Introduction to Corporate Finance
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Know the basic types of financial management
decisions and the role of the financial manager
 Know the financial implications of the various forms
of business organization
 Know the goal of the financial manager
 Understand the conflicts of interest that can arise
between owners and managers
 Understand the various regulations that firms face

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1.1 What is Corporate Finance?
1.2 The Corporate Firm
1.3 The Importance of Cash Flows
1.4 The Goal of Financial Management
1.5 The Agency Problem and Control of the Corporation
1.6 Regulation
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Corporate finance addresses the following three
questions:
1. In what long-lived assets should the firm invest?
2. How can the firm raise cash for required capital
expenditures?
3. How should short-term operating cash flows be
managed?
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Total Value of Assets:
Current Assets
Total Value of the Firm to Investors:
Current
Liabilities
Long-Term
Debt
Fixed Assets
1. Tangible
2. Intangible
Shareholders’
Equity
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Current
Liabilities
Current Assets
Long-Term
Debt
Fixed Assets
1. Tangible
2. Intangible
In what longterm assets
should the firm
invest?
Shareholders’
Equity
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Current
Liabilities
Current Assets
How should the
firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible
2 Intangible
Long-Term
Debt
Shareholders’
Equity
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Current Assets
Fixed Assets
1 Tangible
2 Intangible
Current
Liabilities
Net
Working
Capital
How should
short-term
operating cash
flows be
managed?
Long-Term
Debt
Shareholders’
Equity
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The financial manager’s primary goal is to increase the
value of the firm by:
1.
2.
Selecting value-creating projects
Making smart financing decisions
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Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
Vice President and
Chief Financial Officer (CFO)
Treasurer
Controller
Cash Manager
Credit Manager
Tax Manager
Cost Accounting
Manager
Capital Expenditures
Financial Planning
Financial Accounting
Manager
Information Systems
Manager
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

The 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.
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

The Sole Proprietorship
The Partnership
◦ General Partnership
◦ Limited Partnership

The Corporation
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Corporation
Partnership
Liquidity
Shares can be easily
exchanged
Subject to substantial
restrictions
Voting rights
Usually each share gets one
vote
General partner is in charge;
limited partners may have
some voting rights
Taxation
Double
Partners pay personal taxes
on partnership profits
Reinvestment and dividend
payout
Broad latitude
All net cash flow is
distributed to partners
Liability
Limited liability
General partners may have
unlimited liability; limited
partners enjoy limited
liability
Continuity
Perpetual life
Limited life
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Cash for securities issued by the firm (A)
Firm
Invests
invests
in
in assets
assets
(B)(B)
Current assets
Fixed assets
Financial
markets
Retained
cash flows (E)
Short-term debt
Cash flow
from firm (C)
Dividends and
debt payments (F)
Long-term debt
Taxes
Equity shares
Ultimately, the firm
must be a cashgenerating activity.
Government (D)
The cash flows from
the firm should exceed
the cash flows from
the financial markets.
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
What is the correct goal?
◦
◦
◦
◦
Maximize profit?
Minimize costs?
Maximize market share?
Maximize shareholder wealth?
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
Agency relationship
◦ Principal hires 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
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
Management goals may be different from shareholder
goals
◦ Expensive perquisites
◦ Survival
◦ Independence

Increased growth and size are not necessarily
equivalent to increased shareholder wealth
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
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

Other stakeholders
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
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
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

The Securities Contracts (Regulation) Act of 1956
and the Securities and Exchange Board of India
(SEBI) Act of 1992
SEBI Act Covers
◦ Issuance of Securities, corporate reporting, tender offers and
insider trading

Clause 49 (the Sarbanes-Oxley (“Sarbox” of India)
◦ Came into effect from 2005-06
◦ Quarterly reporting requirements to stock exchanges
◦ A separate section on corporate governance in the reports
These measures have increased the confidence of the public in
the financial markets.
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




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?
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