BUSI 408: Corporate Finance
Chapter 1
Yunzhi Hu
UNC Chapel Hill
Kenan-Flagler Business School
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Chapter Outline
• 1.1 Finance: A Quick Look.
• 1.2 Business Finance and The Financial Manager.
• 1.3 Forms of Business Organization.
• 1.4 The Goal of Financial Management.
• 1.5 The Agency Problem and Control of the Corporation.
• 1.6 Financial Markets and the Corporation.
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Basic Areas of Finance
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1. Corporate finance = Business finance.
2. Investments.
3. Financial institutions.
4. International finance.
A new area: Fintech
• Return to
Quiz
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Investments
• Work with financial assets such as stocks and bonds.
• Value financial assets, risk versus return, and asset
allocation.
• Job opportunities.
– Stockbroker (executes trades for clients) or financial
advisor (gives out general and specific financial advice).
– Portfolio manager (manages money on behalf of
investors).
– Security analyst (researches companies, industries, and
macroeconomy).
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Financial Institutions
• Companies that specialize in financial matters.
– Banks—commercial and investment, credit unions, savings
and loans.
– Insurance companies.
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International Finance
• The international aspects of corporate finance, investments,
or financial institutions.
• Need to be familiar with exchange rates and political risk.
Fintech
• The combination of technology and finance
– A nascent area with strong growth
– Cryptocurrencies, Robo-advising, P2P lending, etc…
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Why Study Finance?
• Finance is useful for other fields
– Marketing: cost/benefit analysis on how to get the highest
payoff from marketing expenditures and programs. How to sell
financial products?
– Accounting: accountants are often required to make financial
decisions. How to read through financial statements?
– Management: business strategies often require financial
strategies.
– Personal Finance: budgeting, retirement planning, college
planning.
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Business Finance
• Business finance studies ways to answer three questions.
– Capital budgeting: what long-term investments should the firm
make?
– Capital structure: where will we get the long-term financing to
pay for the investments? Should we use debt or equity?
– Working capital management: how will we manage the
everyday financial activities of the firm? How much cash and
inventory should we keep? Should we sell on credit? How do
we obtain short-term financing?
▪ Working capital: a firm’s short-term assets, such as inventory,
minus short-term liabilities such as money owed to suppliers.
• Return to Quick
Quiz
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Financial Manager
• Financial managers try to answer some, or all, of these
questions.
• The top financial manager within a firm is usually the Chief
Financial Officer (CFO).
– Treasurer—oversees cash management, credit management,
capital expenditures, and financial planning.
– Controller—oversees taxes, cost accounting, financial
accounting, and data processing.
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Corporate Organization Chart Figure 1.1
• A simplified
organizational chart
• The exact titles and
organization differ from
company to company.
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Forms of Business Organization
• Three major forms in the United States.
• Sole proprietorship.
• Partnership.
– General.
– Limited.
• Corporation.
– S-Corp.
– Limited liability company.
• Return to Quick
Quiz
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Sole Proprietorship
• Business owned by one person
– The most common type of firm in the world
• Advantages.
– Easiest to start.
– Least regulated.
– Single owner keeps all of the
profits.
– Taxed once as personal
income.
• Disadvantages.
– Limited to life of owner.
– Equity capital limited to
owner’s personal wealth.
– Unlimited liability.
– Difficult to sell ownership
interest.
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Partnership
• Business owned by two or more persons
• Advantages.
–
–
–
–
Two or more owners.
More capital available.
Relatively easy to start.
Income taxed once as
personal income.
• Disadvantages.
• Unlimited liability.
– General partnership: all
partners share gains/ losses.
– Limited partnership. Limited
partners liabilities are limited to
the amount contributed.
• Partnership dissolves when one
partner dies or wishes to sell.
• Difficult to transfer ownership.
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Corporation
• A legal “person” distinct from owners and a resident of a
state
• Disadvantages.
• Advantages.
– Separation of ownership
– Limited liability.
and management
– Unlimited life.
(agency problem).
– Separation of ownership and
– Double taxation (income
management.
taxed at the corporate
– Transfer of ownership is
rate and then dividends
easy.
taxed at personal rate,
– Easier to raise capital.
while dividends paid are
not tax deductible).
Example 1.1 (1 of 2)
• Problem
– You are a shareholder in a corporation that has
income before taxes of $4 million.
– Once the firm has paid taxes, it will distribute the rest
of its earnings to its shareholders as a dividend.
– There are 1 million shares outstanding.
– Assume the corporate tax rate is 34%, and the
personal tax rate on dividend income is 20%.
– As a shareholder with 100 shares, how much will you
receive after all taxes are paid?
Example 1.1 (2 of 2)
• Solution
• First, the corporation must pay its taxes. It earned $4
million but must pay 34%  $4 million = $1.36 million in
corporate taxes.
• That leaves $2.64 million to distribute to shareholders.
Collectively, shareholders will have to pay 20%  $2.64
million = $528,000 in taxes on the dividends. This
leaves $2.64 million − $528,000 = $2,112,000 after all
taxes are paid.
• As the owner of 100 shares, you will have $211.20 after
both corporate and personal taxes are paid.
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Goal of Financial Management 1
• What should be the goal of a corporation?
– Maximize the market value of the existing owners’ equity.
▪ Ownership is divided into shares known as stocks
▪ Sum of all ownership is called equity
– Maximize the current value per share of the company’s
existing stock.
• Does this mean we should do anything and everything to
maximize owner wealth?
– Even if companies take illegal or unethical actions?
– No
– Other stakeholders: employees, customer, suppliers,
government
Return to Quick
– E (environmental) S (society) G (governance)
Quiz
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The Agency Problem
• Management controls the firm. Will management necessarily
act in the best interests of the stockholders?
• Agency relationship.
– Principal hires an agent to represent its interests.
– Stockholders hire managers to run the company.
• Agency problem.
– Conflict of interest between principal and agent.
• Management goals and agency costs.
– Managers may give up profitable but risky investments
because they worry about things turning bad.
• Return to Quick
– Empire building
Quiz
Do Managers Act in the Shareholders’
Interests?
• Managerial compensation.
– Incentives can be used to align management and stockholder
interests. Managers are compensated with stock options.
• Corporate control.
– Proxy fight: unhappy stockholders replace existing
management.
– Threat of a takeover may result in better management.
• Other stakeholders
– Employees, customer, suppliers, government
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Example: Work the Web
• The internet provides a wealth of information about
individual companies.
• finance.yahoo.com is an excellent site.
• Examples:
– Southwest Airlines (LUV).
– Harley-Davidson (HOG).
– American Express (AXP).
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Financial Markets
• In financial markets, securities such as debt and equity are
bought and sold between buyers and sellers.
• Primary versus secondary markets.
– Primary: corporations sell securities to investors
– Secondary: investors trade with each other
• Dealer versus auction markets.
– Dealers buy and sell for themselves.
– Auction matches sellers with buyers.
• Listed versus over-the-counter (OTC) securities.
– NYSE.
– Nasdaq.
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Cash Flows Between the Firm and the
Financial Markets
• Figure 1.2
• Cash flows
between the firm
and the financial
markets
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Quick Quiz
• What are the four basic areas of finance? (Slide 1.3).
• What are the three types of financial management decisions,
and what questions are they designed to answer? (Slide
1.9).
• What are the three major forms of business organization?
(Slide 1.12).
• What is the goal of financial management? (Slide 1.16).
• What are agency problems, and why do they exist within a
corporation? (Slide 1.18).