Finance

10-200A
1

CLASS 1:
INTRODUCTION TO
CORPORATE FINANCE
Chapter 1 – Fundamentals of Corporate Finance
 Class Overview
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A. What is finance? What is corporate finance?

B. The types of financial management decisions
C. The goal of the financial manager
D. Agency relationship in financial management
E. Capital markets
F. Different forms of business organization
A - What is finance? 3
Why finance?

Definition:
 Studying different
variables to make money-
related decisions
 Key concept: money $$$

Who makes decisions?

 Individuals
 Companies
 Financial institutions
 Government,
municipalities
 Corporate Finance
4
One branch of finance

Definition of corporate finance:

 Financial decision-making for a company
 Role of: financial manager, CFO, treasurer etc

Some important questions that are answered using finance

 Whatlong-term investments should the firm take on?
 Where will we get the long-term financing to pay for the investment?

 How will we manage the everyday financial activities of the firm?

Financial managers try to answer some or all of these

questions
 B - Financial Management Decisions
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o 3 decisions to make in Corporate Finance:

1. Capital Budgeting (investment decisions)

• What LT investments (assets) should the firm undertake?
• What projects should you undertake?

2. Capital Structure (funding decisions)

• Where and how to secure LT financing for projects and assets?

3. Working capital management

• How do we manage the day-to-day finances of the firm?
 Financial Management Decisions
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o Graphically…
 C - The goal of financial management
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 What should be the goal of a corporation?

 Maximize profit?
 Minimize costs?
 Maximize market share?
 Maximize the current value of the company’s stock?

 Ordinary shareholders:
 Seat on the Board
 Election of the financial manager
 Right to vote
 Satisfaction = ???
 The goal of financial management
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Three equivalent goals of financial management (or

financial manager) :
 Maximize shareholder wealth
 Maximize share price
 Maximize firm value

 Does this mean we should do anything and everything to

maximize owner wealth???

 Limitations of this objective:

 Corporate social responsibility and ethical investing
 LT goal
 Agency problem
 D - Agency relations
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Definition agency relationships:

 Relationship where a person (principal) hires another person (agent) to represent his or her interests

In a corporation... who is the agent and who is the principal?

 Stockholders (principals) hire managers (agents) to run the company

Definition agency problems:

 Conflicts of interest can exist between the principal and the agent

 Sometimes managers do not act in the best interests of shareholders…

 Not necessarily fraud...just biaised

In other words...

 The Board of Directors delegates management of the firm to managers by establishing an Executive
Committee
 Interest of managers does not always align with that of shareholders! It is possible that the
manager's personal interests will come before those of shareholders…

 these misalignment of interests are called agency problems...

 Agency relations
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Agency costs:
 Costs resulting from agency problems
 Who pays for these costs?

Examples:
 Discretionary expense account used for the personal benefit of the manager.
 Company-owned assets used for the well-being of the manager (limousine, private jet,
etc.)
 Unjustified acquisitions of companies in order to increase the prestige of the manager.
 Refusal of certain value-added projects in order not to increase the risk of the firm.
 Control expenditures to monitor officers (internal auditor)

How can we reduce the costs associated with agency problems?

 Several means are put in place:
 Managerial compensation  shares or options
 Active and independent Board of Directors
 E - Capital markets
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Financial markets can be classified as either:

 Money market: short term debt securities
 Capital markets: long term debt and shares of stock eg: TSX
exchange is a capital market

The issuance of securities on the capital markets:

 Primary market:
 The original sale of securities by governments and corporations. The
money goes to the issuer (government or corporations) of the stock

 Secondary market:
 Transfer of ownership of securities between investors: markets where
securities are bought and sold after the original sale
 Investors trade securities for money
 F - Different forms of business organization
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Advantages:

Sole
proprietorshi Partnership Corporation
p
Easiest to start Relatively easy to start Limited liability

Least regulated Not much regulations Unlimited life

Single owner keeps all the Separation of ownership and

Owners keep the profit
profits management

More human and financial Transfer of ownership is easy

Limited funding
capital available and easier to raise capital
 Different forms of business organization
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Disadvantages:

Sole
proprietorshi Partnership Corporation
p
Unlimited liability Unlimited liability Complex

Partnership dissolves when one partner

Limited to life of owner Very regulated
dies or wishes to sell

Equity capital limited to owner’s

Difficult to transfer ownership Double taxation
personal wealth

Separation of ownership and

Possible disagreements between
Difficult to sell ownership interest management  agency conflicts
partners
possible