CHAPTER 1
I N T R O D U C T I O N TO C O R P O R AT E F I N A N C E
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
3-1
1-1
KEY CONCEPTS AND SKILLS
• Know the three main concerns of corporate
financial management
• Grasp the goal of financial management
• Enumerate the financial benefits and drawbacks
of differing forms of business organization
• Understand the conflicts of interest that can arise
between owners and managers
• Comprehend that corporate organizations are
enhanced by financial markets
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-2
CHAPTER OUTLINE
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
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-3
1.1 WHAT IS CORPORATE FINANCE?
• Economic resources are required to establish and
maintain a firm:
• Funds enable materials and processes for delivering
salable goods and services
• Funds are essential for assembling a workforce
• Funds are required to purchase long-lived assets such as
equipment and buildings
• The Balance Sheet offers insight into the array of
decisions, activities and objectives of the
Financial Manager
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-4
BALANCE SHEET MODEL
OF THE FIRM
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-5
THE BALANCE SHEET REVEALS…
…the top three concerns of corporate finance:
1. What long-term investments should the firm
choose?
2. How should the firm raise funds for the
selected investments?
3. How should current assets be managed and
financed?
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-6
THE CAPITAL BUDGETING
DECISION
What long-term
investments
should the firm
choose?
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-7
THE CAPITAL STRUCTURE
DECISION
How should the
firm raise funds
for the selected
investments?
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-8
SHORT-TERM ASSET MANAGEMENT
How should
short-term
assets be
managed and
financed?
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-9
THE FINANCIAL MANAGER
• The firm’s three main financial concerns are
usually handled by a top officer and aides:
• V.P. or Chief Financial Officer
• Strategist, coordinator, authority
•Treasurer
•
Cash flow, capital expenditures, capital structure
• Controller
• Accounting, information systems, taxes
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-10
HYPOTHETICAL ORGANIZATION
CHART
Chairman of
Vice President and
Chief Officer (CFO)
Financial Planning
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-11
1.2 THE CORPORATE FIRM
• First company problem: raise funds
• 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
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-12
FORMS OF BUSINESS
ORGANIZATION
• The Sole Proprietorship
• The Partnership
• General Partnership
• Limited Partnership
• The Corporation
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-13
A COMPARISON
Corporation
Partnership
Liquidity and
marketability
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 taxes on
distributions
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
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-14
A GLOBAL PHENOMENON
• The corporate form of organization is not unique
to the United States:
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-15
1.3 THE IMPORTANCE OF
CASH FLOWS
• If the firm is to prosper, it must:
• Buy assets that generate more cash than they cost
• Sell financial instruments that raise more cash than they
cost
• The successful firm generates more cash than it
uses
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-16
THE CONCEPTUAL FLOW OF CASH
Ultimately, the firm
must be a cash
generating activity.
The cash flows from
the firm must exceed
the cash flows from
the financial markets.
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-17
CASH FLOW ≠
ACCOUNTING INCOME
• Do not confuse cash flow and accounting income
• Non-Cash expense example: Depreciation
• Non-Cash revenue example: Sales on Account
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-18
1.4 THE GOAL OF FINANCIAL
MANAGEMENT
• What is the correct goal?
•
•
•
•
Maximize profit?
Minimize costs?
Maximize market share?
Maximize the value of shareholder equity?
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-19
1.5 THE AGENCY PROBLEM
• 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
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-20
AGENCY COST
• Cost of Conflict of Interest
• Example:
• Large investment positions firm for long term positive
cash flow but has risk in short run
• Owners want this investment – Increases firm value
• Managers object – Risk may have personal cost
• If managers prevail, foregone long term cash flow is the
Agency Cost
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-21
MANAGEMENT GOALS
• Management goals may be different from
shareholder goals
• Expensive perquisites
• Survival
• Independence
• Increased growth and size
• Often lead to management reward
• Not necessarily in best interest of shareholders
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-22
MANAGING MANAGERS
•
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
• Influence of other stakeholders
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-23
1.6 REGULATION
• Sarbanes-Oxley Act of 2002 (“Sarbox”)
• Increased reporting requirements and responsibility
of corporate directors
• Personal consequences for non-compliance
• The Securities Act of 1933 and the Securities
Exchange Act of 1934
• Issuance of Securities (1933)
• Creation of SEC and reporting requirements (1934)
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-24
QUICK QUIZ
• 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?
Copyright ©2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1-25