Introduction to Corporate FinanceChapter 1Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin qKnow the three main concerns of corporate financial managementqGrasp the goal of financial managementqEnumerate the financial benefits and drawbacks of differing forms of business organizationqUnderstand the conflicts of interest that can arise between owners and managersqComprehend that corporate organizations are enhanced by financial marketsKey Concepts and SkillsKey Concepts and Skills1-1 1.1 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 RegulationChapter OutlineChapter Outline1-2 Economic resources are required to establish and maintain a firm:◦Funds enable materials and processes for delivering salable goods and services◦Funds are essential for assembling a workforce◦Funds are required to purchase long-lived assets such as equipment and buildingsThe Balance Sheet offers insight into the array of decisions, activities and objectives of the Financial Manager1.1 What Is Corporate Finance?1.1 What Is Corporate Finance?1-3 1-4Balance Sheet Model of the FirmBalance Sheet Model of the FirmCurrent AssetsFixed Assets1 Tangible 2 IntangibleTotal Value of Assets:Shareholders’ EquityCurrent LiabilitiesLong-Term DebtTotal Firm Value to Investors:4 …the top three concerns of corporate finance:1.What long-term investments should the firm choose?2.How should the firm raise funds for the selected investments?3.How should current assets be managed and financed?The Balance Sheet Reveals…The Balance Sheet Reveals…1-5 1-6The Capital Budgeting DecisionThe Capital Budgeting DecisionCurrent AssetsFixed Assets1 Tangible 2 IntangibleShareholders’ EquityCurrent LiabilitiesLong-Term DebtWhat long-term investments should the firm choose?6 1-7The Capital Structure DecisionThe Capital Structure DecisionHow should the firm raise funds for the selected investments?Current AssetsFixed Assets1 Tangible 2 IntangibleShareholders’ EquityCurrent LiabilitiesLong-Term Debt7 1-8Short-Term Asset ManagementShort-Term Asset ManagementHow should short-term assets be managed and financed?Net Working CapitalShareholders’ EquityCurrent LiabilitiesLong-Term DebtCurrent AssetsFixed Assets1 Tangible 2 Intangible8 The firm’s 3 main financial concerns are usually handled by a top officer and aides:◦ V.P. or Chief Financial Officer Strategist, coordinator, authority◦Treasurer Cash flow, capital expenditure, capital structure◦ Controller Accounting, information systems, taxesThe Financial ManagerThe Financial Manager1-9 Hypothetical Organization ChartHypothetical Organization ChartChairman of the Board and Chief Executive Officer (CEO)President and Chief Operating Officer (COO)Vice President and Chief Financial Officer (CFO)TreasurerControllerCash ManagerCapital ExpendituresCredit ManagerFinancial PlanningTax ManagerFinancial AccountingCost Accounting Data Processing Board of Directors1-10 First company problem: raise fundsThe 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.1.2 The Corporate Firm1.2 The Corporate Firm1-11 1-12Forms of Business OrganizationForms of Business OrganizationThe Sole ProprietorshipThe Partnership◦General Partnership◦Limited PartnershipThe Corporation12 1-13A ComparisonA Comparison CorporationPartnershipLiquidity and marketabilityShares can be easily exchangedSubject to substantial restrictionsVoting RightsUsually each share gets one voteGeneral Partner is in charge; limited partners may have some voting rightsTaxationDoublePartners pay taxes on distributionsReinvestment and dividend payoutBroad latitudeAll net cash flow is distributed to partnersLiabilityLimited liabilityGeneral partners may have unlimited liability; limited partners enjoy limited liabilityContinuity Perpetual lifeLimited life13 The corporate form of organization is not unique to the United States:A Global PhenomenonA Global Phenomenon1-14 If the firm is to prosper, it must:◦Buy assets that generate more cash than they cost◦Sell financial instruments that raise more cash than they costThe successful firm generates more cash than it uses1.3 The Importance of Cash Flow1.3 The Importance of Cash Flow1-15 Cash flowfrom firm (C)The Conceptual Flow of CashThe Conceptual Flow of CashTaxes (D)GovernmentRetained cash flows (F)Investsin assets(B)Dividends anddebt payments (E)Current assetsFixed 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.FirmFirm issues securities (A)FinancialmarketsPlease substitute Figure 1.3 from Text1-16 Do not confuse cash flow and accounting income◦Non-Cash expense example: Depreciation◦Non-Cash revenue example: Sales on AccountCash Flow ≠ Accounting IncomeCash Flow ≠ Accounting Income1-17 What is the correct goal?◦Maximize profit?◦Minimize costs?◦Maximize market share?◦Maximize shareholder wealth?Maximize shareholder wealth?1.4 The Goal of Financial 1.4 The Goal of Financial ManagementManagement1-18 Agency relationship◦Principal hires an agent to represent his/her interest◦Stockholders (principals) hire managers (agents) to run the companyAgency problem◦Conflict of interest between principal and agent1.5 The Agency Problem1.5 The Agency Problem1-19 Cost of Conflict of InterestExample:◦Large investment positions firm for long term positive cash flow but has risk in short runOwners want this investment – Increases firm valueManagers object – Risk may have personal cost◦If managers prevail, foregone long term cash flow is the Agency CostAgency CostAgency Cost1-20 Managerial goals may be different from shareholder goals◦Expensive perquisites◦Survival◦IndependenceIncreased growth and size ◦Often lead to management reward◦Not necessarily in best interest of shareholdersManagerial GoalsManagerial Goals1-21 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 Influence of other stakeholdersManaging ManagersManaging Managers1-22 The Securities Act of 1933 and the Securities Exchange Act of 1934 ◦Issuance of Securities (1933)◦Creation of SEC and reporting requirements (1934)Sarbanes-Oxley (“Sarbox”)◦Increased reporting requirements and responsibility of corporate directors◦Personal consequences for non-compliance1.6 Regulation1.6 Regulation1-23 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 major regulations impact public firms?Quick QuizQuick Quiz1-24 。
