ppt ch01.pptx
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Fundamentals of Corporate
Finance, 2/e
ROBERT PARRINO, PH.D.
DAVID S. KIDWELL, PH.D.
THOMAS W. BATES, PH.D.
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Chapter 1: The Financial Manager and
the Firm
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Learning Objectives
1. IDENTIFY THE KEY FINANCIAL DECISIONS
FACING THE FINANCIAL MANAGER OF ANY
BUSINESS FIRM.
2. IDENTIFY THE BASIC FORMS OF BUSINESS
ORGANIZATION IN THE UNITED STATES AND
THEIR RESPECTIVE STRENGTHS AND
WEAKNESSES.
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Learning Objectives
3. DESCRIBE THE TYPICAL ORGANIZATION OFTHE FINANCIAL FUNCTION IN A LARGECORPORATION.
4. EXPLAIN WHY MAXIMIZING THE CURRENTVALUE OF THE FIRMS STOCK IS THEAPPROPRIATE GOAL FOR MANAGEMENT.
5. DISCUSS HOW AGENCY CONFLICTS AFFECTTHE GOAL OF MAXIMIZING SHAREHOLDERVALUE.
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Learning Objectives
6. EXPLAIN WHY ETHICS IS AN APPROPRIATE
TOPIC IN THE STUDY OF CORPORATE
FINANCE.
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The Role of the Financial Manager
o THREE KEY FINANCIAL DECISIONS
Capital Budgeting: decide which long-term
assets to acquire
Financing: decide how to pay for short-term and
long-term assets
Working Capital: decide how to manage short-
term resources and obligations
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The Role of the Financial Manager
o THREE KEY FINANCIAL DECISIONS
Capital Budgeting
Choose the long-term assets that will yield the greatest
net benefits for the firm.
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The Role of the Financial Manager
o THREE KEY FINANCIAL DECISIONS
Financing
Finance assets with the optimal combination of short-
term debt, long-term debt, and equity.
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The Role of the Financial Manager
o THREE KEY FINANCIAL DECISIONS
Working Capital Management
Adjust current assets and current liabilities as needed
to promote growth in cash flow.
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Cash Flows Between the Firm and Its
Stakeholders and Owners
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How the Financial Managers Decisions
Affect the Balance Sheet
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The Role of the Financial Manager
o THREE KEY FINANCIAL DECISIONS
Poor decisions about capital budgeting,
financing, or working capital may lead to
bankruptcy or business failure
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Basic Forms of Business Organization
o BUSINESS STRUCTURE
Sole Proprietorship
Partnership
Corporation
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Basic Forms of Business Organization
o SOLE PROPRIETORSHIP
Owned by a single person who is financially
responsible for the actions and obligations of
the business
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Basic Forms of Business Organization
o SOLE PROPRIETORSHIP
Advantages
easiest to create
easiest to control
easiest to dissolve
right to all profit
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Basic Forms of Business Organization
o SOLE PROPRIETORSHIP
Disadvantages
owners personal assets at risk
owners unlimited liability for firm obligations
equity only from owner or business profit
business income taxed as personal income
difficult to transfer ownership
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Basic Forms of Business Organization
o PARTNERSHIP
A business owned by more than one person; one
or more of them financially responsible for the
actions and obligations of the business
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Basic Forms of Business Organization
o PARTNERSHIP
Advantages vs. sole proprietorship
limited protection of owners personal assets
owners limited liability for firm obligations
more sources of equity
more sources of expertise
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Basic Forms of Business Organization
o PARTNERSHIP
Disadvantages vs. proprietorship
shared control
shared profit
harder to dissolve
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Basic Forms of Business Organization
o CORPORATION
A business owned by more than one person;
none of them financially responsible for the
actions and obligations of the business. Thecorporation is responsible for its obligations and
actions.
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Basic Forms of Business Organization
o CORPORATION
Advantages
protects personal assets
no shareholder liability for business
easiest to change ownership
greatest access to sources of funds
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Basic Forms of Business Organization
o CORPORATION
Disadvantages
most difficult and expensive to establish
dilutes individual control over the firm
overall higher taxes on income for shareholders
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Basic Forms of Business Organization
o HYBRID FORMS OF BUSINESS ORGANIZATION
Limited Liability Partnerships (LLPs)
Limited Liability Companies (LLCs)
Professional Companies (PCs)
All have the limited liability of a corporation and tax
advantage of a partnership.
