Fundamental of Corporate Finance slideshare

Preah Kossomak Polytechnic Institute (PPI)

FUNDAMENTALS OFFUNDAMENTALS OFCORPORATE FINANCECORPORATE FINANCE

Eighth Edition @2008

Stephen A. RossRandolph W. Westerfield

Bradford D. Jordan

Prepared and Taught by YIN SOKHNG, MFIWebsite: www.morodorkkhmer.comE-mail: [email protected]: (855) 16889872 / 17989972

Chapter 1 Introduction to Corporate Finance

Chapter 2 Financial Statements, Taxes, and Cash Flow

Chapter 3 Working with Financial Statements

Chapter 4 Long-Term Financial Planning and Growth

Chapter 5 Introduction to Valuation: The Time Value of Money

Chapter 6 Discounted Cash Flow Valuation

Chapter 7 Interest Rates and Bond Valuation

Chapter 8 Stock Valuation

Chapter 9 Net Present Value and Other Investment Criteria

Table of Contents

Instructed by YIN SOKHENG, Master in Finance

Chapter 1Introduction to Corporate Finance

Chapter Outline• 1.1 Corporate Finance and the Financial Manager

• 1.2 Corporate Firm/Forms of Business Organization

• 1.3 Corporate Securities as Contingent Claims on Total Firm Value

• 1.4 The Goal of Financial Management

• 1.5 The Agency Problem and Control of the Corporation

• 1.6 Financial Markets and the Corporation3Instructed by YIN SOKHENG, Master in Finance

Corporate finance is the study of financial decision-making in business organizations.

1.1 What is Corporate Finance?

Corporate Finance is the activity of providing :

- money to corporations for investment, and

- the ways that corporations' use this money.

Corporate Finance branch of economics concerned with how businesses raise and spend their money.

4Instructed by YIN SOKHENG, Master in Finance

Financial Management Decisions

• Capital Budgeting

• Capital Structure• Working Capital

Management


Corporate Finance addresses the following three questions:1. What long-term investments should the firm engage

in?

2. How can the firm raise the money for the required investments?

3. How much short-term cash flow does a company need to pay its bills?

Financial Management Decisions


The Capital Budgeting Decision

1. What long-term investments should the firm engage in?

Type and proportions of assets the firm need tend to be set by the nature of the business.

Use the terms capital budgeting and capital expenditure to making and managing expenditures on long-lived assets.


The Capital Structure Decision

2. How can the firm raise the money for the required investments?

The answer to this involves the capital structure, which represents the proportions of :

the firm’s financing from current debt, the firm’s financing from long-term debt, and the firm’s financing from equity


The Net Working Capital Investment Decision

3. How much short-term cash flow does a company need to pay its bills?

The answer to this involves : the firm’s net working capital, the subject of short-term finance, the firm’s short-term management cash flow, and the timing of cash inflows and cash outflows.


Hypothetical Organization Chart


The Financial ManagerA member of the top manager team (CFO)

responsible for:Providing the timely and relevant data to support planning and control activities. Preparing financial statement for external users.

The treasurer is responsible for: handing cash flows, managing capital expenditures decisions, and making financial plans.


The Financial Manager

To create value from the firm’s capital budgeting, financing, and net working capital activities, the financial manager should:

1.Try to make smart investment decisions (try to buy assets that generate more cash than cost).

2.Try to make smart financing decisions (sell bonds or stocks and other financing instruments that raise more cash than cost).


The Firm and the Financial Markets

Cash flowfrom firm (C)

Tax

es (D)

Firm issues securities (A)

Retained cash flows (F)

Dividends anddebt payments (E)

Financialmarkets

Investsin assets(B)

Current assetsFixed assets

Short-term debt

Long-term debt

Equity shares


1.2 The Corporate Firm

• 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 OrganizationThe Sole ProprietorshipThe Partnership

General PartnershipLimited Partnership

The CorporationAdvantages and Disadvantages

Liquidity and Marketability of OwnershipControlLiabilityContinuity of ExistenceTax Considerations


A Comparison of Partnershipand Corporations

Corporation Partnership

Liquidity Shares can easily be 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


1.3 Corporate Securities as Contingent Claims on Total Firm Value


Bonds Compared to Stock• Bondholders are

creditors

• Bonds a liability

• Interest is fixed charge

• Interest is expense

• Interest tax deductible

• No voting

• Stockholders are owners

• Stock is equity

• Dividends not fixed charges

• Dividends not expense

• Dividends not tax deductible

• Voting


Corporate Securities as Contingent Claims on Total Firm Value

• The basic feature of a debt is that it is a promise by the borrowing firm to repay a fixed dollar amount of by a certain date.

