Corporate Finance Professor Phil Holmes Email: P.R.Holmes@lubs.leeds.ac.uk An introduction to Corporate Finance 1 Finance Stories An initial public offering (IPO) occurs when a private company has its first public equity issue. For example, Apple was founded and owned as a private company by Steve Jobs and Steve Wozniak in 1976. 2 Finance Stories In 1980 Apple had an IPO raising funds and generating over $100 million. As a result, Apple had many owners and the company was listed on the stock exchange. But how can a company be valued for an IPO? 3 Finance Stories How are firms valued? How can firms be valued when they have no profits? The five lessons: • • • • • Don’t let a good story make you ignore valuation Beware expensive, cash-starved stocks Prize probability over possibility Beware IPOs Don’t rely on analysts 4 Finance Stories Snap share price since 2017 (above left) and over the year to 2 September 2022 (above right). Date: 2nd September 2022 5 Finance Stories FT 12th September 2019 6 Finance Stories FT 17th September 2019 30th September 2019 IPO postponed indefinitely 7 Finance Stories FT 16th September 2020 8 Corporate Finance And Value Creation: An Introduction Learning outcomes When we have finished this topic you should: • recognise the significance of financial decisions to business success • be familiar with the main types of questions we will be considering in the module and understand why these questions are important • be aware of the assumed single financial objective of the corporation • be familiar with the key sources of long-term funds • understand key differences between the main sources 9 Introduction • The material covered in this module is concerned with how financial decisions within companies are and should be taken. • It is also concerned with how the characteristics of financial markets affect that decision making process. 10 Examples of share price movements: Selected share price movements in 2020 – in the early days of the Covid pandemic 11 Key finance questions for a new business A person starting up and running a business must answer the following questions if they are to be successful: 1. What long-term investments should the business take on? 2. Where should the person raise the long-term funds to pay for the investment? 3. How should they manage their everyday financial activities? 4. Once the business is generating earnings, what should it do with excess earnings? 12 Key finance questions for a new business What long-term investments should the business take on? For example, if you need a computer system, how can you choose between the various alternative systems? 13 Key finance questions for a new business Where should the person raise the long-term funds to pay for the investment? There are essentially two sources of funds: Equity capital Debt capital 14 Key finance questions for a new business How should the company manage their everyday financial activities? This is a really important question and a business which does not have a good answer may well run into serious problems. See textbook by Hillier et al, Part 7. 15 Key finance questions for a business Once the business is generating earnings, what should it do with excess earnings? Should the company reinvest, pay off debt or make payments to equity holders? In the module we will be focussing on the three long-term questions, questions 1, 2 and 4 from the earlier slide. 16 The objective of a private sector business • In order to answer these and other “should” questions we need a benchmark or a system of values. • Managers should manage their firm’s resources with the objective of increasing the firm’s market value by as much as is possible. Note: the goal is NOT to maximise profits. • 17 Finance stories: More on the Snowflake IPO Source: CNBC.com 17/09/20 Source: FT.com 18/09/20 18 The Importance Of Financial Decisions • One of the first questions any new business will face is what assets must it buy. • Assets cost money. The business, therefore, requires funds in order to buy the assets. • The business will need an operating plan. • This will allow the business to know how much of each input is needed and when the inputs are needed. 19 The Importance Of Financial Decisions cont’d • Any operating plan for a business must have alongside it a financial plan which allows implementation of the proposed operational details. • The financial plan will say how much money is needed and when the money is needed. • The financial plan should consider separately short term and long term needs for funds. 20 Sources Of Long-term Funds Essentially, there are two main sources of long-term capital: Capital provided by the owners of the firm is known as equity capital. Funds from borrowing are known as debt capital. 21 Sources Of Long-term Funds: Equity capital The holders of equity capital own the company Each share represents a share of ownership and entitles the holder to a share of any profits Shares can be bought and sold on either the primary market or the secondary market Equity holders have a residual claim Equity capital represents the risk capital of the company 22 Sources Of Long-term Funds: Debt capital Debt capital is also known as loan stock, bonds and debentures Debt capital can also be bought and sold on either the primary market or the secondary market While equity holders have a residual claim, debt holders have a prior claim on the assets of the company 23 Sources Of Long-term Funds: Debt capital cont’d Debtholders can force the company into bankruptcy if payments are not made For the provider of funds, debt capital is less risky than equity capital and so requires a lower rate of return Debt interest payments are often tax deductible Since owners are concerned about after tax income, lowering the tax to be paid can be beneficial 24 Summary An overview of key questions in corporate finance has been provided. We have considered some share price patterns to illustrate the valuation issue. We have considered should questions in corporate finance. We have identified the key objective for financial managers in corporations. We have discussed key features of sources of long term funds. 25 Reading Hillier et al: Chapters 1 and 14 26
