1. Primary market : provide new capital for
business or other activities in the form of
shares or bonds.
2. Secondary market : trade existing
securities, thus, provides liquidity to
investors.
FINANCIAL MARKETS
• Promote savings and investment by

providing mechanisms whereby the
financial requirements of lenders
(suppliers of funds) and borrowers (users
of funds) can be met.

SUPPLIERS OF FUNDS
Direct • Businesses Deposit and
Investment •Individuals investment
•Government
FINANCIAL Investment FINANCIAL

MARKETS INSTITUTIONS
• Money market • Banks
•Capital Market REAL •Pension funds
•Exchanges INVESTMENTS •Insurance
•Over-the-counter • Land companies
•Buildings •Finance companies
•Plant
•Stock
New issues and •Debtors
other financial Loans,
instruments overdrafts,
Users of funds
• Businesses mortgages,
• Individuals venture capital,
• Government leasing, etc.
FINANCIAL INSTITUTIONS
• Can provide capital to businesses.

• Intermediaries collecting funds from
savers to lend to their corporate and other
customers through the money and capital
markets, or directly through loans, leasing
and other forms of financing.

FINANCIAL INSTITUTIONS
Perform the following functions:

• Re-packaging, or pooling, finance
• Risk reduction
• Liquidity transformation
• Cost reduction
• Financial advice

REFERENCES
• Berk J. & DeMarzo, P. (2014) Corporate Finance, 3rd

edition, Pearson Education Limited.
• Brigham, E.F. & Ehrhardt, M.C. (2005). Financial
Management: Theory And Practice, 11th Edition,
Thomson South-Western.
• Pike, R., Neale, B., Linsley, P. (2012). Corporate Finance
And Investment : Decision and Strategies, 7th Edition,
Pearson Education Limited.

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CORPORATE FINANCE

© LMS SEGi education group 1

© LMS SEGi education group 2

Upon completion of topic, student will be able:

 Understand the rationale for separation of ownership

 Understand who determine the goal of the firm and the

issues relating to it.

environment. © LMS SEGi education group 3

Corporate Finance addresses the following

Last Updated: © LMS SEGi education group 4

Last Updated: © LMS SEGi education group 5

Last Updated: © LMS SEGi education group 6

How should the Long term

Last Updated: © LMS SEGi education group 7

Last Updated: © LMS SEGi education group 8

SOLE PARTNERSHIPS LIMITED

Last Updated: © LMS SEGi education group 9

• No separation between the firm and the owner

• Only one owner

• Owner has unlimited personal liability for the firm’s

Last Updated: © LMS SEGi education group 10

• All partners have unlimited liability for the firm’s debt.

• Partnership ends on death or withdrawal of a partner

unless it provides for alternatives such as buyout of a

Last Updated: © LMS SEGi education group 11

Last Updated: © LMS SEGi education group 12

• Due to unlimited liability, partners can establish limited

Last Updated: © LMS SEGi education group 13

• Common in real estate, oil, equipment

Private limited companies

to trade their shares on an organised exchange.

(GmbH) in Germany, Societe a responsabilitire

Aktiengesellschaft (AG) in Germany, Societe

Last Updated: © LMS SEGi education group 16

Last Updated: © LMS SEGi education group 17

Last Updated: © LMS SEGi education group 19

Last Updated: © LMS SEGi education group 20

• In theory, the goal of the firm should be

Last Updated: © LMS SEGi education group 22

• Ideally, all shareholders will agree that

Last Updated: © LMS SEGi education group 23

Last Updated: © LMS SEGi education group 24

• When businesses want to invest or raise

Last Updated: © LMS SEGi education group 26

MONEY MARKET CAPITAL DERIVATIVES FOREIGN

© LMS SEGi education group 27

Last Updated: © LMS SEGi education group 28

Last Updated: © LMS SEGi education group 29

• Financial markets provide access to

• Promote savings and investment by

Last Updated: © LMS SEGi education group 32

FINANCIAL Investment FINANCIAL

• Can provide capital to businesses.

Last Updated: © LMS SEGi education group 34

Perform the following functions:

Last Updated: © LMS SEGi education group 35

• Berk J. & DeMarzo, P. (2014) Corporate Finance, 3rd

© LMS SEGi education group 36

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