Download - Chapter 1 Corporate Finance
INTRODUCTION TO CORPORATE FINANCE
Chapter 1
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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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
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CHAPTER OUTLINE
1.1 What is Corporate Finance?1.2 The Corporate Firm1.3 The Importance of Cash Flows1.4 The Goal of Financial Management1.5 The Agency Problem and Control of the
Corporation1.6 Regulation
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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
BALANCE SHEET MODEL OF THE FIRM
Current Assets
Fixed Assets
1 Tangible
2 Intangible
Total Value of Assets:
Shareholders’ Equity
Current Liabilities
Long-Term Debt
Total Firm Value to Investors:
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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?
THE CAPITAL BUDGETING DECISION
Current Assets
Fixed Assets
1 Tangible
2 IntangibleShareholders’
Equity
Current Liabilities
Long-Term Debt
What long-term investments should the firm choose?
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THE CAPITAL STRUCTURE DECISION
How should the firm raise funds for the selected investments?
Current Assets
Fixed Assets
1 Tangible
2 IntangibleShareholders’
Equity
Current Liabilities
Long-Term Debt
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SHORT-TERM ASSET MANAGEMENT
How should short-term assets be managed and financed?
Net Working Capital
Shareholders’ Equity
Current Liabilities
Long-Term Debt
Current Assets
Fixed Assets
1 Tangible
2 Intangible
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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
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HYPOTHETICAL ORGANIZATION CHART
Chairman of the Board and Chief Executive Officer (CEO)
President and Chief Operating Officer (COO)
Vice President and Chief Financial Officer (CFO)
Treasurer Controller
Cash Manager
Capital Expenditures
Credit Manager
Financial Planning
Tax Manager
Financial Accounting
Cost Accounting
Data Processing
Board of Directors
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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.
FORMS OF BUSINESS ORGANIZATION
• The Sole Proprietorship• The Partnership• General Partnership• Limited Partnership• The Corporation
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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
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A GLOBAL PHENOMENON
• The corporate form of organization is not unique to the United States:
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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
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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.
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CASH FLOW ≠ ACCOUNTING INCOME
• Do not confuse cash flow and accounting income• Non-Cash expense example: Depreciation• Non-Cash revenue example: Sales on Account
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1.4 THE GOAL OF FINANCIAL MANAGEMENT
•What is the correct goal?• Maximize profit?• Minimize costs?• Maximize market share?• Maximize shareholder wealth?
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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
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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
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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
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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
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1.6 REGULATION
• The Securities Act of 1933 and the Securities Exchange Act of 1934 • Issuance of Securities (1933)• Creation of SEC and reporting requirements
(1934)• Sarbanes-Oxley Act of 2002 (“Sarbox”)• Increased reporting requirements and responsibility of
corporate directors• Personal consequences for non-compliance
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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?