CORPORATE FINANCE ESSENTIALS:

-every business requires money to operate, and corporate finance seeks to acquire and manages this
money.

A. the five basic corporate finance functions

Corporate finance= the activities involved in managing cash flows (money) in a business environment.

1) Raising capital to support companies operations and investments programs

2) Selecting the best projects in which to invest firms resources, based on each project’s perceived
risk and expected return( the capital budgeting function)
3) Managing firms internal cash flows, working capital, and their mix of debt and equity financing,
both to maximize the value of firms debt and equity claims and to ensure that companies can
pay off obligation when due ( the financial management function)
4) Developing company-wide ownership and corporate governance structures that forces
managers to behave ethically and make decisions that benefit shareholder ( the corporate
governance functions)
5) Managing firms exposures to all types of risk, both insurable and uninsurable, to maintain an
optimal risk-return trade-off and therefore maximize shareholders value ( the risk-management
function)

EXTERNAL FINANCING

-they can raise capital either by selling equity (common or preferred), or by borrowing money from
creditors

Venture capitalist- specialize in making high-risk/high-return investments in rapidly growing

entrepreneurial businesses. *when the organization is new

Initial public offering of stock- selling shares to outside investors and listing the shares for trade on a
stock exchange.

CAPITAL BUDGETING

- It represents firms financial managers single most important activity, for two reasons:
a. Managers evaluate very large investments in the capital budgeting processes
b. Companies can prosper in a competitive economy only by seeking out the most
promising new products, processes, and services to deliver to customers.

Process;

1. Identifying potential investments

 2. Analyzing the set of investment opportunities and identifying those that create shareholders
value
3. Implementing and monitoring the investments

FINANCIAL MANAGEMENT

-involves managing firms operating cash flow as efficiently and profitably as possible.

- ensure that firms have enough working capital on hand for day-to-day operations

Capital structure decision- finding the right mix of debt and equity securities to maximize the firms
overall market value.

CORPORATE GOVERNANCE

-governance systems determine who benefits most from company activities, then they establish
procedures to maximize firm value and to ensure that employees act ethically and responsibly.

Collective action problem-* pag yung mga managers di sumusunod sa goals

*boards must develop fixed(salary) and contingent(bonus and stock-based) compensation packages that
align managers incentives with those of shareholders *to address the problem

RISK MANAGEMENT

-attempts to quantify the sources and magnitude of firms risk exposure and to decide whether to accept
them or to manage them.

Insurable risks= loss caused by fire or flood, employees theft, or injury to customers by the company’s
products.

Uninsurable risks

DEBT AND EQUITY: THE TWO FLAVORS OF CAPITAL

2 broad types of capital:

-debt capital= includes all of a company’s long term borrowing from creditors. The borrower is
obliged to pay interest, at a specified annual rate, on the full amount borrowed as well as to pay
 the principal amount of the debt's maturity. The creditor can force the company into
bankruptcy.

-equity capital= expected to remain permanently invested in the company. They can not push
the company into bankruptcy.

 Common stockholders=bear most of the firms business and financial risk,

because they receive returns only after creditors and preferred stockholders are
paid in full
 Preferred stockholders= promised a fixed annual payment on their investment
capital.

FINANCIAL INTERMEDIATION AND MODERN FINANCE

Financial intermediary= an institutions that raises capital by issuing liabilities against itself, and then uses
the capital to raise to make loans to corporate and individuals.

*the best known American financial intermediary is the commercial bank.

The growing importance of financial markets

-banks as providers of debt capital to corporations has declined for decades. Instead, nonfinancial
corporations have increasingly turned to capital markets for external financing; principally because the
cost of information processing makes it easier for large numbers of investors to obtained evaluate
financial data.

Primary-market transactions= true capital raising events because the firms actually receives the cash.
Corporations sell securities to investors in exchange of cash.

Secondary-market transactions= generate no cash inflow to the firm. Trade between investors and
investors.

LEGAL FORMS OF BUSINESS ORGANIZATION

A. BUSINESS ORAGANIZATIONAL FORMS IN THE U.S

1. Sole proprietorship-a business with a single owner. No legal distinction arises between the
business and the owner=joint and several liability.
 Characteristics
a. Limited life- it ceases to exist when the owner dies or retires
b. Limited access to capital- it can obtain its capital only by reinvested profits and
owners personal borrowing
 c. Unlimited personal liability- the owner is personally liable for all the debts of
the business
2. Partnership= is essentially a proprietorship with two or more owners who have joined their
skills and personal wealth.
=partnership income is taxed only once
 Characteristics
a. Limited life= because partnership are long-term, multi-person business
association they also suffer instability problems as partners leave and others
join them
b. Limited access to capital= firms are still limited to retained profits and personal
borrowing if the partnership wants to expand or make capital investments.
c. Unlimited personal liability= partners are subject to joint and several liability.
3. Limited partnership= it combines the best features of the partnership and the corporate
organizational forms
=most investors in limited partnership have the limited liability of
corporate shareholders but their shares are taxed as partnership income.
=limited partners are passive
=disadvantage is lack of liquidity, no right to control the company and
his name will never be associated with the firm.
4. Corporation= is a legal separate entity with many of the same economic rights and
responsibilities as those of individuals.
 Characteristics
a. Unlimited life= it has a perpetual life unless they are explicitly terminated
b. Limited liability= shareholders cannot be held personally for the firms debts
c. Individual contracting= it can contract individually
d. Unlimited access to capital= it can borrow from creditors and issue share stock
to have capital

Shareholders=owners of stocks

Board of directors= responsible for the management of corporations

Corporate charter= the legal document created at the corporations inception to govern
the firms operation.

