INTRODUCTION TO

CORPORATE FINANCE
1-1 Corporate Investment and
Financing Decisions
• Real Assets
• Used to produce goods and services

• Financial Assets/Securities
• Financial claims on income generated by another firm real assets
• Bonds, Stocks, Specialized instruments
1-1 Corporate Investment and
Financing Decisions

• Investment Decision
• Capital budget or Capital expenditure
• Examples
- Tangible assets i.e Expanding stores
- Intangible asset i.e Research and Development
1-1 Corporate Investment and
Financing Decisions

• Financing Decision
• Equity financing
- Issue of new shares
- Reinvesting the cash generated
• Debt

• Capital Structure
• Choice between debt and equity financing
 Table 1.1 Recent Investment/
Financing Decisions
Company Recent Investment Decisions Recent Financing Decisions

Boeing (U.S.) Delivers first Dreamliner after investing a Reinvests $1.7 billion of profits.
reported $30 billion in development costs.
ExxonMobil Spends $7 billion to develop oil sands at Fort Spends $12 billion buying back shares.
(U.S.) McMurray in Alberta.
GlaxoSmith- Spends $4 billion on research and Pays $3.2 billion as dividends.
Kline (UK) development for new drugs.
LVMH (France) LVMH acquires the Italian Jeweler, Bulgari, Pays for the acquisition with a mixture of cash and
for $5 billion. shares.
Procter & Spends $8 billion on advertising. Raises 100 billion Japanese yen by an issue of 5-
Gamble (U.S.) year bonds.
Tata Motors Opens a plant in India to produce the world's Raises $400 million by the sale of new shares.
(India) cheapest car, the Nano. The facility costs
$400 million.
Union Pacific Invests $330 million in 100 new locomotives Repays $1.4 billion of debt.
(U.S.) and 10,000 freight cars and chassis.
Vale (Brazil) Opens a copper mine at Salobo in Brazil. The Maintains credit lines with its banks that allow the
project cost nearly $2 million. company to borrow at any time up to $1.6 billion.
Walmart (U.S.) Invests 12.7 billion, primarily to open 458 Issues $5 billion of long-term bonds in order to
new stores around the world. repay short-term commercial paper borrowings.
1-1 Corporate Investment and
Financing Decisions

• What Is a Corporation?
• Legal entity, owned by shareholders
• Can make contracts, carry on business, borrow, lend, sue, and be
sued
• Shareholders have limited liability and cannot be held personally
responsible for corporation’s debts
Figure 1.1 Cash Flow between
Financial Markets and Firm’s
Operations

(2) (1)

Firm's Financial Financial

operations manager (4a) markets

(3) (4b)
(1) Cash raised from investors
(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to
investors
1-2 The Financial Goal of the
Corporation

• Stockholders Want Three Things

• To maximize current wealth
• To transform wealth into most desirable time pattern of
consumption
• To manage risk characteristics of chosen consumption plan
 1-2 The Financial Goal of the
Corporation

• Profit Maximization
• Not a well-defined financial objective
• Which year’s profits?
• Shareholders will not welcome higher short-term profits if long-term profits are
damaged
• Company may increase future profits by cutting year’s dividend,
investing freed-up cash in firm
• Not in shareholders’ best interest if company earns less than opportunity cost
of capital
1-2 The Financial Goal of the
Corporation
• The Investment Trade-off
• Hurdle Rate/Cost of Capital

• Minimum acceptable rate of return on

investment
• Opportunity Cost of Capital

• Investing in a project eliminates other

opportunities to use invested cash
Figure 1.2 The Investment
Trade-off
1-2 The Financial Goal of the
Corporation

• Shareholders desire wealth maximization

• Managers have many constituencies, “stakeholders”
• “Agency Problems” represent the conflict of interest
between management and owners
1-2 The Financial Goal of the
Corporation

• Agency Problems
• Managers, acting as agents for stockholders, may act in their own
interests rather than maximizing value
• Stakeholder
• Anyone with a financial interest in the firm
1-2 THE FINANCIAL GOAL OF THE
CORPORATION
• Agency Problems—Ownership versus
Management

• Difference in Information • Different Objectives

• Stock prices and returns • Managers vs. stockholders
• Issues of shares and other securities • Top mgmt vs. operating mgmt
• Dividends • Stockholders vs. banks and lenders
• Financing

1-14
1-2 The Financial Goal of the
Corporation

• Agency costs are incurred when:

• Managers do not attempt to maximize firm value
• Shareholders incur costs to monitor managers and constrain their
actions
1-2 The Financial Goal of the
Corporation

• Tools to Ensure Management Pays Attention to the Value

of the Firm
• Manager’s actions subject to the scrutiny of board of directors
• Shirkers are likely to find they are ousted by more energetic
managers
• Financial incentives provided, such as stock options