Introduction to
Corporate Finance
Chapter 1
What is Corporate Finance?
Corporate Finance consists of the financial activities related to running a firm. It is
primarily concerned with maximizing shareholder value through financial planning
and strategy implementation (i.e. capital investments, financing, investment
banking, etc).
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Economic resources are required to establish and maintain a firm
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Funds enable materials and processes to deliver goods and services
Funds are essential for assembling a workforce
Funds are required to purchase assets, such as equipment and buildings
The Balance Sheet offers insight into the array of decisions, activities and
objectives of the Financial Manager
Concerning Corporate Finance
The top three concerns of corporate finance:
1. Capital Budgeting
a.
What long-term investments should the firm choose?
2. Capital Structure
a.
How should the firm raise funds for the selected investments?
3. Net Working Capital
a.
How should operating cash-flow be managed?
The Balance Sheet Model
Total Value of Assets
Total Firm Value to Investors
Current Liabilities
Current Assets
Long-Term Debt
Fixed Assets
(tangible + intangible)
Shareholders’ Equity
The Capital Budgeting Decision
Total Value of Assets
Total Firm Value to Investors
Current Liabilities
Current Assets
Long-Term Debt
Fixed Assets
(tangible + intangible)
What long-term
investments should
the firm choose?
Shareholders’ Equity
The Capital Structure Decision
Total Value of Assets
Total Firm Value to Investors
Current Liabilities
Current Assets
How should the
firm raise funds for
the selected
investments?
Fixed Assets
(tangible + intangible)
Long-Term Debt
Shareholders’ Equity
Net Working Capital
Total Value of Assets
Total Firm Value to Investors
Current Liabilities
Current Assets
NWC
Fixed Assets
(tangible + intangible)
Long-Term Debt
How should operating
cash-flow be managed?
Shareholders’ Equity
The Financial Manager
The Financial Manager’s primary goal is to increase the value of the firm.
1. Selecting value-creating projects
2. Making intelligent financing decisions
The Corporate Firm
The corporate form of a business is the standard method for solving the problems
associated with raising large amounts of cash.
Businesses can take other forms.
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Sole Proprietor
Partnership
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Limited
General
Corporation
Limited Liability Company*
The Importance of Cash Flow
The successful company generates more cash than it uses.
If a company is to be successful and prosper, it must:
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Purchase assets that generate more cash than they cost
Sell financial instruments that raise more cash than they cost
The Firm and the Financial Markets
Firm
Invests in Assets
(B)
Current Assets
Fixed Assets
Firm issues securities (A)
Financial Markets
Retained cash
flows (E)
Cash flow from
firm (C)
Dividends and
debt payments (F)
Short-Term Debt
Long-Term Debt
Equity Shares
Taxes 🙁
Total Value of Assets
Government
(D)
Total Firm Value to Investors
The Goal of Financial
Management is to...
Maximize
Shareholder Wealth
Shareholders
vs. Stakeholders
Does maximizing shareholder
wealth imply taking extreme
positions toward other
claimants?
No
Balancing Interests
Agency Relationship
The Agency
Problem
The Corporate structure is
characterized by the separation
of Ownership and Control
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Principal hires agent to
represent his/her interest
Stockholders (principals) hire
managers (agents) to run the
company
Agency Problem
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Conflict of interest between
principal and agent
The Agency Problem
Principals
Agents
Board of Directors
Vote
Stockholders
Hire
Cash
Stock ^
Dividend ^
Corporation
Run
Managers
Managing Managers
Managerial compensation
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Incentives can be used to align management and stockholder interests
The incentives need to be structured carefully in order to achieve their
intended goal
Corporate control
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The threat of a takeover may result in better management
Influence of other stakeholders
Regulation
The Securities Act of 1933 and the Securities Exchange Act of 1934
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Issuance of Securities (1933)
Creation of SEC and reporting requirements (1934)
Sarbanes-Oxley (“Sarbox”)
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Increased reporting requirements and responsibility
Personal consequences for non-compliance