FINA1310 Session I

Introduction to Corporate Finance

 Learning Objectives

Define the basic types of

financial management Explain the goal of
decisions and the role of financial management
the financial manager

Articulate the financial Explain the conflicts of

implications of the interest that can arise
different forms of between managers and
business organization owners

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Finance: A Quick Look

 Financial topics are usually grouped into five main areas:

 Corporate finance is the focus of this course
 Investments deals with financial assets (e.g., stocks and
bonds)
– Career paths in this field include becoming a financial advisor,
portfolio manager, or security analyst
 Financial institutions are businesses that deal primarily in
financial matters (e.g., banks and insurance companies)
 International finance careers generally involve international
aspects of either corporate finance, investments, or financial
institutions
 Fintech is the combination of technology and finance

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Corporate Finance and the Financial Manager

 What is corporate finance?

 Corporate finance, broadly speaking, is the study of
ways to answer these three questions:
1. What long-term investments should you take on (i.e., what
lines of business will you be in and what sorts of buildings,
machinery, and equipment will you need?)

2. Where will you get the long-term financing to pay for your
investment? Will you bring in other owners or will you
borrow the money?

3. How will you manage your everyday financial activities,

such as collecting from customers and paying suppliers?
Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 The Financial Manager

 Owners (i.e., stockholders) of large corporations are usually

not directly involved in making business decisions, especially
on a day-to-day basis
 Corporations employ managers to represent the owners’
interests and make decisions on their behalf
 Financial management function is usually associated with a
top officer of the firm, such as a vice president of finance of the
chief financial officer (CFO)
 Vice president of finance coordinates activities of the treasurer
and the controller
 Controller’s office handles cost and financial accounting, tax
payments, and management information systems
 Treasurer’s office is responsible for managing the firm’s cash
and credit, financial planning, and capital expenditures

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 A Sample Simplified Organizational Chart

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Goal of Financial Management

 In a for-profit business, the goal of financial

management is to make money or add value for the
owners
 What are some possible financial goals of a
corporation?
 Goals tend to fall into two classes:
– Profitability goals relate to different ways of earning or
increasing profits (e.g., sales, market share, and cost
control)
– Goals focused on controlling risk (e.g., bankruptcy
avoidance, stability, and safety)
 From the stockholders’ point of view, what is a good
financial management decision?
Goal of financial management is to maximize the
current value per share of the existing stock

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Financial Management Decisions

 The financial manager must be concerned with three

basic types of questions:
1. Capital budgeting is the process of planning and
managing a firm’s long-term investments
– Evaluating the size, timing, and risk of future cash flows
is the essence of capital budgeting
2. Capital structure is the mixture of debt and equity
maintained by a firm
– How much should the firm borrow (i.e., what mixture of
debt and equity is best)?
– What are the least expensive sources of funds for the
firm?
3. Working capital management refers to a firm’s short-
term assets and liabilities
Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Cash Flows Between the Firm and Financial Markets

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Forms of Business Organization

 Large firms are almost all organized as corporations

Three different legal forms of business organization



exist, each with its own advantages and

disadvantages for the life of the business, the ability
of the business to raise cash, and taxes:
1. Sole proprietorship
2. Partnership
3. Corporation

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Business Organization: Sole Proprietorship

Sole proprietorship is a business owned by a single

individual
Advantages include the following:
 Simplest type of business to start
 Least regulated form of organization
 Owner keeps all the profits

 Disadvantages include the following:

 Owner has unlimited liability for business debts
 All business income is taxed as personal income
 Life of sole proprietorship is limited to owner’s life span
 Amount of equity that can be raised is limited to the
amount of the proprietor’s personal wealth
 Ownership may be difficult to transfer

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Business Organization: Partnership

A partnership is a business formed by two or more

individuals or entities
 General partnership versus limited partnership
Advantages and disadvantages are basically the same
as those of a proprietorship
Primary disadvantages of sole proprietorships and
partnerships are the following, which add up to a single,
central problem of the inability to raise cash for
investment:
 Unlimited liability for business debts on the part of the
owners
 Limited life of the business

 Difficulty of transferring ownership

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Business Organization: Corporation

A corporation is a business created as a distinct legal



entity composed of one or more individuals or entities

 Legal “person,” separate and distinct from its owners
with many of the rights, duties, and privileges of an
actual person
 Stockholders and managers are usually separate groups

 Advantages include the following:

 Ownership can be readily transferred
 Life of corporation is unlimited

 Limited liability for stockholders

 Significant disadvantage includes the following:

 Double taxation, meaning corporate profits are taxed
twice, first at the corporate level when they are earned
and again at the personal level when they are paid out
Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Stakeholders

 Management and stockholders are not the only

parties with an interest in the firm’s decisions
 Employees, customers, suppliers, and even the
government all have a financial interest in the firm

 A stakeholder is someone other than a

stockholder or creditor who potentially has a
claim on the cash flows of the firm
 Such groups will also attempt to exert control over
the firm, perhaps to the detriment of the owners

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 The Agency Problem and Control of the Corporation

Relationship between stockholders and management is

called an agency relationship
 Exists when someone (the principal) hires another (the agent)
to represent his or her interests
The agency problem is the possibility of conflict of
interest between the stockholders and management of a
firm
Agency costs refer to the costs of the conflict of interest
between stockholders and management
 Indirect agency costs are lost opportunities
 Direct agency costs come in two forms:
1. Corporate expenditures that benefits management but costs
the stockholder (e.g., luxurious and unneeded corporate jet)
2. Expense that arises from the need to monitor management
actions
Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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 Do Managers Act in the Stockholder’s Interests?

 Managerial compensation
 Management will frequently have a significant economic
incentive to increase share value for two reasons:
1. Managerial compensation is usually tied to financial
performance in general and often to share value in
particular
2. Managers who are successful in pursuing stockholder goals
will be in greater demand in the labor market and thus
command higher salaries
 Control of the firm
 Stockholders ultimately control the firm, as they elect the
board of directors, who in turn hire and fire managers
 Existing management may be replaced by stockholders via
proxy fights and takeovers

Source: Ross, Westerfield, Jordan, Lim, and Tan © 2022 McGraw Hill. All rights reserved.
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