FUNDAMENTALS OF
CORPORATE FINANCE
Fourth Canadian Edition
Stephen A. Ross
Randolph W. Westerfield
Bradford D. Jordan
Gordon S. Roberts
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copyright © 2002 McGraw-Hill Ryerson,Ltd.
The University of Lethbridge Faculty of Management
Management 3040Y - Finance
Terry D. Harbottle
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1999
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Outline of the Text
Part I:
Part II:
Part III:
Part IV:
Part V:
Part VI:
Part VII:
Part VIII:
Part IX:
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Overview of Corporate Finance
Financial Statements and Long-Term Financial
Planning
Valuation of Future Cash Flows
Capital Budgeting
Risk and Return
Cost of Capital and Long-Term Financial Policy
Short-Term Financial Planning and Management
Topics in Corporate Finance
Derivative Securities and Corporate Finance
copyright © 2002 McGraw-Hill Ryerson, Ltd.
Table of Contents
Chapter 1
Chapter 2
Chapter 3
Chapter 4
Chapter 5
Chapter 6
Chapter 7
Chapter 8
Chapter 9
Chapter 10
Chapter 11
Chapter 12
Chapter 13
Chapter 14
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Introduction to Corporate Finance
Financial Statements, Taxes, and Cash Flow
Working with Financial Statements
Long-Term Financial Planning and Corporate Growth
Introduction to Valuation: The Time Value of Money
Discounted Cash Flow Valuation
Interest Rates and Bond Valuation
Stock Valuation
Net Present Value and Other Investment Criteria
Making Capital Investment Decisions
Project Analysis and Evaluation
Some Lessons from Capital Market History
Return, Risk, and the Security Market Line
Cost of Capital
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Table of Contents (continued)
Chapter 15
Raising Capital
Chapter 16
Financial Leverage and Capital Structure Policy
Chapter 17
Dividends and Dividend Policy
Chapter 18
Short-Term Finance and Planning
Chapter 19
Cash and Liquidity Management
Chapter 20
Credit and Inventory Management
Chapter 21
International Corporate Finance
Chapter 22
Leasing
Chapter 23
Mergers and Acquisitions
Chapter 24
Risk Management: An Introduction to Financial
Engineering
Chapter 25
Options and Corporate Securities
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T1.1 Chapter Outline
Chapter 1
Introduction to Corporate Finance
Chapter Organization
 1.1 Corporate Finance and the Financial Manager
 1.2 Forms of Business Organization
 1.3 The Goal of Financial Management
 1.4 The Agency Problem and Control of the Corporation
 1.5 Financial Markets, Financial Insts, & the Corporation
 1.6 Trends in Financial Markets & Financial Mgmt.
 1.7 Outline of the Text
 1.8 Summary and Conclusions
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T1.2 The Four Basic Areas of Finance - Corporate Finance
Corporate Finance
 Long-term investments

Capital Budgeting
 Long-term financing

Capital Structure
 Short-term financing

Working Capital Management
 Financial Risk management

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Derivative securities
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Capital Budgeting
‘The Process of planning and managing a firm’s long term
investments’


evaluating the size, timing and risk of future cash flows are
the key components of capital budgeting
overall objective is to identify and invest in projects & assets
that will generate a return greater than the firm’s cost of
capital
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1999
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Cqpital Structure
‘addresses the the question of how a firm should obtain and
manage the long term financing needed to support its long
term investments and’


it is the specific mixture of long term debt and equity capital
the decision on how much debt vs. Equity impacts the risk
level for the firm and the firm’s
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1999
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Working Capital Management
Working capital refers to a firms short term assets and short
term liabilities


includes accounts receivable, inventory and accounts
payable
how much cash to keep on hand, inventory to carry, credit
terms to offer to customers are examples of working capital
management decisions
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Financial Risk Management
The process of identifying, quantifying and decisions to
manage certain types of risk:



