Introduction To Corporate Finance

1

• Introduction To Corporate Finance

2
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 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

3
Chapter 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

4
Corporate Finance

• 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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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

6
Financial Management 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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Forms of Business Organization

• Three major forms in the United States
• Sole proprietorship
• Partnership
• General
• Limited
• Corporation
• S-Corp
• Limited liability company

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Sole 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 owners personal wealth
• Unlimited liability
• Difficult to sell ownership interest

9
Partnership

• Advantages
• Two or more owners
• More capital available
• Relatively easy to start
• Income taxed once as personal income

• Disadvantages
• Unlimited liability
• General partnership
• Limited partnership
• Partnership dissolves when one partner dies or
  wishes to sell
• Difficult to transfer ownership

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Corporation

• 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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Goal Of Financial Management

• What should be the goal of a corporation?
• Maximize profit?
• Minimize costs?
• Maximize market share?
• Maximize the current value of the companys
  stock?
• Does this mean we should do anything and
  everything to maximize owner wealth?

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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

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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 goal
• Corporate control
• The threat of a takeover may result in better
  management
• Other stakeholders

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Work 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!

15
Financial Markets

• Cash flows to the firm
• Primary vs. secondary markets
• Dealer vs. auction markets
• Listed vs. over-the-counter securities
• NYSE
• NASDAQ

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Primary Markets v/s Secondary Markets

• Primary Markets
• A market that issues new securities on an
  exchange. Companies, governments and other groups
  obtain financing through debt or equity based
  securities. Primary markets are facilitated by
  underwriting groups, which consist of investment
  banks that will set a beginning price range for a
  given security and then oversee its sale directly
  to investors.  Also known as "new issue market"
  (NIM).

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• Secondary Markets
• A market where investors purchase securities or
  assets from other investors, rather than from
  issuing companies themselves. The national
  exchanges - such as the New York Stock Exchange
  and the NASDAQ are secondary markets.

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Dealer and Auction Markets

• What Does Auction Market Mean?A market in which
  buyers enter competitive bids and sellers enter
  competitive offers at the same time. The price a
  stock is traded represents the highest price that
  a buyer is willing to pay and the lowest price
  that a seller is willing to sell at. Matching
  bids and offers are then paired together and the
  orders are executed. 

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An example of Auction Market

• The New York Stock Exchange (NYSE) is an example
  of an auction market. Auction markets differ from
  over the counter where trades are negotiated. For
  example, 4 buyers want to buy a share of XYZ and
  make the following bids 10.00, 10.02, 10.03 and
  10.06. Conversely, there are 4 sellers that
  desire to sell XYZ and they submitted offers to
  sell their shares at the following prices
  10.06, 10.09, 10.12 and 10.13. In this
  scenario, the individuals that made bids/offers
  for XYZ at 10.06 will have their orders
  executed. All remaining orders will
  not immediately be executed and the current price
  of XYZ will then be 10.06.

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Dealer Markets

• What Does Dealer Market Mean?
• A market where dealers are assigned for specific
  securities. The dealers create liquid markets by
  purchasing and selling against personal
  inventory.

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An example of Dealer Market

• An example of Dealer MarketUnlike auction
  markets, the benefit of this type of market is
  the rapid access that investors have to buyers
  and sellers of a particular security. The best
  example of a dealer market is the Nasdaq.

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Listed v/s Over-the-Counter Securities

• OTC Securities
• A security traded in some context other than on a
  formal exchange such as the NYSE, TSX, AMEX, etc.
  The phrase "over-the-counter" can be used to
  refer to stocks that trade via a dealer network
  as opposed to on a centralized exchange.
• It also refers to debt securities and other
  financial instruments such as derivatives, which
  are traded through a dealer network.

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A Quick note on Nasdaq

• Although Nasdaq operates as a dealer
  network, Nasdaq stocks are generally not
  classified as OTC because the Nasdaq is
  considered a stock exchange. As such, OTC stocks
  are generally unlisted stocks which trade on the
  Over the Counter Bulletin Board (OTCBB) or on the
  pink sheets.
• Be very wary of some OTC stocks, however the
  OTCBB stocks are either penny stocks or are
  offered by companies with bad credit records.

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Quick 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?

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• End of Chapter