• The shareholder’s claim on firm value is the residual amount that remains after the debtholders are paid.

• If the value of the firm is less than the amount promised to the debtholders, the shareholders get nothing.


Debt and Equity as Contingent Claims

Payoff to debt holders

Value of the firm (X)

Debt holders are promised $F.

If the value of the firm is less than $F, they get the whatever the firm if worth.

If the value of the firm is more than $F, debt holders get a maximum of $F.

Payoff to shareholders


If the value of the firm is less than $F, share holders get nothing.

If the value of the firm is more than $F, share holders get everything above $F.

Algebraically, the bondholder’s claim is: Min[$F,$X]

Algebraically, the shareholder’s claim is: Max[0,$X – $F]


$F

$F

Combined Payoffs to debt holders and shareholders


Debt holders are promised $F.

Payoff to debt holders

Payoff to shareholders

If the value of the firm is less than $F, the shareholder’s claim is: Max[0,$X – $F] = $0 and the debt holder’s claim is Min[$F,$X] = $X.

The sum of these is = $X

If the value of the firm is more than $F, the shareholder’s claim is: Max[0,$X – $F] = $X – $F and the debt holder’s claim is:

Min[$F,$X] = $F.

The sum of these is = $X

Combined Payoffs to Debt and Equity


1.4 Goals of the Corporate Firm

• The traditional answer is that the managers of the corporation are obliged to make efforts to maximize shareholder wealth.


Managerial Goals

• Managerial goals may be different from shareholder goals– Survival

– Independence

– Minimize costs and Maximize profits.

• Increased growth and size are not necessarily the same thing as increased shareholder wealth.


1.5 The Agency Problem• The agency relationship

• Will managers work in the shareholders’ best interests?

Agency costs

Direct agency Costs

Indirect agency Costs

• Control of the firm

• How do agency costs affect firm value (and shareholder wealth)?


1.6 Financial Markets• Financial markets are composed of the money

markets and capital markets.

• Money Markets– For debt securities that will pay off in the short

term.

– Usually less than one year.

• Capital Markets– For long-term debt (equity securities).

– With maturity at over one yare.

– For equity shares. 25Instructed by YIN SOKHENG, Master in Finance

Money Market Capital Markets

Non-government securities:Debt securities:-Certificate of Deposits (CDs)-Commercial Paper (CP)-Repurchase Agreements (Repo.)-Banker’s acceptances (BAs)

Non-government securities:- Corporate bond/ Bond payable

Stock/Equity shares:-Preferred stock- Common stock

Financial Instruments

Government securities:-Treasury notes (T-notes)-Long-term Municipal Bonds-Treasury bonds (T-bonds)

Government securities: - Treasury bills (T-bills) - Short term Municipal bonds


Financial Markets• The function of market in financial market are

divided two (transaction) markets:

• Primary Market– When a corporation issues securities, cash flows

from investors to the firm.

– Usually an underwriter is involved

• Secondary Markets– Involve the sale of “used” securities from one

investor to another.

– Securities may be exchange traded or trade over-the-counter (OTC) in a dealer market.


Financial Markets

Firms Investors

Secondary Market

money

securities

Stocks and Bonds

Money

Primary Market

SBUs


SBUs

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The Public Issue

• The Basic Procedure– Management gets the approval of the Board of

Directors.– The firm prepares and files a registration

statement with the SEC.– The SEC studies the registration statement during

the waiting period.– The firm prepares and files an amended

registration statement with the SEC.


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Exchange Trading of Listed Stocks

• Auction markets are different from dealer markets in two ways:– Trading in a given auction exchange takes place at

a single site on the floor of the exchange.

– Transaction prices of shares are communicated almost immediately to the public.


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Fundamental of Corporate Finance slideshare