currency risks
interest rate risks
commodity price risk
Other risks such as strategic, operating and commerical risks
need to be considered by the firm as a whole - ideally
looking at risk on an enterprise wide basis (holistic risk
management)
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1999
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T1.2 A Simplified Organizational Chart (Figure 1.1)
Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
President and Chief
Operations Officer (COO)
Vice President
Marketing
Controller
Treasurer
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1999
Vice President
Production
Vice President
Finance (CFO)
Cash Manager
Credit Manager
Tax Manager
Cost Accounting
Manager
Capital
Expenditures
Financial
Planning
Financial
Accounting
Manager
Data Processing
Manager
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Forms of Organization
 Sole Proprietorship
 Partnership
General Partnership / Limited Partnership
 Corporation
Limited Liability Company
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1999
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Corporations
A corporation is a legal entity separate and distinct from its
owners
 has many of the same rights, duties and privileges of an
actual person:



borrow money
can own property
can enter into contracts
 shareholders and management are usually separate in
most larger corporations


the sharedolders elect the board of directors
the board then selects the senior managers who in theory are
charged with running the affairs in the interests of the
shareholders
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Advantages/Dis-advantages of the Corporate Form
Advantages
 ownership (shares) can be readily transferrred
 life of the corporation is not limited
 limited liability makes this form attractive to investors
 all of the above make it easy to raise cash - sells new
stock
Dis-advantages
 double taxation of its profits
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The Goal of Financial Management
 What are firm decision-makers hired to do?
“General Motors is not in the business of making automobiles.
General Motors is in the business of making money.”
Alfred P. Sloan
 Possible goals
Maximize profits
Maximize shareholder wealth/value
Maximize share price
Maximize firm value
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The Agency Problem and Control of the Firm
 Agency Relationships and Management Goals

potential for conflict - is their too much emphasis on
corporate survival, job security and (more recently) with
mangement wealth creation?

Do managers Act in the Shareholders’ interests? They
are influenced by:
• how they are compensated - does their compensation
encourage them to make decisions that will enhance
shareholder value
• how easily are they replaced if they do not pursue
shareholder goals - control here is with the board of
directors
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T1.6 The Agency Problem Continued
Agency costs
Agency Costs - defined as the costs associated with the
conflict of interests :
Direct agency costs
Indirect agency costs
 Impact of Agency Costs on Shareholder Wealth or Value
 direct - expenditures benefiting Management e.g. the
unneeded corporate jet or
 direct - monitoring costs e.g. outside auditors
 indirect - lost opportunity where Management is not acting in
the best interests of its shareholders e.g. costly acquisitions
driven more by desire for power and prestige
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1999
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Conflict of Interest
 Will Managers work in the Shareholder’s best interest?

Mechanisms to ensure Managers are acting in
shareholders’ interest:
• managerial compensation
• active and knowledgable iboard of directors
• Active institutional investors
• Takeover activity
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1999
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T1.7 Financial Markets
Financial Institutions, Markets and the
Corporation
Financial Institutions
 Act as intermediaries between investors and firms
raising funds - banks, trust companies, investment
dealers, insurance companies, etc.

direct finance

indirect finance
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T1.7 Financial Markets Continued
Financial Markets - brings buyers and sellers
of debt and equity securities together
 How do financial markets differ?

Type of securities traded/how trading is conducted and
who the buyers and sellers are
 Money markets and capital markets

money market - short term debt securities

capital market - long term debt and equity
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T1.7 Financial Markets Continued
 Primary vs. secondary markets

Primary Market- where the original sale of issue of a
security by a government or corporation occurs
• public offering - underwritten by an investment
dealer and registered with provincial securities
commissions
• private placement - debt and equity sold directly to
a buyer - typically life insurance companies and ,
pension funds
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T1.7 Financial Markets Continued

Secondary Market - trading of securities subsequent to
the initial sale - enables the transfer of ownership
• auction market - TSE
• dealer market - ‘over the counter (OTC) ‘
 How do financial markets benefit society?
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Financial Markets and Society
 what is the benefit to society?






Channel savings into investment
produce and transmit information on returns and
risk
provide a media and a payments system
enable the shifting of the timing of consumption
over a life cycle
enable the management of risk
enable the diversification of portfolios
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1999
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T1.9
Financial Markets and the Corporation - Cash Flows Between the Firm and the Financial
Markets (Figure 1.2)
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1999
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T1.9 Chapter 1 Quick Quiz
Quick Quiz
1. Who performs the financial management function in
the typical corporation?
2. What are the major advantages and disadvantages of
the corporate form of organization?
3. Why is shareholder wealth maximization a more
appropriate goal than profit maximization?
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1999
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