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10.04.23 1
AD 311 Business Finance
Fall 2009
Attila Odabaşı
Lect 1: Introduction to Corporate Finance
(ref. Ch 1)
10.04.23 2
Main Points
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 managementUnderstand the conflicts of interest that can
arise between owners and managersUnderstand the various types of financial
markets
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Corporate Finance
Some important questions that are answered using financeWhat 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?
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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 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?
Forms of Business Organization
Three major forms in the United StatesSole proprietorship
PartnershipGeneral
Limited
CorporationS-Corp
Limited liability company
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Sole Proprietorship
A business form for which there is one owner. This single owner has unlimited liability for all debts of the firm.
Oldest form of business organization.
Business income Business income is accounted for on your personalpersonal income tax formincome tax form.
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Sole Proprietorship
AdvantagesEasiest to start
Least regulated
Single owner keeps all the profits
Taxed once as personal income
DisadvantagesLimited to life of
owner
Equity capital limited to owner’s personal wealth
Unlimited liability
Difficult to sell ownership interest
Partnerships
A business form in which two or more individuals act as owners.
Business income Business income is accounted for on each partner’s personalpersonal income tax formincome tax form.
General PartnershipGeneral Partnership -- all partners have unlimited liability and are liable for all obligations of the partnership.
Limited PartnershipLimited Partnership -- limited partners have liability limited to their capital contribution (investors only). At least one general partner is required and all general partners have unlimited liability.
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Partnership
AdvantagesTwo or more
owners
More capital available
Relatively easy to start
Income taxed once as personal income
DisadvantagesUnlimited liability
General partnership
Limited partnership
Partnership dissolves when one partner dies or wishes to sell
Difficult to transfer ownership
Corporations
A business form that legally separate from its owners.
An artificial entity that can own assets and incur liabilities.
Business income Business income is accounted for on the income tax form of the corporationincome tax form of the corporation.
Separation of ownership and management
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Corporation
AdvantagesLimited liability
Unlimited life
Separation of ownership and management
Transfer of ownership is easy
Easier to raise capital
DisadvantagesSeparation of
ownership and management
Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)
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Şirketlerin Sınıflandırılması
Borçlar Yasasına göre düzenlenmiş Adi şirketler
Türk Ticaret Yasasına göre düzenlenmiş Şahıs şirketleri
Kollektif şirketler
Komandit şirketler
Sermaye şirketleri Hisseli Komandit şirketler
Anonim şirketler
Limited şirketler
Kooperatif Yasasına göre düzenlenmiş Kooperatifler
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Goal Of Financial Management
What should be the goal of a corporation?Maximize sales or market share?
Minimize costs?
Maximize profit?
Maintain steady growth?
Maximize the current value of the company’s stock?
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Shortcomings of Alternative Perspectives
Minimize costs – We can minimize costs today by not purchasing new equipment or delaying maintenance, but this may not be in the best interest of the firm or its owners...
Shortcomings of Alternative Perspectives
Profit maximizing: Maximizing a firm’s earnings after taxes.
Problems: Long-term or short-term? Do we mean accounting profits or some measure of
cash flow? Could increase current profits while harming firm (e.g.,
defer maintenance).
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Shortcomings of Alternative Perspectives
Maximize market share – This has been a strategy of many of the dot.com companies. They issued stock and then used it primarily for advertising to increase the number of “hits” to their web sites. Many firms failed to translate those ‘hits’ to money to pay the expenses etc...
10.04.23 18
Stockholder’s view..
From a stockholder perspective, the purpose of a for-profit business should be to make money for its owners. How? Maximizing the current stock price increases the wealth of the owners of the firm.
The more general goal is: Maximize the current value of the owner’s equity. There is no short run vs. long run here. The stock
price should incorporate expectations about the future of the company and consider the trade-off between short-run profits and long-run profits.
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Maximization of Shareholder Wealth!
Do not forget that if stockholders win (residual owners), it must be true that everyone else is winning also.
This goal does not imply that the financial manager should take illegal or unethical actions in the hope of increasing the value of the equity.
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The Agency Problem Agency relationship
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
Management goals and agency costs
Agency costs
Direct costs: unneeded expenses for management, monitoring costs (auditors)
Indirect costs: sub optimal decisions, lost oppotunities
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
Incentives include, stock optionsstock options,, perquisitesperquisites,, and bonusesbonuses.
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Managing Managers
Corporate controlControl of the firm rests with stockholders. They
elect the board of directors, who in turn hire and fire managers.
Ways of replacing managers:Proxy fights
Takeover
Stakeholders (customers, suppliers, government) sometmes may attempt to exercise cotrol on the firm as well.
Financial Markets
Businesses interact continually with the financial financial markets.markets.
Financial MarketsFinancial Markets are composed of all institutions and procedures for bringing buyers and sellers of financial instruments together.
The purpose of financial markets is to efficiently allocate savings to ultimate users.
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Financial markets and the corporation
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What are some types of Markets?
A market is a method of exchanging one asset (usually cash) for another asset.Physical assets vs. financial assets
Financial Markets:Debt and equity securities are bought and soldFinancial markets differ in detail:
Type of securities traded: debt, equity, derivatives, ...How trading is conducted? outcry auction, electronic
systemsWho the buyers and sellers are?
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Primary versus Secondary Markets
Financial markets function as both primary and secondary markets.Primary market: original sales of securities by
corporations (or governments).The transaction raises money for the corporation.
Secondary markets: securities are bought and sold after the original sale.The transaction does not raise money for the
corporation.
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How are secondary markets organized? By the way that orders from buyers and sellers
are matched:Auction markets,
An auction market has a physical location like Wall Street or Istanbul Stock Exchange (ISE).
Buyers and sellers are matched directly.Dealers markets.
Dealers buy and sell for themselves, at their own risk.
Like car dealers; opposite of real-estate agents. Most dealer markets are called over-the-counter
(OTC) markets.
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Auction MarketsNYSE and AMEX are the two largest
auction markets for stocks.
NYSE is a modified auction, with a “specialist.”
Specialist is a market maker.
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Dealer MarketsDealers buy and sell for themselves, at
their own risk. Dealers are connected electronically.
Computerized quotation system keeps track of bid and ask prices, but does not automatically match buyers and sellers.
NASDAQ: National Association of Securities Dealers Automated Quotation system.