President/chief executive officer= responsible for day-day operation

Agency cost= arises because of the conflicts between shareholders and managers

Double taxation problem= government tax corporate income at both company and
personal levels.
 Jobs and growth tax relief reconciliation act of 2003= reduced the taxation problem

Before= 35% corporate profit tax and 38% personal tax

After= 35% corporate profit tax and 15% personal tax

5. S corporation= allow shareholders to be taxed as partners yet retain their limited status.
= it yields the limited liability benefit of the corporate form, along with favorable
taxation of the partnership form.
 Requirement
a. Must have 75 or fewer shareholders
b. Shareholders must be individuals
c. They cannot hold a controlling fraction of the stock in another company
6. Limited liability companies= combine partnerships pass-through taxation with s corporations
limited liability
= LLC are taxed as partnerships, their owners face no personal
liability for other partners misconducts.

The corporate financial managers’ goals

*managers should act according to the interests of the firm’s owners.

What should a financial manager try to maximize?

A. Maximize profit= to maximize profits, financial managers should take only those actions that
they expect will increase the firm revenues than it costs. It is the maximizing earnings per share
defined as earnings available for common stockholders divided by the number of shares
 Several flaws
a. Reflecting past performance rather than what is happening now or what will
happen in the future.
b. They may ignore the timing of those profits
c. A firm that is profitable accdng to acctng principles may spend more cash than
it receives
d. Focusing only on earning ignore risk
B. Maximizing shareholders wealth=firms proper goal is to maximize shareholder wealth, as
measured by the market price of the firms stock
=it reflects the timing, magnitude, and risk of the cash flows
that investors expect a firm to generate over time.
=actions that will increase the value of the firms future cash
flows
=if firms did not operate to maximize shareholders wealth,
investors would have little incentive to accept the risk necessary
 to buy stock and provide the funds necessary for a business to
thrive.
C. Focus on stakeholders= many firms have broadened their interest to include the interest of
other stakeholders.

How can agency costs be controlled in corporate finance?

A. Types of agency cost

*agency problems= cost arising from the likelihood that managers may place personal goals
ahead of corporate goals

Solutions:

- Relying on market forces to exert managerial discipline

- Incurring monitoring and bonding costs necessary to supervise managers
- Structuring executive compensation packages to align managers interests with stockholders
interests.

Hostile takeover= the acquisition of one firm by another through an open market bid

Bonding expenditure= insure firms against the potential consequences of dishonest act by managers

Monitoring expenditures= pay for audits and control procedures that alerts shareholders if managers
pursue their own interest too aggressively.

B. Use of compensation contracts to control agency costs= reducing agency cost through the
design of executive compensation contracts.
=incentive compensation plans attempt to tie managerial wealth directly to the firms share
price.

Why are ethics important in corporate finance?

*Sarbanes-oxley act=enforce higher ethical standards and increase penalties for violators.

=this act requires both CEO and CFO of all large companies to personally certify
their firms’ financial statements
CHAPTER 3: THE TIME VALUE OF MONEY

3.1 FUTURE VALUE OF A LUMP SUM

Compound interest= interest earned both on principal amount and on the interest earned in
previous periods.
Principal=amount of money on which the interest is paid
Simple interest=interest paid only on the initial principal of an investment, not on the
interest that accrues in earlier periods

3.1.b the equation for future value

Analysis: a. the higher the interest rates, the higher the future value

b.the longer the period of time, the higher the future value

3.2 PRESENT VALUE OF A LUMP-SUM

3.2.A the concept of present value

Discounting= describes the process we use to calculate the present value of future cash flows.

REFER ON THE PPT(COMPLETE)

A. Deposits needed to accumulate a future sum.

*supposes that someone wishes to determine the annual deposit necessary to accumulate a
certain amount of money at the same point in the future

B. Loan amortization
Loan amortization- refers to a situation in which a borrower makes equal periodic payments
over time to fully repay a loan
= it involves finding a level stream of payments with a present value
calculated at the loan interest rate equal to the amount borrowed. Lenders use amortization
schedule to determine these payments and the allocation of each payment to interest and
capital.

3.6 ADDITIONAL APPLICATION OF TIME-VALUE TECHNIQUES two most important specialized ises
of time value techniques=
a. implied interest growth rates
b. the number of compounding periods.
3.6.a implied interest or growth rates
Growth rate=annual rate of change in values

A. Lump sum
B. Annuities=rate represents the equal annual end-of-year payments on loan
C. Mixed stream= yield-to-maturity/ internal rate of return= using an iterative trial and error
approach to find the interest rates that would cause the inflows just equal with outflows

3.6.b number of compounding periods

A. lump sum
b. annuities=table
c. mixed stream=table and trial and error