essence of corporate

7/25/2019 Essence of Corporate

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McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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 variousforms of business organization

!Know the goal of financial management

!Understand the conflicts of interest that canarise between owners and managers

!Understand the various types of financialmarkets


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Chapter Outline1.1 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

Corporation1.5 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 firmchoose?

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

Current Assets

Fixed Assets1 Tangible

2 Intangible

Total Value of Assets:

Shareholders

Equity

Current

Liabilities

Long-Term

Debt

Total Firm Value to Investors:


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The Capital Budgeting Decision

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Shareholders

Equity

Current

Liabilities

Long-TermDebt

What long-terminvestmentsshould the firmchoose?


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The Capital Structure Decision

How should the

firm raise funds

for the selected

investments?

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Shareholders

Equity

Current

Liabilities

Long-TermDebt


7/21McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Short-Term Asset Management

How should

short-term assetsbe managed andfinanced?

Net

WorkingCapital

Shareholders

Equity

Current

Liabilities

Long-TermDebt

Current Assets

Fixed Assets

1 Tangible

2 Intangible



Capital Structure

The value of the firm can be

thought of as a pie.

The goal of the manager is

to increase the size of the

pie.

The Capital Structure

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.

50%

Debt

50%

Equity

25%

Debt

75%

Equity

70%

Debt

30%

Equity



The Financial Manager

The Financial Managers primary goal is to

increase the value of the firm by:

1. Selecting value creating projects2. Making smart financing decisions



Hypothetical Organization Chart

Chairman of the Board andChief Executive Officer (CEO)

Board of Directors

President and ChiefOperating Officer (COO)

Vice President andChief Financial Officer (CFO)

Treasurer Controller

Cash Manager

Capital Expenditures

Credit Manager

Financial Planning

Tax Manager

Financial Accounting

Cost Accounting

Data Processing



Cash flowfrom firm (C)

The Firm and the Financial Markets

Taxes

(D)

Firm

Government

Firm issues securities (A)

Retainedcash flows (F)

Invests

in assets

(B)

Dividends anddebt payments (E)

Current assets

Fixed assets

Financial

markets

Short-term debt

Long-term debt

Equity shares

Ultimately, the firm

must be a cash

generating activity.

The cash flows from

the firm must exceed

the cash flows from

the financial markets.



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.



Forms of Business Organization

" The Sole Proprietorship

" The Partnership

# General Partnership# Limited Partnership

" The Corporation



A ComparisonCorporation Partnership

Liquidity Shares can be easily

exchanged

Subject to substantial

restrictions

Voting Rights Usually each share gets one

vote

General Partner is in charge;

limited partners may have

some voting rights

Taxation Double Partners pay taxes on

distributions

Reinvestment and dividend

payout

Broad latitude All net cash flow is

distributed to partners

Liability Limited liability General partners may have

unlimited liability; limited

partners enjoy limited

liability

Continuity Perpetual life Limited life



1.3 The Goal of Financial Management

" What is the correct goal?

# Maximize profit?

# Minimize costs?# Maximize market share?

# Maximize shareholder wealth?



1.4 The Agency Problem

"Agency relationship

#Principal hires an agent to represent his/her interest

#Stockholders (principals) hire managers (agents) torun the company

"Agency problem

#

Conflict of interest between principal and agent



Managerial Goals

" Managerial goals may be different from

shareholder goals

# Expensive perquisites# Survival

# Independence

" Increased growth and size are not necessarilyequivalent to increased shareholder wealth


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Managing Managers

"Managerial compensation

# Incentives can be used to align management andstockholder interests

#The incentives need to be structured carefully tomake sure that they achieve their intended goal

"Corporate control

#The threat of a takeover may result in bettermanagement

"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

FirmsInvestors

Secondary

Market

money

securitiesSueBob

Stocks and

Bonds

Money

Primary Market


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McGraw Hill/Irwin Copyright 2007 by The McGraw Hill Companies Inc All rights reserved

Quick Quiz

"What are the three basic questions Financial

Managers must answer?

"

What are the three major forms of businessorganization?

"What is the goal of financial management?

"

What are agency problems, and why do they existwithin a corporation?

"What is the difference between a primary market

and a secondary market?

essence of corporate

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