Introduction to corporate

finance

Forms of B.O.: Limited (LLC.s,

Ltd.s, etc.) vs. unlimited
Limited vs. unlimited
Limited liability share capital firms
Limited by guarantee
Limited by capital
Unlimited liability share capital firms

Common forms of (for profit) business organisation

Sole Proprietorship
Partnership (2-10 banking; 20 others: IPA, 1932)
Limited Liability Partnership (2-unlimited: LLP Act, 2008)
Limited Company (2-200 for Pvt. Ltd. Company; 7 or more for a
Public Ltd. Company; ICA 1956/2013)

Financial management
Fundamental financial theories have been
developed around decisions taken in the
corporate setting (Corporate Finance
Decisions) though the underlying logic is
generic and applicable to similar decision
settings whether corporate or any other
form of business organisation (Financial
Management Decisions).

What is Corporate Finance?

Corporate Finance addresses the following
four questions:
1. What long-term investments should the firm
choose?
2. How should the firm raise funds for the selected
investments?
3. Whether to reinvest surplus or return to the
investors?
4. How should short-term assets be managed and
financed?

Balance Sheet Model of the

Firm
Total Value of Assets:

Current
Assets

Total Firm Value to Investors:

Current
Liabilities
Long-Term
Debt

Fixed Assets
1 Tangible
2 Intangible

Shareholders
Equity

The Capital Budgeting or

Investment Decision
Current
Liabilities

Current
Assets

Fixed Assets
1 Tangible
2 Intangible

Long-Term
Debt

What long-term
investments
should the firm
choose?

Shareholders
Equity

The Capital Structure or

Financing Decision
Current
Assets

How should the

firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible
2 Intangible

Current
Liabilities
Long-Term
Debt

Shareholders
Equity

Capital Structure
The value of the firm can be
thought of as a pie.
The goal of the manager is
to increase the size of the
pie.
The Capital Structure
decision can be viewed as
how best to slice the pie.

70%50%30%
25%
DebtDebt
Equity
75%
50%
Equity

If how you slice the pie affects the size of the pie,
then the capital structure decision matters.

The Firm, Financial Markets and

The Dividend Decision
Firm

Firms issue Securities (A)

Investors invests in assets (B)
Retained
cash flows (F)

Current assets
Fixed assets

Financial
markets
Short-term debt
Long-term debt

Dividends and
debt payments (E)

Equity shares

Taxes (D)

Cash flow
from firm (C)

Ultimately, the firm

must be a cash
generating activity.

Government

The cash flows from

the firm must exceed
the cash flows from
the financial markets.

Liquidity vs. Profitability and the

Short-Term Asset Management
Decision
Current
Assets

Fixed Assets
1 Tangible
2 Intangible

Current
Liabilities

Net
Working
Capital

How should
short-term assets
be managed and
financed?

Long-Term
Debt

Shareholders
Equity

Role of Financial Manager

The Financial Managers primary goal is to
increase the value of the firm by:
1. Selecting value creating projects
2. Making smart financing decisions
3. Deciding on payout and its form
4. Deciding on WC and its efficient
management

Finance in organizational structure

(Hypothetical Organization Chart)
Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
President and Chief
Operating Officer (COO)
Vice President and
Chief Financial Officer (CFO)

Treasurer

Controller

Cash Manager

Credit Manager

Tax Manager

Cost Accounting

Capital Expenditures

Financial Planning

Financial Accounting

Data Processing

The Goal of Financial Management

What is the correct goal?
Maximize profit?
Minimize costs?
Maximize market share?
Maximize shareholder wealth?

How to make sure that the shareholder

wealth is getting maximized?

Agency problem
Separation of ownership and management (information
asymmetry)
Agency problem arises when agents (managers) have a
conflict of interest against principals (owners)
It results in sub-optimal behaviour of managers who may have
an incentive (moral hazard) to engage in activities which may
decrease or destroy firm value (adverse selection) or limit
action on opportunities for enhancement of firm value (risk
aversion)
Agency problem results in loss in firm value either due to
suboptimal behaviour manager or due to cost of monitoring
born to control suboptimal behaviour.
Corporate governance
Executive compensation and performance measurement