Chapter 1
What is Corporate Finance?
Corporate Finance deals with the following questions
What long-term investments should be undertaken
(Capital Budgeting)?
building,
machinery
equipment
Where will you get the long-term financing to invest
(Capital Structure)?
Bring other owners (issue equity/stocks)
Borrow (issue debt/bonds)
How will you manage the company’s short-term cash flow (Working
Capital Management)?
Collecting from customers
paying suppliers
Jacoby, Stangeland and Wajeeh, 2000
1
The Balance-Sheet Model
ASSETS
Current Assets
Fixed Assets
Tangible
Intangible
LIABILITIES
Current Liabilities
Long-Term Debt
Shareholders’ Equity
Jacoby, Stangeland and Wajeeh, 2000
2
The Balance-Sheet Model
ASSETS
LIABILITIES
Net Working Capital
Long-Term Debt
Fixed Assets
Tangible
Intangible
Shareholders’ Equity
Jacoby, Stangeland and Wajeeh, 2000
3
Forms of Business Organization
The Sole Proprietorship
Formed by a single individual
 Simplest and least regulated
 Owner keeps all profits and pays taxes as personal income
 Owner has an unlimited liability
 Cease to exist once the owner dies or withdraws
 Cannot raise equity beyond the owner’s wealth (limits growth)
Jacoby, Stangeland and Wajeeh, 2000
4
Forms of Business Organization
The Partnership
Formed by 2 or more individuals/legal entities
General Partnership
An agreement b/w partners to provide work/cash and share
profits/losses
Unlimited liability
Limited Partnership
Limited liability for some partners (not involved in
management)
Simple and easy to form
Owners pay taxes as personal income
Cease to exist once a general partner dies or withdraws
difficult to raise equity
Jacoby, Stangeland and Wajeeh, 2000
5
Forms of Business Organization
The Corporation
A distinct legal entity owned by one or more individuals/legal
entities
More complicated (articles of incorporation, bylaws)
Liquidity and marketability of ownership
Control (shareholders, directors, managers)
Limited liability
Continuity of Existence
Double taxation
Jacoby, Stangeland and Wajeeh, 2000
6
Goals of the Corporate Firm
The Agency Problem
Goal of the shareholders (principals)
Maximize the shareholders’ wealth
Goal of the managers (agents)
Maximize the corporate wealth
Jacoby, Stangeland and Wajeeh, 2000
7
Separation of Ownership and Control
Board of Directors
Assets
Shareholders
Debt
Debtholders
Management
Equity
Jacoby, Stangeland and Wajeeh, 2000
8
Shareholders’ Control Devices
Shareholders elect the board of directors, who hire/fire the
management
Management compensation plans
The takeover threat
Competition in the managers job market
Shareholders Ability to Control the Firm Depends on
Monitoring costs
Costs of applying control devices
Benefits of controls
Agency Costs
Jacoby, Stangeland and Wajeeh, 2000
9
Financial Markets and the Corporation
Money Markets
For short-term debt instruments
Capital Markets
For long-term debt and equity
Primary Markets
Original sale of securities by gov’t and corporations, via
public offerings
requires registration with the OSC with proper disclosure
involve considerable accounting, legal, and selling costs
private placements
avoid regulation and costs
Secondary Markets
Where securities are bought/sold after original sale. 2 types:
Dealer markets (OTC) - no physical location
Auction Markets (TSE, MSE, VSE)
Jacoby, Stangeland and Wajeeh, 2000
10