Chapter 1: Introduction to Corporate Finance

I. Corporate Finance and the Financial Manager a. Corporate Finance i. The study of ways to answer the following questions: 1. What long-term investments to take on? 2. Where to get long-term financing to pay for investments? 3. How to manage everyday financial activities? b. Financial Manager i. Stockholders are usually not directly involved in business decisions. ii. Mangers represent the owners interest and make decisions on their behalf. iii. The controllers office cost and financial accounting, tax payments, and management information systems. iv. Treasurers office firms cash and credit, financial planning, and its capital expenditures. c. Capital budgeting: the process of planning and managing a firms long-term investments. i. Financial manager will identify investment opportunities that are worth more to the firm than they cost to acquire. 1. Value of cash flow generated by assets > cost of asset. ii. Examples: 1. Wal-Mart deciding to open another store. 2. Develop and market a new spreadsheet program. iii. Evaluating the size, timing, and risk of future cash flow. 1. Financial manager must be concerned with how much cash and when it will be received. d. Capital Structure: the mixture of debt and equity maintained by a firm. i. Ways in which the firm obtain and manages the long-term financing it needs to support its long-term investments. ii. Mixture will affect both the risk and the value of the firm. iii. Financial manager concerns: 1. How much should the firm borrow? 2. What are the least expensive sources of funds for the firm? e. Working Capital Management: a firms short-term assets and liabilities. i. Assets = inventory; Liabilities = money owed to suppliers. ii. Ensures that the firm has sufficient resources to continue its operations and avoid costly interruptions. iii. Decides how much inventory to keep on hand, should they sell on credit, and how they will obtain any needed short-term financing.

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Forms of Business Organization a. Sole Proprietorship: a business owned by a single individual. i. Least regulated form of organization more of these than any other type of business. ii. Owner keeps all the profits, but has unlimited liability for the business debts. 1. Creditors can look beyond business assets to the proprietors personal assets for payment. 2. All business income is taxed as personal income. iii. Life is limited to the owners life span. iv. Equity is limited to the amount of the proprietors personal wealth. b. Partnership: a business formed by two or more individuals or entities. i. Types: 1. General Partnership: a. All the partners share in gains or losses, and all have unlimited liability for all partnership debts. b. Partnership agreement: describes the partnership division, and can be an informal oral agreement or a formal written document. 2. Limited Partnership: a. one or more general partners will run the business and have unlimited liability, but there will be one or more limited partners who will not actively participate in the business. b. Will be one or more limited partners who will not actively participate in the business limited partners liability for business debts is limited to the amount that partner contribute to the partnership. Ex. Real estate ventures ii. All income is taxed as personal income to the partners iii. Main disadvantages of sole proprietorships and partnerships: 1. Unlimited liability for business debts on the part of the owners. 2. Limited life of the business. 3. Difficulty of transferring ownership. c. Corporation: a business created as a distinct legal entity composed of one or more individuals or entities. i. A legal person, separate and distinct from its owners, and it has many of the rights duties, and privileges of an actual person. ii. Can borrow money and own property, sue and be sued, and can enter into contracts, can be a general or limited partner in a partnership, and a corporation can own stock in another corporation. iii. Forming a corporation involves preparing articles of incorporation and a set of bylaws.

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iv. Stockholders control the corporation because they elect the directors. v. Advantages: 1. Ownership can be readily transferred = lifespan is not limited. 2. Borrows money in its own name. 3. Stockholders have limited liability for corporate debts. vi. Disadvantages: 1. Must pay taxes 2. Double taxation: corporate profits are taxed twice. Once at the corporate level when the are earned and again at the personal level when they are paid out. vii. LLC Limited liability company 1. Operate and be taxed like a partnership but retain limited liability for owners. viii. Corporation by another name 1. Joint stock companies 2. Public limited companies 3. Limited liability companies The Goal of Financial Management a. Goal is to make money and add value for the owners. b. Good decisions increase the value of the stock, and poor decisions decrease the value of the stock. i. Financial manager acts in the shareholders best interest by making decisions that increase the value of the stock. c. The goal of financial management is to maximize the current value per share of the existing stock. i. The total value of the stock in a corporation is simply equal to the value of the owners equity Maximize the market value of the existing owners equity. d. Sarbanes-Oxley Act of 2002: i. Serves to protect investors from corporate abuses. ii. Section 404 requires that each companys annual report must have an assessment of the companys internal control structure and financial reporting. 1. Independent auditor The Agency Problem and Control of the Corporation a. Agency relationship the relationship between stockholders and management. i. Principal hires agent to represent them. ii. Agency Problem: the possibility of conflict of interest between the stockholders and management of a firm. b. Agency costs the costs of the conflict of interest between stockholders and management.

i. Indirect lost opportunity. ii. Direct 1. Corporate expenditure that benefits management but costs the stockholders. 2. Expense that arises from the need to monitor management actions. c. Managers act in the shareholders interest? i. Managerial compensation is usually tied to financial performance. ii. Better performers within the firm will get promoted. iii. Proxy fight when a group solicits proxies in order to replace the existing board and thereby replace existing managers. iv. Takeover v. Stockholders control the firm and that stockholder wealth maximization is the relevant goal of the corporation. d. Stakeholder: someone other than a stockholder or creditor who potentially has claim on the cash flows of the firm. i. Employees, customers, supplies, and even the government.