Introduction to
Corporate Finance
Corporate Finance and
the Financial Manager
Finance
 Finance consists of three interrelated areas:
 Money and capital markets
 Investments
 Corporate finance
Corporate Finance
 Three main areas of concern:
 What long-term investments should the firm take?
 Where will the firm get the long-term financing to pay
for its investments?
 How should the firm manage its everyday financial
activities?
Financial Management Decisions
 Capital budgeting
 Strategic long-term investment decision
 What long-term investments or projects should the firm take?
 Capital structure
 Strategic long-term financing decision
 How should the firm get the long-term financing to pay for its
investments?
 What is the mixture of a firm’s debt and equity financing?
 Working capital management
 Short-term financial planning and management
 How should the firm manage its everyday financial activities?
The Role of the Financial Manager
 Forecasting and planning
 Making major investments and financing decisions
 Capital budgeting
 Capital structure
 Working capital management
 Coordination and control
 Interaction with money and capital markets
 The primary task is to make decisions about sources and
uses of funds so as to maximize the value of the firm.
The Financial Managers
 The top financial manager in a firm is usually the Chief
Financial Officer (CFO)
 Treasurer – cash management, credit management, capital
expenditures, and financial planning, etc.
 Controller – taxes, cost accounting, financial accounting and
data processing, etc.
Which of the following questions are addressed by
financial managers?
 A. How should a product be marketed?
 B. Should customers be given 30 or 45 days to pay for
their credit purchases?
 C. Should the firm borrow more money?
 D. Should the firm acquire new equipment?
Which one of the following is a capital budgeting
decision?
 A. determining how many shares of stock to issue
 B. deciding whether or not to purchase a new machine
for the production line
 C. deciding how to refinance a debt issue that is
maturing
 D. determining how much inventory to keep on hand
 E. determining how much money should be kept in
the checking account
Forms of Business Organization
Forms of Business Organization
Sole
Proprietorship
Owner of the
business
Are managers
and owners
separate?
What is the
owner’s liability?
Are the owner
and business
taxed separately?
Partnership
Corporation
Forms of Business Organization
Sole
Proprietorship
How is it formed?
How about
raising large
sums of capital?
What is the life
of the business?
How about
transferring
ownership?
Partnership
Corporation
Forms of Business Organization
Sole
Proprietorship
Partnership
Corporation
Owner of the
business
One person
Two or more
partners
The
shareholders
Are managers
and owners
separate?
No
No
Yes
What is the
Unlimited
owner’s liability?
Unlimited
Limited
Are the owner
No
and business
taxed separately?
No
Yes
Forms of Business Organization
Sole
Proprietorship
Partnership
Corporation
How is it formed? Easy
Easy
Complex and
time-consuming
How about
raising large
sums of capital?
Difficult
Difficult
Easy
What is the life
of the business?
Limited
Limited
Unlimited
How about
transferring
ownership?
Difficult
Difficult
Easy
The Value of the Corporation
 The value of a business will probably be maximized if
it is organized as a corporation.
 Limited liability reduces the firm’s risk. The lower the
firm’s risk, the higher the value.
 A firm’s value depends on its growth opportunities. The
greater the ability to raise capital, the more its growth
opportunities.
 The value of the asset depends on its liquidity. The easier
the ability to sell the asset and convert it to cash, the
higher the value.
The Goal of Financial
Management
Possible Goals
 Maximize sales?
 Minimize costs?
 Maximize profits?
 Maximize growth?
 Maximize market share?
 Maximize stockholder wealth?
 Maximize stakeholder wealth?
Stakeholders and Their Goals
Stakeholder
Goal
Owners
Dividend or stock appreciation
Managers
High salary and perquisites
Creditors
Low risk and return of principal and
interest
Employees
High salary and job security
Customers
Low price and high quality
Suppliers
High price and long-term relationship
Government
Taxes
Society
Good citizenship
The Goal of Financial Management
 Modern Finance Theory usually assumes that the objective
of the firm is to maximize stockholder wealth.
 The goal of financial management in a for-profit business
is to make decisions that increase the value of the stock or
increase the market value of the equity.
 Is it good for other stakeholders of the company?
 Is it good for society?
 If the primary goal is appropriately defined, the other goals
which are not mutually exclusive can also be accomplished.
Agency Problem
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.
 Conflict of interest between stockholders and managers.
Agency costs
 The costs of the conflicts of interest between
stockholders and management.
 Direct agency costs
 Expenditures to monitor managerial actions.
 Expenditures that benefit the management but cost the
stockholders.
 Indirect agency costs
 Opportunity costs
Managing Managers
 Proper structuring of managerial incentives
 Managerial compensation
 Job prospects
 Control of the firm
 The threat of firing
 The threat of takeover
Financial Markets
Financial Markets
 The advantages of the corporate form are enhanced by
the existence of financial markets.
 Easy to transfer ownership
 Easy to raise large amounts of capital
 Functions
 Source of funding
 Investor liquidity
 Risk management
 Source of information
Primary vs. Secondary Markets
 Primary markets
 The original sale of securities
 Secondary markets
 The resale of securities after the original sale