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McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
CHAPTER
1 Introduction to Corporate Finance
Slide 2
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
Key Concepts and SkillsKnow the basic types of financial
management decisions and the role of the Financial Manager
Know the financial implications of the various forms of business organization
Know the goal of financial managementUnderstand the conflicts of interest that can
arise between owners and managersUnderstand the various types of financial
markets
Slide 3
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
Chapter Outline
1.1 What is Corporate Finance?
1.2 The Corporate Firm
1.3 The Goal of Financial Management
1.4 The Agency Problem and Control of the Corporation
1.5 Financial Markets
Slide 4
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
1.1 What is Corporate Finance?
Corporate Finance addresses the following three questions:1. What long-term investments should the firm
choose?
2. How should the firm raise funds for the selected investments?
3. How should short-term assets be managed and financed?
Slide 5
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
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:
Slide 6
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
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?
Slide 7
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
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
Slide 8
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
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
Slide 9
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
Capital Structure
The value of the firm can be thought of as a pie.
The goal of the manager is to increase the size of the pie.
The Capital Structure decision can be viewed as how best to slice the pie.
If how you slice the pie affects the size of the pie, then the capital structure decision matters.
50% Debt
50% Equity
25% Debt
75% Equity
70% Debt
30% Equity
Slide 10
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
The Financial Manager
The Financial Manager’s primary goal is to increase the value of the firm by:
1. Selecting value creating projects
2. Making smart financing decisions
Slide 11
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
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
Slide 12
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
Cash flowfrom firm (C)
The Firm and the Financial Markets
Tax
es (D)
Government
Retained cash flows (F)
Investsin assets(B)
Dividends anddebt payments (E)
Current assetsFixed assets
Short-term debt
Long-term debt
Equity shares
Ultimately, the firm must be a cash generating activity.
The cash flows from the firm must exceed the cash flows from the financial markets.
Invests in assets
Current assetsFixed assets
Firm Firm issues securities (A)
Short-term debtLong-term debtEquity shares
Financialmarkets
Slide 13
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
Identification of Cash Flows
Slide 18
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
Forms of Business Organization
• The Sole Proprietorship• The Partnership• The Corporation
Slide 19
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
1.3 The Goal of Financial Management
• What is the correct goal?– Maximize profit?– Minimize costs?– Maximize market share?– Maximize shareholder wealth?
Slide 20
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
The goal of financial management is to
• Maximize the current value per share of the existing stock.
• Maximize the market value of the existing owners’ equity. (A more general goal)
Slide 21
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
The most important job of a financial manager:
To create value from the firm’s capital budgeting, financing, and net working-capital activities.
Slide 22
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
Corporate Finance
• The study of the relationship between business decisions and the value of the stock in the business.
Slide 23
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
1.4 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
Slide 24
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
Managerial Goals
• Managerial goals may be different from shareholder goals– Expensive perquisites– Survival– Independence
• Increased growth and size are not necessarily equivalent to increased shareholder wealth
Slide 25
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
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
• Other stakeholders
Slide 26
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
1.5 Financial Markets
• Primary Market– Issuance of a security for the first time
• Secondary Markets– Buying and selling of previously issued
securities– Securities may be traded in either a dealer or
auction market• NYSE• NASDAQ
Slide 27
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw-Hill/Irwin
Financial Markets
FirmsInvestors
Secondary Market
money
securitiesSueBob
Stocks and Bonds
Money
Primary Market