Business Finance
Introduction
Chapter 1. Introduction to Corporate Finance
Note: These lecture notes summarize the in-class presentation by the instructor and the online video lectures
covered in this week. Reading these notes alone does not guarantee understanding everything discussed or
required by the course.
Disclaimer: These notes have not been subjected to the usual scrutiny reserved for formal publications.
They may be distributed outside this class only with the permission of the Instructor.
1
What is finance?
There is a broad definition and a narrow one. Finance classes basically focus on the narrow definition.
1.1
Broad Definition
Finance broadly defined as:
ˆ Identifying what you need to buy;
ˆ Where you are going to get the money to buy it;
ˆ How to manage those things once they’re inside the company
1.2
Narrow Definition
Item 2 in the above list. Involves two parties and a middleman:
ˆ The company: How to get the money? Borrow it? Seek it from investors?
ˆ The investor: Which company to invest?
ˆ Financial institutions: match the two parties together.
1.3
The Four Basic Area
ˆ Corporate finance (= business finance = financial management) : focus of this course
ˆ Investments
– Value of financial assets, risk vs. return, and asset allocation
– Job opportunities: Stockbroker or financial advisor / Portfolio manager / Security analyst
ˆ Financial institutions
1-1
1-2
Lecture 1:
– Banks, insurance companies, brokerage firms
ˆ International finance
– May allow you to work in other countries or travel
– Need to be familiar with exchange rates and political risk
– Need to understand the languages and customs of other countries
ˆ Relationship between the four areas:
2
Business Finance
2.1
What is business finance?
The process of making a company more valuable in the long-run. Focuses on 3 questions:
ˆ What should we invest in? (Capital budgeting)
ˆ How do we finance those investments? (Capital structure)
ˆ How do we manage the day-to-day operations of the firm? (Working capital management)
2.2
The role of the financial manager
The chief financial officer (CFO) or vice president of finance. CFO coordinates the activities of
ˆ the treasure: oversees cash management, credit management, capital expenditures, and financial planning
ˆ the controller: oversees taxes, cost accounting, financial accounting, and data processing
2.3
Financial management decisions
The chief financial officer (CFO) concerned with 3 types of questions
ˆ Capital budgeting: planning and managing a firm’s long-term investments.
ˆ Capital structure: the mixture of debt and equity maintained by a firm.
ˆ Working capital management: managing a firm’s short-term assets, such as inventory, and its shortterm liabilities, such as money owed to suppliers.
Lecture 1:
3
Forms of Business Organization
3.1
Sole Proprietorship (one owner)
1-3
Pros:
ˆ Easy startup.
ˆ Taxed as personal income.
Cons:
ˆ Unlimited liability.
ˆ Life limited to that of owner.
ˆ Equity limited to owner’s wealth.
ˆ Difficulty in transferring ownership.
3.2
Partnership (two or more owner)
General vs. Limited Partners
ˆ General partnership: all partners share in gains or losses, and all have unlimited liability for debts
ˆ Limited partnership: one or more general partners will run the business and have unlimited liability,
but there will be one or more limited partners (silent partners)
Pros:
ˆ Easy startup.
ˆ Taxed as personal income.
Cons:
ˆ Unlimited liability
ˆ Life limited to that of the owners.
ˆ Equity limited to owners’ combined wealth.
ˆ Difficulty in transferring ownership.
1-4
Lecture 1:
3.3
Corporation
A business created as a distinct legal entity composed of one or more individuals or entities.
Separation of Ownership and Control
ˆ Shareholders
ˆ Directors
ˆ Managers
Pros:
ˆ Separation of ownership and management.
ˆ Easy transfer of ownership.
ˆ Unlimited life.
ˆ Limited liability for corporate debts.
ˆ Equity is not limited, easy to raise capital by selling new shares.
Cons:
ˆ Difficult to startup.
ˆ Corporation profits are taxed twice (double taxation).
4
The Goal of Financial Management
4.1
In a corporation
ˆ The goal of financial management is to maximize the current value per share of the existing stock.
4.2
A more general goal
ˆ Maximize the market value of the existing owners’ equity.
4.3
Sarbanes-Oxley Act, a.k.a. “Sarbox”
ˆ To strengthen protection against corporate accounting fraud and financial malpractice
ˆ Contains a number of requirements designed to ensure that companies tell the truth in their financial
statements.
Lecture 1:
5
Financial Markets
5.1
Cash Flows to and from the Firm
Figure 1.2 of the textbook
5.2
Primary vs Secondary Market
ˆ Transactions in the primary markets
– Public offering: selling securities to the general public
– Private placement: negotiated sale involving a specific buyer
ˆ Secondary market transactions involves one owner or creditor selling to another
1-5