Course Overview Finance: what is it?

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Course OverviewFinance what is it?
Corporate Finance
Money and capital markets
Investments
Investors
Financial Markets Banks, Stock Exchanges
Corporations
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Valuation is the central concept

• In corporate finance we are concerned with making
  decisions that enhance firm value.
• In investments we week to value securities and
  maximize the value of our portfolio.

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BUS 785 course organization
BUS 785
Module 1 Valuation of financial assets
Module 2 Valuation of real assets
Module 3 Options theory and its applications
Module 4 Capital structure theory
Portfolio theory Mean-variance analysis
Discounting and valuation
Modigliani-Miller theorems 1 and 2
Black-Scholes valution
Risk and return CAPM and WACC
Binomial valuation, replication and risk-neutral
probabilities
Investing in risk-free projects
Tax, dividend and share repurchase (not be
covered in this class)
Multi-factor models APT
Investing in risky projects
Bankruptcy costs and the conflict between debt
holders and equity holders
Valuing managerial flexibility using real
option methodology
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Valuation of financial assets

• This module is the foundation of corporate
  finance
• Corporate finance is simply the application of
  asset pricing theories
• It covers the most fundamental theories in
  finance
• Portfolio diversification, mean-variance
  analysis, risk and return
• CAPM, how to calculate cost of capital

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Valuation of real assets

• This part is about the application of asset
  pricing theory in capital budgeting.
• It covers
• Present value and NPV rule
• Investing in risky projects

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Option pricing theory and its applications

• This module, together with the first module,
  provides a complete picture about asset pricing.
• It covers
• Black-Sholes valuation and its use in industries
• Real options Applications of option theory in
  valuing managerial flexibility waiting,
  expansion, and shutting down

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If you are the CEO of an industrial company

• you can make your company more valuable by
  choosing better projects (capital budgeting
  decision)
• you can make your company more valuable by
  changing the mixture of your financing, i.e. the
  ratio of debt to equity (capital structure
  decision)

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Financial decisions

• Capital budgeting decisions (how to invest money)
• Real capital investments
• Mergers acquisitions
• Capital structure decisions (how to raise and
  return money)
• Equity
• Debt
• Distribution (Dividend, share repurchase)

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Balance-Sheet of the Firm
The Capital Budgeting Decision
Current Assets
Current Liabilities
Long-Term Debt
Fixed Assets 1 Tangible 2 Intangible
Shareholders Equity
What long-term investments should the firm engage
in?
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Balance-Sheet of the Firm
The Capital Structure Decision
Current Assets
Current Liabilities
Long-Term Debt
How can the firm raise the money for the required
investments?
Fixed Assets 1 Tangible 2 Intangible
Shareholders Equity
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Chapter 1Business Forms
Sole Proprietorships
Partnerships
Corporations
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A Comparison of Partnershipand Corporations
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What should be the financial Goal of a company?

• Maximizing revenue, cut cost, secure market
  share?
• The primary financial goal is shareholder wealth
  maximization, which (generally) translates to
  maximizing stock price.

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Is stock price maximization the same as profit
maximization?

• No, despite a generally high correlation amongst
  stock price, EPS, and cash flow.
• Some actions may cause an increase in earnings,
  yet cause the stock price to decrease (and vice
  versa). E.g., cut RD.

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Agency relationships

• An agency relationship exists whenever a
  principal hires an agent to act on their behalf.
• Within a corporation, agency relationships exist
  between
• Shareholders and managers
• Shareholders and creditors

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Shareholders versus Managers

• Managers are naturally inclined to act in their
  own best interests (Shirking, empire building,
  corporate jets, entrenchment).
• To mitigate the problem
• Bonus, stock options
• Direct intervention by shareholders
• The threat of firing
• The threat of takeover

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Shareholders versus Creditors

• Shareholders (through managers) could take
  actions to maximize stock price that are
  detrimental to creditors.
• For example taking too risky projects. (Are you
  willing to lend money to someone who gamble a
  lot?)

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• When the outcome is very good, shareholders enjoy
  the fruit.
• When the outcome is bad, shareholders are
  protected by limited liability. E.g., can get
  away by declaring bankruptcy.

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