Chapter 1 Introduction To Corporate Finance Mc GrawHillIrwin

Chapter 1 • Introduction To Corporate Finance Mc. Graw-Hill/Irwin Copyright © 2006 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Chapter Outline • • • 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 1 -1

Finance • Corporate Finance: Managing a corporate’s cash flows • Investment: Securities’ cash flows • Financial institutions • Financial Derivatives: Financial products based the underlying asset such as stocks • Corporate Valuation: Valuation of corporate’s cash flows • International (Corporate) Finance: Corporate finance in global markets • Project finance 1 -2

Corporate Finance • Major financial issues or questions of financial managers (CFO) • What long-term investments should the firm take on? → Investment Issue (Capital budgeting) • Where will we get the long-term financing to pay for the investment? → (Capital structure) • Debt/Equity, Dividend policy • How will we manage the everyday financial activities of the firm? → Working capital management (Shortterm financing Issue) 1 -3

Financial Manager • Financial managers try to answer some or all of these questions • The top financial manager of a firm is usually called as the Chief Financial Officer (CFO) • Treasurer – oversees cash and credit management, capital expenditures and financial planning • Controller – oversees taxes, cost accounting, financial accounting and data processing 1 -4

Forms of Business Organization • Three major forms • Sole proprietorship • Partnership • General • Limited • Corporation • Limited liability company 1 -5

Sole Proprietorship • Advantages • Easiest to start • Least regulated • Single owner keeps all the profits • Taxed once as personal income • Disadvantages • Limited to life of an owner • Equity capital limited to a owner’s personal wealth • Unlimited liability • Difficult to sell ownership interest 1 -6

Partnership • Advantages • • Two or more owners More capital available Relatively easy to start Income taxed once as personal income • Disadvantages • General partnership • Unlimited liability • Limited partnership • General partner + Limited partner • Partnership can dissolve when one partner dies or wishes to sell. • Difficult to transfer ownership 1 -7

Corporation • Advantages • Limited liability • Unlimited life • Separation of ownership and management • Transfer of ownership is easy • Easier to raise capital • Disadvantages • Separation of ownership and management • Double taxation (income taxed at the corporate and then dividends taxed at the personal rate) 1 -8

Goal of Financial Management • What should be the goal of a corporation? • • • Maximize profit? Minimize costs? Maximize market share? Maximize the current value of the company’s stock? Maximize benefits of stakeholders such as equityholders, employees, suppliers and so on. • Does this mean we should do anything and everything to maximize owner wealth? 1 -9

The Agency Problem • Agency relationship • Principals (owners) hire 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 • Management goals and agency costs 1 -10

How to align managers’ Interests to stockholders’ ? • Board of Directors • 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. 1 -11

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! 1 -12

Financial Markets • Cash flows to the firm • Primary vs. secondary markets • auction markets vs. Dealer • Listed vs. over-the-counter securities • NYSE • NASDAQ 1 -13

Quick Quiz • What are three types of financial management decisions and what questions are they designed to answer? • What are 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? 1 -14

Chapter 1 • End of Chapter Mc. Graw-Hill/Irwin Copyright © 2006 by The Mc. Graw-Hill Companies, Inc. All rights reserved.