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The Scope Of Corporate Finance. Professor Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics. Corporate Finance. Budgeting, financial forecasting, cash management, credit administration, investment analysis, fund procurement. Commercial Banking. Consumer banking - PowerPoint PPT Presentation
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The Scope Of Corporate Finance
Professor Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
2
Finance Career Opportunities
Corporate Finance
• Budgeting, financial forecasting, cash management, credit administration, investment analysis, fund procurement
Commercial Banking
• Consumer banking• Corporate banking
Investment Banking
• High income potential• Very competitive industry
Money Manageme
nt
• Opportunities in investment advisory firms, mutual fund companies, pension funds, investment arms of financial departments
Consulting • Advise on business practices and strategies of corporate clients
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
3
Raising Capital: Key Facts
Primary vs. secondary market transactions or offerings
Most financing comes from internal rather than external sources (“pecking
order”).Most external financing issued as debt
Traditional financial intermediaries (banks) declining as a source of capital
for large firmsSecurities markets growing in
importance
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
4
Role of The Financial Manager
(3) Cash generated by operations
(3)
(4a) Cash reinvested
(4a)
(4b) Cash returned to investors
(4b)
Financial
managerFirm's
operationsFinancial
markets
(1) Cash raised from investors
(1)
(2) Cash invested in firm
(2)
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
5
Corporate Finance Functions
Financial Management
External Financing
Capital Budgeting
Risk Management
Corporate Governance
Corporate Finance
Functions
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
6
Dimensions of the External Financing Function
6
Equity vs. debt
Funding via capital market vs. via financial intermediary
Public vs. private capital markets
Going public
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
7
The Capital Budgeting Function
Capital Budgeting – the process firms use to choose the set of investments that generate the most wealth for
shareholders
Select investments for which the marginal benefits exceed the marginal costs.
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
8
The Financial Management Function
Managing daily cash inflows and outflows
Forecasting cash balances
Building long-term financial plans
Choosing the right mix of debt and equity
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
9
The Risk Management Function
Managing the firm’s exposure to significant risks:
Interest rate risk
Exchange rate risk
Commodity price risk
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
10
The Corporate Governance FunctionEnsuring that managers pursue shareholders’
objectives
Dimensions of
corporate governanc
e
• Boards of directors• Ownership structures• Capital structures• Compensation plans• Country’s legal environment - in
U.S., Sarbanes-Oxley Act of 2002
Takeover market disciplines firms that don’t govern themselves.
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
11
What Should Managers Maximize?• Profit maximization as goal:
– Does not account for timing of returns– Profits - not necessarily cash flows– Ignores risk
Maximize shareholder wealth
• Maximize stock price, not profits• Accounts for risk• As “residual claimants,” shareholders have
better incentives to force management to maximize firm value than do other stakeholders.
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
12
Separation of Ownership and Control
Principal – Agent Relations
MoralHazard
Fringe – BenefitConsumption
Management Compensation
Schemes
Information Asymmetry
Controlling Procedures
(Agency Costs)
Fringe – BenefitConsumption
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
13
Goals of The Corporation
• Shareholders desire wealth maximization
• Do managers maximize shareholder wealth?
• Managers have many constituencies or “stakeholders”
• “Agency Problems” represent the conflict of interest between management and owners
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
14
Managerial Goals
• Managerial goals may be different from shareholder goals
– Expensive perquisites– Survival– Independence
• Increased growth and size are not necessarily the same thing as increased shareholder wealth.
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
15
Do Shareholders Control Management ?
• Shareholders vote for the board of directors, who in turn hire the management team.
• Compensation Schemes can be carefully constructed to be incentive compatible.
• There is a market for managerial talent—this may provide market discipline to the managers—they can be replaced.
• If the managers fail to maximize share price, they may be replaced in a hostile takeover.
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
16
Loan p Cash Flow Creditor/Bank Debtor
Option A 100 1,0 120 120 0
Option B 100 0,5 200 120 80
0,5 0 0 0
Option B 100 60 40
Example: Moral Hazard in Financial Relations
Loan p Cash Flow Creditor/Bank Debtor/Corp.
Option A 100 1,0 120 110 10
Option B 100 0,5 200 110 90
0,5 0 0 0
Option B 100 55 45
Increase the interest rate to 20% does not lead to a solution
Moral Hazard can destroy business opportunities:
Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics
17
Equity Loan p Cash Flow Creditor Debtor
Option A 63,64 36,36 1,0 120 40 80
Option B 63,64 36,36 0,5 200 40 160
0,5 0 0 0
Option B 100 20 80
36,36x
20x55,0
x55,0100x1,1120
5,010,1x200110,1x120
Expected
Value Option A
Expected Value
Option B
Solution of Moral Hazard Problems By Credit Limits
A solution should provide no incentives to the management to follow the risky option B, i.e. the expected values of each option should at least equal
=
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