Cf chap 1 final

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Salman Masood SheikhM.Com, MBA, M.Phil, Ph.D (Scholar),

FCMA, FPFA, ACPA, AITM, CA (Int)

Associate Dean / Director Quality AssuranceFaculty of Management Sciences, Superior University

Lahore

Professional Experience: 7 Years as Manager FinanceAcademic Experience: 13 Years (Teaching)

Contact # 0300-6337009

E-mail ID: [email protected]

Resource Person Introduction

McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

11Introduction To

Corporate Finance

Salman Masood Sheikh

M.Com, MBA, M.Phil, Ph.D (Scholar), FCMA, FPFA, ACPA, AITM,

CA (Int)

Director Quality AssuranceSuperior University Lahore

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Key Concepts and SkillsKey Concepts and Skills

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 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 OutlineChapter Outline

Corporate Finance and the Financial Manager

Forms of Business Organization The Goal of Financial Management The Agency Problem and Control of

the Corporation Financial Markets and the Corporation

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Corporate (Company)Corporate (Company) Corporations are the most common form of business

organization, and one which is chartered by a state and given many legal rights as an entity separate from its owners. This form of business is characterized by the limited liability of its owners, the issuance of shares of easily transferable stock, and existence as a going concern. The process of becoming a corporation, called incorporation, gives the company separate legal standing from its owners and protects those owners from being personally liable in the event that the company is sued (a condition known as limited liability).

A company is defined as an artificial judicial person, having a perpetual secession and a common seal with the limited liability upto the shares of the owners invested in amount.

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FinanceFinance??

A branch of economics concerned with resource allocation as well

as resource management, acquisition and investment. Simply,

finance deals with matters related to money and the markets.

A foremost concept in finance concerns how individuals interact in

order to allocate resources (capital) and/or shift consumption

across time by borrowing or investing.

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Financial ManagerFinancial Manager

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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Figure 1.1 Hypothetical Organization Figure 1.1 Hypothetical Organization ChartChart

Cash Manager Credit Manager

Capital Expenditures Financial Planning

Treasurer

Tax Manager Cost Accounting Manager

Financial AccountingManager

Data Processing Manager

Controller

Vice President and Chief Financial Officer (CFO)

President and Chief Operations Officer (COO)

Chairman of the Board and Chief Executive Officer (CEO)

Board of Directors

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Duties of Finance ManagerDuties of Finance Manager

Some important questions that are answered using finance What 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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Corporate Finance DecisionsCorporate Finance Decisions

Capital budgeting What long-term investments or projects

should the business take on? Capital structure

How should we pay for our assets? Should we use debt or equity?

Working capital management How do we manage the day-to-day

finances of the firm?

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The Balance-Sheet Model of the The Balance-Sheet Model of the FirmFirm

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Total Value of Assets:

Shareholders’ Equity

Current Liabilities

Long-Term Debt

Total Firm Value to Investors:

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Current Assets

Fixed Assets

1 Tangible

2 IntangibleShareholders’

Equity

Current Liabilities

Long-Term Debt

What long-term investments should the firm engage in?

The Capital Budgeting Decision(Investment Decision)

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

The Capital Structure Decision (Financing Decision)

Current Assets

Fixed Assets

1 Tangible

2 IntangibleShareholders’

Equity

Current Liabilities

Long-Term Debt

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

The Net Working Capital Investment Decision

(Financial Decision)

Net Working Capital

Shareholders’ Equity

Current Liabilities

Long-Term Debt

Current Assets

Fixed Assets

1 Tangible

2 Intangible

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Forms of Business OrganizationForms of Business Organization

Three major forms of Business Organization

Sole proprietorship

Partnership General Limited

Corporation

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Sole ProprietorshipSole Proprietorship

Advantages Easiest to start Least regulated Single owner keeps

all the profits Taxed once as

personal income

Disadvantages Limited to life of

owner Equity capital limited

to owner’s personal wealth

Unlimited liability Difficult to sell

ownership interest

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PartnershipPartnership

Advantages Two or more owners

More capital available

Relatively easy to start

Income taxed once as personal income

Disadvantages Unlimited liability

Partnership dissolves when one partner dies or wishes to sell

Difficult to transfer ownership

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CorporationCorporation

Advantages Limited liability Unlimited life Separation of

ownership and management

Transfer of ownership is easy

Easier to raise capital

Disadvantages Separation of

ownership and management

Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)

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Most Important Goal Of CompanyMost Important Goal Of Company

What should be the goal of a corporation?

Survival?

Avoid Financial distress and Bankruptcy?

Maximize profit?

Minimize costs?

Maximize market share? Maximize the current value of the company’s

stock?

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Market Vs. Intrinsic valuesMarket Vs. Intrinsic values Market values are what investors are willing to

either buy or sell an asset for, based on investors’ expectations of future performance. Market values are very often publicly observed, e.g.,

the transactions in the stock markets.

In contrast, intrinsic values are usually considered as private estimates of what something, e.g., a common stock, is actually worth. Intrinsic value is not something that you can prove. If ten analysts are asked to value IBM stock, then

there will likely be ten different intrinsic value estimates!

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Financial goals of the corporationFinancial goals of the corporation

The primary financial goal is shareholder wealth

maximization — a function of future cash flow and risk.

In reality, this is maximizing intrinsic value

For now we will assume that this is synonymous with

maximizing the market value, i.e., stock price maximization.

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The Agency Concept and Control The Agency Concept and Control of Corporationof Corporation

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

a) For example: Investment with Increase in market share and Risk

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Agency Cost Cost of conflict of interest between stockholders

and management.

Types of Agency Cost1) Direct

a) Corporate Expenditure that benefits the Management but costs the shareholders

b) Expense that arise from the need to monitor Management Actions

2) Indirecta) Lost Opportunity

Management Goals & Management Goals & Agency CostAgency Cost

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Managing ManagersManaging 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 Corporate control

Hiring and firing of Managers through Elections The threat of a takeover may result in better

management Other stakeholders

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Code of Corporate Code of Corporate GovernanceGovernance

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Financial MarketsFinancial Markets

Money Market Deals with Short Term Investments

Capital Market Deals with Long Term Investments

Primary Market Deals with Initial Public Offering

Secondary market Deals with Invested Securities

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Cash Flows between the Firm & Cash Flows between the Firm & The Financial MarketsThe Financial Markets

Tax

es

Firm Investsin assets(B)

Current assetsFixed assets

Cash flowfrom firm (C)

Financialmarkets

Short-term debtLong-term debtEquity shares

Government(D)

Firm issues securities (A)

Retained cash flows (E)

Dividends anddebt payments (F)

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Work the Web ExampleWork the Web Example

The Internet provides a wealth of information about individual companies

One excellent site is finance.yahoo.com

Click on the web surfer to go to the site, choose a company and see what information you can find!

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Quick QuizQuick Quiz What are the three types of financial management

decisions and what questions are they designed to 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?

McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

11End of Chapter

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