CHAPTER 1
Introduction to Financial
Management
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What is corporate finance?
Forms of Businesses
Goals of the Corporation
Conflicts Between Managers and
Shareholders
1-1
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Careers in Finance
Career
Commercial Banking
Loan Officer
Department Manager
Annual Salary
$ 90,000 +
$ 200,000 +
Corporate Finance
Financial Analyst
Credit Manager
Chief Financial Officer
$ 61-78,000
$ 73-92,000
$ 222-367,000
Investment Banking (bulge bracket)
First Year Analyst
First Year Associate
Assistant Vice President
Director/Principal
Managing Director/Partner
Department Head
$ 90-180,000
$ 200-350,000
$ 300-900,000
$ 500k - 2 mil
$ 600k - 30 mil
$ 1 mil - 70 mil
Money Management
Portfolio Manager
Bank Trust Department
$ 500,000 +
$ 60k - 150,000
Course Overview
Finance: what is it?
Corporate Finance
Corporations
Money and capital markets
Financial Markets:
Banks, Stock Exchanges
Investments
Investors
1-3
If you are an investor

In investments we seek to value
securities and maximize the value of
our portfolio (Valuation of bonds and
stocks).
1-4
If you are the CEO of an
industrial company

In corporate finance we are concerned
with making decisions that enhance firm
value.
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you can make your company more valuable by
choosing “better” projects (capital budgeting
decision)
you can make your company more valuable by
changing the mixture of your financing, i.e. the
ratio of debt to equity (capital structure
decision)
1-5
Financial decisions
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Capital budgeting decisions (how to invest money)
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Real capital investments/Intangible Assets
Mergers; acquisitions
Capital structure decisions (how to raise and return
money)
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Equity
Debt
Distribution (Dividend, share repurchase)
1-6
Balance-Sheet of the Firm
The Capital Budgeting Decision
Current
Liabilities
Current Assets
Long-Term
Debt
Fixed Assets
1 Tangible
2 Intangible
What long-term
investments
should the firm
engage in?
Shareholders’
Equity
1-7
Balance-Sheet of the Firm
The Capital Structure Decision
Current
Liabilities
Current Assets
Fixed Assets
1 Tangible
2 Intangible
How can the firm
raise the money
for the required
investments?
Long-Term
Debt
Shareholders’
Equity
1-8
Corporate finance: what is it?


A set of concepts, theories and
approaches that help the firm make
financial decisions.
Corporate finance boils down to the
investment and financing decisions
made by corporations.
The Role of The Financial Manager
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(2)
(1)
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Firm's
operations
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Real assets
Financial
Manager
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(3)
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(4a)
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(4b)
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(1) Cash raised from investors
(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
Investors
(debt&equity)

Financial
assets
FIN 351: course organization
FIN 351

Module 1
Module 2
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Fundamentals of valuation
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Fundamentals of PV
Financial decision
Interest rates
Perpetuities and
annuities calculation
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Valuing stocks
and bonds
NPV and other criteria
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Valuing risky investments
Risk and return
Module 3
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Corporate financial decisions
Portfolio theory
Diversification and covariance
Types of securities
Stocks, bonds and other
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Tangency portfolio, CAPM
risk and return
Module 4
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Market efficiency and options
Weak, semi-strong and
 strong form efficiency
Information and stock prices
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Modigliani-Miller theorems
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WACC and discount rate
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Course organization
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This course is broken-down into four
modules
Module 1: time value of money
Module 2: risk and return
Module 3: capital structure
Module 4: financial markets
Time value of money
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A basic building block
We will soon have the necessary skills
needed to value stocks and bonds
In this module, we don’t consider risk
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It is assumed that future cash flows are
riskless
It is assumed that the discount rate is
riskless
Risk and return
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This part teaches us about uncertainty
How do we measure risk?
How much is a risky cash flow in the
future worth (today)?
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conceptually more difficult
Financing decisions

If you are the CEO of an industrial
company


you can make your company more
valuable by choosing “better” projects
you can also make your company more
valuable by changing the mixture of your
financing (i.e. the ratio of debt to equity)
The efficiency of financial
markets

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We will look at how information gets
absorbed into security prices
We will learn three forms market
efficiency
We will examine the implication of
market efficiency on financing
Alternative Forms of Business
Organization
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Proprietorship
Partnership
Corporation
1-18
Proprietorships & Partnerships
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Advantages
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Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages
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Difficult to raise capital
Unlimited liability
Limited life
1-19
Corporation
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Advantages
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Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages
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Double taxation
Cost of set-up and report filing
1-20
Organizing a Business
Sole
Partnership
Proprietorship
Corporation
Who owns the
business?
The manager
Partners
Shareholders
Are managers
and owners
separate?
What is the
owner’s
liability?
Are the owner
& business
taxed
separately?
No
No
Usually
Unlimited
Unlimited
Limited
No
No
Yes

21
A Comparison of Partnership
and Corporations
Corporation
Partnership
Liquidity
Shares can easily be
exchanged.
Subject to substantial
restrictions.
Voting Rights
Usually each share gets
one vote
Taxation
Double
General Partner is in
charge; limited partners
may have some voting
rights.
Partners pay taxes on
distributions.
Formation
difficult
easy
Liability
Limited liability
Continuity
Perpetual life
General partners may
have unlimited liability.
Limited partners enjoy
limited liability.
Limited life
1-22
What should be the financial Goal
of a company?
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Maximizing revenue, cut cost, secure
market share?
The primary financial goal is
shareholder wealth maximization,
which (generally) translates to
maximizing stock price.
1-23
Is stock price maximization the
same as profit maximization?
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No, despite a generally high correlation
amongst stock price, EPS, and cash flow.
Some actions may cause an increase in
earnings, yet cause the stock price to
decrease (and vice versa). E.g., cut R&D.
1-24
Factors that affect stock price
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Projected cash
flows to
shareholders
Timing of the
cash flow stream
Riskiness of the
cash flows
1-25
Agency relationships
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An agency relationship exists whenever
a principal hires an agent to act on their
behalf.
Within a corporation, agency
relationships exist between:
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Shareholders and managers

Shareholders and creditors
1-26
Shareholders versus Managers
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Managers are naturally inclined to act in
their own best interests (Shirking,
empire building, corporate jets,
entrenchment).
To mitigate the problem:
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Bonus, stock options
Direct intervention by shareholders
The threat of firing
The threat of takeover
1-27
Shareholders versus Creditors
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Shareholders (through managers)
could take actions to maximize stock
price that are detrimental to creditors.
For example: taking too risky projects.
(Are you willing to lend money to
someone who gamble a lot?)
1-28
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When the outcome is very good,
shareholders enjoy the fruit.
When the outcome is bad, shareholders
are protected by limited liability. E.g.,
can get away by declaring bankruptcy.
1-29
1-30