Chapter 1
Introduction to Corporate Finance
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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 various
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
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
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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?
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Balance Sheet Model of the Firm
Total Value of Assets: Total Firm Value to Investors:
Current
Liabilities
Current Assets
Long-Term
Debt
Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity
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The Capital Budgeting Decision
Current
Liabilities
Current Assets
Long-Term
Debt
Fixed Assets
What long-term
1 Tangible investments Shareholders’
2 Intangible should the firm Equity
choose?
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The Capital Structure Decision
Current
Liabilities
Current Assets
Long-Term
How should the Debt
firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible Shareholders’
2 Intangible Equity
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Short-Term Asset Management
Current
Liabilities
Current Assets
Net
Working Long-Term
Capital Debt
How should
Fixed Assets
short-term assets
1 Tangible be managed and Shareholders’
financed?
2 Intangible Equity
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Capital Structure
The value of the firm can be
thought of as a pie.
The goal of the manager is 70%50%30%
25%
to increase the size of the DebtDebt
Equity
pie.
75%
50%
The Capital Structure Equity
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.
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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
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Hypothetical Organization Chart
Board of Directors
Chairman of the Board and
Chief Executive Officer
(CEO)
President and Chief
Operating Officer
(COO)
Vice President and
Chief Financial Officer
(CFO)
Treasurer Controlle
r
Cash Manager Credit Manager Tax Manager Cost Accounting
Capital Financial Financial Data Processing
Expenditures Planning Accounting
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The Firm and the Financial Markets
Firm Firm issues securities (A) Financial
markets
Invests
Retained
in assets cash flows (F)
(B)
Short-term debt
Current assets Cash flow Dividends and
Long-term debt
Fixed assets from firm (C) debt
(E)
payments
Equity shares
Taxes (D)
The cash flows from
Ultimately, the firm
the firm must exceed
must be a cash Government
the cash flows from
generating activity.
the financial markets.
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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.
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Forms of Business Organization
□ The Sole Proprietorship
□ The Partnership
■ General Partnership
■ Limited Partnership
□ The Corporation
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A Comparison
Corporation Partnership
Liquidity Shares can be easily Subject to substantial
exchanged restrictions
Voting Rights Usually each share gets one General Partner is in charge;
vote limited partners may have
some voting rights
Taxation Double Partners pay taxes on
distributions
Reinvestment and dividend Broad latitude All net cash flow is
payout distributed to partners
Liability Limited liability General partners may have
unlimited liability; limited
partners enjoy limited
liability
Continuity Perpetual life Limited life
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1.3 The Goal of Financial Management
□ What is the correct goal?
■ Maximize profit?
■ Minimize costs?
■ Maximize market share?
■ Maximize shareholder wealth?
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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
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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
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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 intended goal
□ Corporate control
■ The threat of a takeover may result in better
management
□ Other stakeholders
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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
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Financial Markets
Stocks and
Investors
Bonds
Firms securities
Money Bob Sue
money
Primary Market
Secondary
Market
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Quick Quiz
□ What are the three basic questions Financial
Managers must 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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