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Lecture 1a
(chapters 1 and 2)

Introduction To
Corporate Finance

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1.1 Lecture Outline
• Corporate Finance and the Financial Manager
• Forms of Business Organization
• The Goal of Financial Management
• The Agency Problem
• Financial Markets and the Corporation
• Financial Statements
• Taxes
• Cash Flaw

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1.2 Corporate Finance
• Some important questions that are answered
using finance
– What long-term investments should the firm take
on? (capital budgeting)
– Where will we get the long-term financing to pay
for the investment? (capital structure)
– How will we manage the everyday financial
activities of the firm? (working capital
management)

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1.3 Financial Manager
• Financial managers try to answer some or all of
these questions
• The top financial manager within a firm is
usually the Chief Financial Officer (CFO)
– Treasurer – oversees cash management, credit
management, capital expenditures and financial
planning
– Controller – oversees taxes, cost accounting,
financial accounting and data processing

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1.4 Forms of Business Organization
• Three major forms in the united states
– Sole proprietorship
– Partnership
• General
• Limited
– Corporation
• S-Corp
• Limited liability company

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1.5 Sole Proprietorship
• Advantages • Disadvantages
– Easiest to start – Limited to life of owner
– Least regulated – Equity capital limited to
– Single owner keeps all owner’s personal wealth
the profits – Unlimited liability
– Taxed once as personal – Difficult to sell
income ownership interest

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1.6 Partnership
• Advantages • Disadvantages
– Two or more owners – Unlimited liability
– More capital available • General partnership
– • Limited partnership
Relatively easy to start
– – Partnership dissolves
Income taxed once as
personal income when one partner dies or
wishes to sell
– Difficult to transfer
ownership

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1.7 Corporation
• Advantages • Disadvantages
– Limited liability – Separation of ownership
– Unlimited life and management
– Separation of ownership – Double taxation (income
and management taxed at the corporate rate
– Transfer of ownership is and then dividends taxed
easy at personal rate)
– Easier to raise capital

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1.8 Goal Of Financial Management
• What should be the goal of a corporation?
– Maximize profit?
– Minimize costs?
– Maximize market share?
– Maximize the current value of the company’s
stock?

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1.9 The Agency Problem
• Agency relationship
– Principal hires an agent to represent their interest
– Stockholders (principals) hire managers (agents) to
run the company
• Agency problem
– Conflict of interest between principal and agent
• Management goals and agency costs
• Ethics

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1.10 Financial Markets
• Cash flows to the firm
• Primary vs. secondary markets
– Dealer vs. auction markets
– Listed vs. over the counter securities
• NYSE
• NASDAQ

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1.11 Balance Sheet
• The balance sheet is a snapshot of the firm’s
assets and liabilities at a given point in time
• Assets are listed in order of liquidity
– Ease of conversion to cash
– Without significant loss of value
• Balance Sheet Identity
Assets = Liabilities + Stockholders’ Equity

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1.12 The Balance Sheet - Figure 2.1

Work the Web:

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1.13 Net Working Capital and Liquidity
• Net Working Capital
– Current Assets – Current Liabilities
– Positive when the cash that will be received over the next
12 months exceeds the cash that will be paid out
– Usually positive in a healthy firm
• Liquidity
– Ability to convert to cash quickly without a significant loss
in value
– Liquid firms are less likely to experience financial distress
– But, liquid assets earn a lower return
– Trade to find balance between liquid and illiquid assets

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1.14 US Corporation Balance Sheet – Table 2.1

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1.15 Market Vs. Book Value
• The balance sheet provides the book value of
the assets, liabilities and equity.
• Market value is the price at which the assets,
liabilities or equity can actually be bought or
sold.
• Market value and book value are often very
different.
• Which is more important to the decision-
making process?

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1.16 Income Statement
• The income statement is more like a video of
the firm’s operations for a specified period of
time.
• You generally report revenues first and then
deduct any expenses for the period
• Matching principle – GAAP say to show
revenue when it accrues and match the expenses
required to generate the revenue

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1.17 US Corporation Income Statement – Table 2.2

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1.18 Taxes
• The one thing we can rely on with taxes is that
they are always changing
• Marginal vs. average tax rates
– Marginal – the percentage paid on the next dollar
earned
– Average – the tax bill / taxable income
• Other taxes

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1.19 Example: Marginal Vs. Average Rates
• Suppose your firm earns $4 million in taxable
income.
– What is the firm’s tax liability?
– What is the average tax rate?
– What is the marginal tax rate?
• If you are considering a project that will
increase the firm’s taxable income by $1
million, what tax rate should you use in your
analysis?

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1.20 The Concept of Cash Flow
• Cash flow is one of the most important pieces of
information that a financial manager can derive
from financial statements
• Cash is generated from utilizing assets:
Cash Flow From Assets = Operating Cash Flow
– Net Capital Spending – Changes in NWC
• Cash is paid to those that finance the purchase
of the assets:
Cash Flow From Assets (CFFA) = Cash Flow to
Creditors + Cash Flow to Stockholders

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1.21 Example: US Corporation

• OCF (I/S) = EBIT + depreciation – taxes = $547

• NCS ( B/S and I/S) = ending net fixed assets –
beginning net fixed assets + depreciation = $130
• Changes in NWC (B/S) = ending NWC – beginning
NWC = $330
• CFFA = 547 – 130 – 330 = $87
• CF to Creditors (B/S and I/S) = interest paid – net
new borrowing = $24
• CF to Stockholders (B/S and I/S) = dividends paid –
net new equity raised = $63
• CFFA = 24 + 63 = $87

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1.22 Cash Flow Summary Table 2.5

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