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L.chapter 1. Overview of CF (New) - SV
L.chapter 1. Overview of CF (New) - SV
L.chapter 1. Overview of CF (New) - SV
ACADEMY OF FINANCE
CORPORATE FINANCE
DEPARMENT
1
Learning objectives
- What is finance?
- What is corporate finance?
- What is financial management?
Chapter 1: Overview of Corporate Finance
Financial decisions
Financing Dividend
Investment Working capital
decision decision decision
management
Chapter 1: Overview of Corporate Finance
Investment decision
(Capital budgeting)
Debt
1.1 Corporate finance
Investors are lenders
Equity
Financing decision Investors become
(Capital structure) owners
Flexibility in structuring
To raise money for
No promise to pay
investment & operation
dividend
Long-term
consequences
Chapter 1: Overview of Corporate Finance
Pay dividend
Dividend decision
To allocate returns Shareholders’
return
Reinvest
Share
in Business
price
profitable growth
increases
projects
Treasurer Controller
- Cash management
- Prepare financial statements
- Raise new capital
- Internal budget and accounts
- Relationship with banks &
- Tax affairs
other investors
Ensure efficient use of capital
Obtain & manage capital
Chapter 1: Overview of Corporate Finance
1.1 Corporate finance
The financial manager
Partnership
Advantage ?
Corporation
Disadvantage?
Limited liability
company
Chapter 1: Overview of Corporate Finance
Sole
Form of business Partnership Corporation
proprietorship
Separation of ownership
No No Yes
and management
Separation of personal
No No Yes
and corporate tax liability
Chapter 1: Overview of Corporate Finance
Advantages Disadvantages
Owned by an individual, make it Unlimited personal liability for the
easily and inexpensively business’s debts. If the business
formed and easy to manage fails, the sole proprietor is personal
Has tax advantage because only pay liable for the debt.
personal income tax (Taxed once as Difficult to obtain large sums of
personal income tax) capital to facilitate growth and
Few Government and reporting expansion.
regulations Difficult to transfer to another
Minimize agency problems related It has limited life. It exist only the
to separation of ownership rights owner does.
and control/management
Chapter 1: Overview of Corporate Finance
or business associates.
• Common business structure associated with professional occupations
(such as lawyers or accountants)
• Business is governed by a legal partnership agreement
• Partnership agreement sets out:
- responsibilities in making decisions
- how profits are divided.
• Each partner has unlimited liability on debts
Note: Sole proprietorship and Partnership have tax advantage, i.e they just pay
personal income tax, no corporate income tax liability
1.2. Forms of business organization
2 Partnership:
Advantages Disadvantages
Taxed once as personal income tax Still hard to raise capital compared
Easy to establish to corporation
Able to raise funds when there is The partners have unlimited
more than one owner liabilities to the business
Improved management with more Not easy to transfer without the
than one owner agreement of the remaining partners
Wider pool of knowledge, skills, and All partners have to bear legal
contacts responsibilities equally if being sued
Has limited life, when the owners
die, the business does not exist
Chapter 1: Overview of Corporate Finance
Tax liability
3 Corporation :
Advantages Disadvantages
Easy to raise fund Double tax (Taxed separately from
Easily transferable between individual, income is taxed twice)
different owners: shares are traded Costly to set up and exist
in the market Obey a lot of regulations and
Limited liabilities: Owners are not reports
subject to losses beyond the amount Conflict between “big”
originally invested shareholders and “small”
Improved management shareholders.
Unlimited life. If the investors die, Agency problem
the company still lives
Chapter 1: Overview of Corporate Finance
• LLP is similar to a LLC but are used for professional firms, such as
accountants, lawyers, architects and real estate businesses (often called
professional corporation, the business has limited liability, but the
professionals can still be sued personally, for example for malpractice)
Advantages Disadvantages
Utilize the advantages of limited Complicated structure
and unlimited forms General partners have unlimited
Limited partners have limited liability for the company’s debt
liability
Have tax advantage (pay personal
income tax)
Chapter 1: Overview of Corporate Finance
1.3. Goals of financial management
Profit
maximization?
Applying different
accounting principles
The goal of financial management
• Because the firm can earn a return on funds it receives, the receipt
of funds sooner rather than later is preferred.