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Organization of the Financial Function
o CHIEF EXECUTIVE OFFICER (CEO)
Chief manager in the firm
Ultimate power to make decisions and ultimate
responsibility for decisions
Reports directly to the board-of-directors who
protect shareholders interests
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Simplified Corporate Organization
Chart
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Organization of the Financial Function
o CHIEF FINANCIAL OFFICER (CFO)
The V.P. of Finance/CFO is responsible for the
quality of the financial reports received by the
CEO
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Organization of the Financial Function
o KEY FINANCIAL REPORTS
The Controller is the firms accountant and
prepares its financial reports
The Internal Auditor controls and reports onactivities to limit the firms exposure to internal
threats such as fraud and inefficient use of
resources
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Organization of the Financial Function
o EXTERNAL AUDITOR
Conducts an independent audit of a firms
financial activities
Provides an opinion about whether the financialreports the firm prepared are reasonably
accurate and conform to generally accepted
accounting principles
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The Goal of the Firm
o DO NOT MAXIMIZE MARKET SHARE
Giving away goods or services for free will
maximize a firms market share for a while, but
the firm will not be able to pay its bills and stayin business
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The Goal of the Firm
o DO NOT MAXIMIZE PROFIT
Accounting profit differs from economic profit
Profit earned may not equal cash received
Cash not received cant be used to pay bills
The strategy ignores the timing of future cash
flows
The strategy ignores the risks associated withhaving to wait for cash flows
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The Goal of the Firm
o MAXIMIZE SHAREHOLDERS WEALTH!
Future cash flows are considered
The timing of future cash flows is considered
The risks associated with having to wait to for
cash flows are considered
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The Goal of the Firm
o MAXIMIZE SHAREHOLDERS WEALTH!
Maximizing the price of a firms stock will
maximize the value of a firm and the wealth of
its shareholders (owners)
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The Goal of the Firm
o ITS ALL ABOUT CASH FLOW!
Positive residual cash flow may be paid to firm
owners as dividends or invested in the firm
The larger the positive residual cash flow, thegreater the value of a firm
Negative residual cash flowover the long run -
leads to bankruptcy or closing a business
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Agency Conflicts
o AGENCY RELATIONSHIP
An agency relationship is created when the
owner (a principal) of a business hires an
employee (an agent) The owner surrenders some control over the
enterprise and its resources to the employee
Separating ownership from control creates thepotential for agency conflicts
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Agency Conflicts
o AGENCY RELATIONSHIP
An agency relationship exists between
stockholders (principals) and the firms hired
management (agents) In large corporations, shared ownership among
many shareholders may result in relatively little
control over management
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Agency Conflicts
o OWNERSHIP AND CONTROL
Shareholders own the corporation, but
managers control the firms assets and may use
them for their own benefit
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Major Factors Affecting Stock Prices
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Agency Conflicts
o AGENCY COSTS
Arise from (incurring and preventing) conflicts-
of-interests between a firms owners and its
managers May reduce positive residual cash flow, stock
price, and shareholder wealth
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Agency Conflicts
o GIVING AGENTS THE RIGHT INCENTIVE
Managers tend to focus on wealth maximization
when their compensation depends on stock
price
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Agency Conflicts
o GIVING AGENTS THE RIGHT INCENTIVE
Today, the firms stock trades at $0.95 per share.
The CEO has an option to buy 2.5 million
shares from the firm for $1.15 per share at anytime, beginning one year from today. If the
stock price rises to $3.15, the option will be
worth $5 million.
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Agency Conflicts
o GIVING AGENTS THE RIGHT INCENTIVE
Want to keep their jobs
Oversight by the board of directors
Oversight by large blockholders
Potential takeover of the firm
The legal and regulatory environment.
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Agency Conflicts
o SARBANES-OXLEY AND REGULATORY REFORM
Better corporate governance reduces agency
costs by requiring
more effective monitoring of managers activities
programs that promote appropriate behavior by
managers
penalties for executives who do not fulfill their fiduciary
responsibilities
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Ethics in Corporate Finance
o WHAT ARE ETHICS?
Ethics
societys standards for judging whether an action is
right or wrong
Business Ethics
societys standards for acceptable behavior applied to
business and financial markets
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Ethics in Corporate Finance
o EXAMPLES OF ETHICAL CONFLICT IN BUSINESS
Agency Cost
employees unacceptable use of employers computer
Conflict of Interestmortgage contract which a home-buyer is unlikely to
fulfill but earns a mortgage broker more money
Information Asymmetry
seller knows about prior damage to the vehicle but the
potential buyer does not
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Ethics in Corporate Finance
o BUSINESS BEHAVIOR
Regulation and market forces are not enough to
maintain integrity in the marketplace
Business norms must be based on ethicalbeliefs, customs, and practices
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Ethics in Corporate Finance
o CONSEQUENCES OF UNETHICAL BEHAVIOR
Inefficiency in the economy and costs to society
High legal and social costs
Problems such as the recent financial crisis in
the U.S.
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Ethics in Corporate Finance
o ETHICAL BEHAVIOR
Sometimes, it is difficult to judge whether
behavior is ethical or not
Was the manager too careful?
Did the manager take too much risk?
Was it an honest mistake?
Was it against policy, but well-intentioned?
A F k f h A l i f E hi l
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A Framework for the Analysis of Ethical
Conflicts