Introduction to Corporate Finance

Chapter 1

Introduction to Corporate FinanceCopyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinKey Concepts and SkillsKnow the basic types of financial management decisions and the role of the financial managerKnow the financial implications of the different forms of business organizationKnow the goal of financial managementUnderstand the conflicts of interest that can arise between owners and managersUnderstand the various types of financial markets1-#Why is Finance Important?Permeates all aspects of the businessHow?

1-#Corporate FinanceSome important questions that are answered using finance:What long-term investments should the firm take on?Where will we get the long-term financing to pay for the investment?How will we manage the everyday financial activities of the firm?1-#1.4Financial ManagerFinancial managers try to answer some or all of these questionsThe top financial manager within a firm is usually the Chief Financial Officer (CFO)Treasurer oversees cash management, credit management, capital expenditures, and financial planning (mostly forward-looking)Controller oversees taxes, cost accounting, financial accounting and data processing (mostly compiling historical results)1-#1.5Financial Management DecisionsCapital budgetingWhat long-term investments or projects should the business take on?Capital structureHow should we pay for our assets?Should we use debt or equity?Working capital managementHow do we manage the day-to-day finances of the firm?1-#1.6Forms of Business OrganizationThree major forms in the United StatesSole ProprietorshipPartnershipGeneralLimitedCorporationsC-corpS-corpLimited Liability Company1-#1.7Sole ProprietorshipAdvantagesEasiest to startLeast regulatedSingle owner keeps all the profitsTaxed once as personal incomeDisadvantagesLimited to life of ownerEquity capital limited to owners personal wealthUnlimited liabilityDifficult to sell ownership interest1-#1.8PartnershipAdvantagesTwo or more ownersMore capital availableRelatively easy to startIncome taxed once as personal incomeDisadvantagesUnlimited liabilityGeneral partnershipJoint and several liabilityLimited partnership provides limited liabilityPartnership dissolves when one partner dies or wishes to sellDifficult to transfer ownership1-#1.9CorporationsAdvantagesLimited liabilityUnlimited lifeSeparation of ownership and managementTransfer of ownership is easyEasier to raise capitalDisadvantagesDouble taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)Exception: LLCs and S-corp, but there are size restrictions1-#1.10Goal of Financial ManagementWhat should be the goal of a corporation?Maximize profit?Minimize costs?Maximize market share?Maximize revenue?Maximize employee wealth?Maximize the current value of the companys stock?Does this mean we should do anything and everything to maximize owner wealth?1-#1.11The Agency ProblemAgency relationshipPrincipal hires an agent to represent his/her interestsStockholders (principals) hire managers (agents) to run the companyAgency problemConflict of interest between principal and agentManagement goals and agency costs1-#1.12Managing ManagersManagerial compensationIncentives can be used to align management and stockholder interestsThe incentives need to be structured carefully to make sure that they achieve their goalCorporate controlThe threat of a takeover may result in better managementOther stakeholders1-#1.13Financial MarketsCash flows to and from the firmThe right-hand side of the balance sheetPrimary vs. secondary marketsDealer vs. auction marketsListed vs. over-the-counter securitiesNYSENASDAQ1-#1.14Ethical IssuesEXTREMELY IMPORTANT IN FINANCE!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)?1-#1.15Quick QuizWhat are the three major forms of business organization? What are the advantages and disadvantages of each?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?1-#