fcfchap001
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financeTRANSCRIPT
Chapter 1
Introduction to Corporate Finance
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Key Concepts and Skills
• Know the basic types of financial management decisions and the role of the financial manager
• Know the financial implications of the different forms of business organization
• Know the goal of financial management• Understand the conflicts of interest that can
arise between owners and managers• Understand the various types of financial
markets
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Chapter Outline
• Corporate Finance and the Financial Manager
• Forms of Business Organization• The Goal of Financial Management• The Agency Problem and Control of
the Corporation• Financial Markets and the
Corporation
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What Is Corporate Finance?
• Corporate finance provides answers to some important questions:– What long-term investments should the
firm take on?– Where will the firm get the long-term
financing to pay for the investments?– How will the firm manage its everyday
financial activities?
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The 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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Financial Management Decisions
• Capital budgeting– What long-term investments or projects
should the business take on?
• Capital structure– How much should the firm borrow to pay for
its assets?• What is the best mixture of debt and equity?• The least expensive sources of funds?
• Working capital management– How do we manage the day-to-day finances
of the firm?1-6
Forms of Business Organization
• Three major forms – Sole Proprietorship– Partnership
• General• Limited
– Corporation• Limited Liability Company• Limited Liability Partnerships
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Sole Proprietorship
• Advantages– Easiest to start– Least regulated– Single owner keeps
all 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
• Advantages– Two or more
owners– More capital
available– Relatively easy to
start– Income taxed once
as personal income
• Disadvantages– Unlimited liability
• General partnership
• Limited partnership
– Partnership dissolves when one partner dies or wishes to sell
– Difficult to transfer ownership
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Corporation
• Advantages– Limited liability– Unlimited life– Separation of
ownership and management
– Transfer of ownership is easy
– Easier to raise capital
• Disadvantages– Separation of
ownership and management
– May involve double taxation in some countries (income taxed at the corporate rate and then dividends taxed at the personal rate)
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Summary of 3 Business Forms
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Goal of Financial Management
• What should be the goal of a corporation?– Maximize profits?– Minimize costs?– Maximize market share?– Maximize the current value of the company’s
stock?
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Maximizing Shareholders’ Wealth
• Maximizing the share price is equivalent to maximizing shareholders’ wealth
• Why is this a valid goal?– Decisions are made in shareholders‘
best interest– Considers cash flows not profits– Incorporates time dimension– Does not consider profitability but also
risk
The Agency Problem
• Agency relationship– The relationship exists when a principal
hires an agent to represent his/her interests
– Stockholders (principals) hire managers (agents) to run the company
• Agency problem– Conflict of interest between principal and
agent• Agent may not work in the best interest of the
principal
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Management Goals
• Management goals may be different from shareholder s’ goals– Management may be more interested in:
• Consuming expensive perks• It’s own survival • It’s independence
• Management may focus on increased growth and size rather than increasing shareholders’ wealth
Agency Costs
• Costs due to the conflict of interest between shareholders and management– Direct
• Corporate expenditure that benefits management but costs shareholders, e.g. country club membership
• Costs to monitor management actions, e.g. auditor costs
– Indirect• Lost opportunity due to management forgoing
profitable but risky projects for fear of losing job if project fails
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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 goal
• Corporate control– The threat of a takeover may result in better
management
• Other stakeholders
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Work the Web Example
• The Internet provides a wealth of information about individual companies
• One excellent site is finance.yahoo.com• Click on the web surfer to go to the site,
choose a company and see what information you can find!
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Financial Markets
• Primary market– A market where the firm sells its
securities to public for the first time
• Secondary markets– A market in which the securities issued
by firms are traded• Listed securities trade in an organized
exchange, e.g. the stock market (NYSE)• Over-the-counter securities are bought from or
sold to a dealer
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Quick Quiz
• What are the three types of financial management decisions and what questions are they designed to 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 is the difference between a primary
market and a secondary market?
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Ethics Issues
• Is it ethical for tobacco companies to sell a product that is known to be addictive and a danger to the health of the user? Is it relevant that the product is legal?
• Should boards of directors consider only price when faced with a buyout offer?
• Is it ethical to concentrate only on shareholder wealth, or should stakeholders as a whole be considered?
• Should firms be penalized for attempting to improve returns by stifling competition (e.g., Microsoft)?
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End of Chapter
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