Corporate Finance BUSN 6020

Dr. Alex Ng

What is Corporate Finance

• Aims to answer these questions…
1. What long-term investments should we make?
= Capital Budgeting
Chapter 1
Introduction to Corporate Finance 2. Where will we get the funds to pay for investments?
1.1 Corporate Finance and the Financial Manager = Capital Structure
1.2 The Goal of Financial Management
1.3 Forms of Business Organization 3. How will we collect from customers to pay bills?
1.4 The Agency Problem and Control of the Corporation = Working Capital
1.5 Financial Markets, Financial Institutions, and the Corporation
1.6 Trends in Financial Markets & Financial Management
1.7 Outline of the Text
1.8 Summary and Conclusions
© Dr. Alex Ng, Thompson Rivers University

What Opportunities Can the

Simplified Organizational Chart
Company Pursue Growth?
• Customers Board of Directors

• Relevance
• Capability Chairman of the Board and
Chief Executive Officer (CEO)

• Crises
• Cost Efficiency
President and Chief
Operations Officer (COO)

• Corporate Social Responsibility

Vice President Vice President Vice President
Marketing Finance (CFO) Production

Treasurer Controller

Cash Manager Credit Manager Cost Accounting

Tax Manager
Manager

Financial Financial Data Processing

Capital
Accounting Manager
Expenditures Planning
Manager

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Corporate Finance BUSN 6020
Dr. Alex Ng

The Goal of Financial Management The Goal of Financial Management Cont’d

• What are firm decision-makers hired to do? • Three equivalent goals of financial management:

“ General Motors is not in the business of

making automobiles. General Motors is in 1. Maximize shareholder wealth
the business of making money.”
– Alfred P. Sloan
2. Maximize share price
• Possible goals:
• Survive in business 3. Maximize firm value
• Avoid financial distress, bankruptcy

• Beat the competition and more

The Role of the Financial Manager The Role of the Financial Manager

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Corporate Finance BUSN 6020
Dr. Alex Ng

Forms of Organization Limited Liability Companies

• Sole Proprietorship • Created by law

• Partnership • Governed by “operating agreement” (not articles of incorporation)

• General Partnership / Limited Partnership
• Ownership interest – may or may not evidenced by ownership shares
• Corporation
• Limited Liability Company • Legal and economic considerations

• Legal Considerations • Limited liability

• How do owners’ roles differ across forms? • Partnership for tax
purposes
• Economic Considerations
• Why are corporations generally larger than other forms?

The Agency Problem

LO4 Managing Managers
• The agency relationship

• Will managers work in the shareholders’ best interests?

• Managerial compensation
– Incentives can be used to align management and
• Direct agency costs stockholder interests
• Indirect agency costs – The incentives need to be structured carefully to
make sure that they achieve their goal
• Control of the firm
• Corporate control
• How do agency costs affect firm value (and shareholder wealth)?
– The threat of a takeover may result in better
management
• Conflicts with other stakeholders

© 2013 McGraw-Hill Ryerson Limited

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Corporate Finance BUSN 6020
Dr. Alex Ng

MANAGERIAL COMPENSATION The Agency Problem

• Management frequently has a significant economic
incentive to increase share value for two reasons:
• compensation is usually tied to financial performance in
general and often to the share value in particular.
– For example, managers are frequently given the option to buy stock at
current prices. The more the stock is worth, the more valuable this
option becomes.9
• better job prospects i.e. getting promoted.
– Successful managers are in greater demand in the labor market and
thus command higher salaries.
• Compensation sometimes get off track
– Excessive management pay and unauthorized management
consumption are examples of agency costs.

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Financial Markets Financial Markets Cont’d

• What is the role of financial markets in corporate finance? • Direct vs. Indirect Finance

• Cash flows to and from the firm • Financial intermediary such as investment dealers – indirect

• Money markets and capital markets • Banks giving loans – direct

• Primary vs. secondary markets

• How do financial markets benefit society?

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Corporate Finance BUSN 6020
Dr. Alex Ng

Cash Flows Between the Firm and the Financial Markets Trends in Financial Markets and Financial Management
Total Value of the Firm • Financial engineering
Total Value of to Investors in
Firm’s Assets the Financial Markets
• Creation of new securities/financial processes

• Help to reduce risk, lower financing costs, and/or minimize tax

A. Firm issues securities
B. Firm Financial
invests in Markets
assets • i.e. Junk bond
E. Retained cash flows F. Dividends and Short-term debt
Long-term debt
Current debt payments
Equity shares
• Globalization
Assets
Fixed C. Cash flow from
Assets firm’s assets • International trade of stocks and bonds

• Computer technology

• Breakdown of four pillars of finance: bank, trusts, insurance and

D. Government investment dealers

• Open competition

Quiz Answers – Chapter 1

1.Who performs the financial management function in the typical corporation?
The Treasurer

2. What are the major advantages and disadvantages of the corporate form of
organization?
Advantages: limited liability for stockholders, unlimited life for
business = easy to raise capital
Disadvantages: double taxation

3.Why is shareholder wealth maximization a more appropriate goal than profit

maximization?
Is ambiguous – short or long-term? This year or 5 years from now?
Creates conflict… profit vs. risk, more profit involves more risk
Shareholder wealth maximization reflects both profit and risk goals.