• In our example, in spite of the fact that the total earnings from Rotor
are smaller than those from Valve, Rotor provides much greater
earnings per share in the first year. The larger returns in year 1
could be reinvested to provide greater future earnings.
• Cash Flows
• Profits do not necessarily result in cash flows available to the
stockholders. Owners’ cash flows are in the form of cash
dividends or the proceeds from selling shares for a higher
price than initially paid. Greater EPS do not necessarily mean
that a firm’s board of directors will vote to increase dividend
payments.
• Furthermore, higher EPS do not necessarily translate into a
higher stock price.
• Risk
• Profit maximization also disregards risk—the chance that actual
outcomes may differ from those expected.
• A basic premise in managerial finance is that a trade-off exists
between return (cash flow) and risk. Return and risk are in fact the
key determinants of share price, which represents the wealth of the
owners in the firm.
• Higher cash flow is generally associated with a higher share price.
Higher risk tends to result in a lower share price because the
stockholder must be compensated for the greater risk.
Maximize Shareholder Wealth
No
Reject
When considering each financial decision alternative or possible action in terms of its impact on the share price
of the firm’s stock, financial managers should accept only those actions that are expected to increase share price.
Chapter 1: Overview of Corporate Finance
1.3. Goals of financial management
The focus of this subject is primarily on public companies (companies that are
listed on a recognised stock exchange) and are owned by the shareholders
who hold company equity capital.
Interest conflict
Do managers
really maximize
value? Agency
problem
Managers do not
behave for
shareholders’ best
interests
Chapter 1: Overview of Corporate Finance
* The stock market: a market on which securities are issued & traded.
+ Maturity:
Financial
intermediaries
Shares (1)
Investors Mutual funds Pension funds %Paycheck Employees
$$$ (2)
Portfolios
Investment return
Chapter 1: Overview of Corporate Finance
Financial institutions
Insurance
companies
Chapter 1: Overview of Corporate Finance
Obligations
Funds
Banks
Insurance Cos. Intermediary
Brokerage firms
Obligations Funds
Depositors
Policymakers Investor
Investors
Chapter 1: Overview of Corporate Finance
1.4. Financial institutions and markets
* Functions of financial markets:
Functions
Information provision Liquidity
Payment mechanism
Chapter 1: Overview of Corporate Finance
Summary
a. Financial management can be broken down into the investment or capital
budgeting decision, financing decision and dividend decision. The firm has to
decide how much to invest and which real assets to invest in and how to raise
the necessary cash and how to distribute the profit.
b. Almost all managers are involved to some degree in investment decisions, but
some managers specialize in finance, for example, the treasurer, controller, and
CFO).
c. Value maximization is the natural financial goal of the firm. Maximizing
value maximizes the wealth of the firm’s owners; its shareholders. Shareholders
can invest or consume that wealth as they wish.
d. Conflicts of interest between managers and stockholders can lead to agency
problems. These problems are kept in check by compensation plans that link the
well-being of employees to that of the firm; by monitoring of management by
the board of directors, security analysts, and creditors; and by the threat of
takeover.
Chapter 1: Overview of Corporate Finance
Summary
e. The ultimate source of financing is individuals’ savings. The savings may flow
through financial markets and intermediaries. The intermediaries include mutual
funds, pension funds, and financial institutions, such as banks and insurance
companies.
f. Mutual and pension funds allow investors to diversify in professionally managed
portfolios. Pension funds offer an additional tax advantage, because the returns on
pension investments are not taxed until withdrawn from the plan.
g. Financial markets help channel savings to corporate investment, and they help
match up borrowers and lenders. They provide liquidity and diversification
opportunities for investors. Trading in financial markets provides a wealth of useful
information for the financial manager.
Chapter 1: Overview of Corporate Finance
Summary
h. Financial institutions carry out a number of similar functions but in different way.
They channel savings to corporate investment, and they serve as intermediaries
between borrowers and lenders. They provide liquidity for depositors and, of course,
play a special role in the economy's payment systems. Insurance company allow
policyholders to pool risks.
i. In conclusion, Corporate finance is a field of economics relating to financing,
investing and dividend decisions within a company. These decisions are conducted in
an effective way and oriented to the value maximazation objective by financial
managers of the firms.