Because learning changes everything.

Principles of Corporate Finance, 14th

Edition
Chapter 1: Introduction to Corporate Finance

Brealey, Myers, Allen, and Edmans

© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
 Topics Covered
Corporate Investment and Financing Decisions.
The Financial Goal of the Corporation.
Preview of Coming Attractions.

© McGraw Hill 2
 Corporate Investment and Financing
Decisions 1

Real assets.
• Assets used to produce goods and services.

Financial assets.
• Financial claims to the income generated by the firm’s real
assets.

© McGraw Hill 3
 Corporate Investment and Financing
Decisions 2

Investment decision.
• Purchase of real assets.

Financing decision.
• Sale of financial assets.

© McGraw Hill 4
 Investment Decisions
Capital budgeting decision.
• Decision to invest in tangible or intangible assets.
• Also called the investment decision.
• Also called capital expenditure or CAPEX decisions.

© McGraw Hill 5
 Table 1.1 Examples of Recent Investment and
Financing Decisions by Major Public Corporations

Company Recent Investment Decisions Recent Financing Decisions

Intel (U.S.) Invests $7 billion in expanding Borrows $600 million from

semiconductor plant in Chandler, Chandler Industrial Development
Arizona. Authority.
Amazon (U.S.) Acquires self-driving start-up, Zoox, Reinvests $33 billion that it
for over $1.2 billion generates from operations
Tesla (U.S.) Announces construction of new Announces plans to sell $2 billion
plant to build the electric of shares
Cybertruck
Shell (U.K./Holland) Starts production at a deep-water Cuts dividend to preserve cash
development in the Gulf of Mexico
GlaxoSmithKline (U.K.) Spends $6 billion on research and Raises $1 billion by an issue 8-
development for new drugs. year bonds
Ørsted (Denmark) Completes a 230-MW wind farm in Arranges a borrowing facility with
Nebraska 14 international banks
Unilever (U.K./Holland) Spends $8 billion on advertising Pays a dividend and completes
and marketing $200 million program to buy back
shares
Carnival Corporation Launches four new cruise ships Raises $770 million by sale of
(U.S./U.K.) bonds; each bond can be
converted into about 19 shares

© McGraw Hill 6
 Financing Decisions
Shareholders are equity investors.
• Contribute equity financing.
Capital structure decision.
• Choice between debt and equity financing.
• Capital refers to firm’s sources of long-term financing.

© McGraw Hill 7
 What Is a Corporation?
Corporation.
• A business organized as a separate legal entity owned by
shareholders.
Types of Corporations.
• Public companies.
• Private corporations.
• Limited liability corporations (LLC).

© McGraw Hill 8
 Other Forms of Business Organization
Sole proprietorships.
Partnerships.
Corporations.
Limited liability options.
• Limited liability partnerships.
• Limited liability companies.
• Professional limited liability companies.

Limited liability: The owners of a corporation are not

personally liable for its obligations.

© McGraw Hill 9
 Figure 1.1 Flow of Cash Between Financial Markets and the
Firm’s Operations

1) Cash raised by selling financial assets to investors.

2) Cash invested in the firm’s operations and used to purchase real
assets.
3) Cash generated by the firm’s operations.
4) (a) Cash reinvested (b) Cash returned to investors.
Access the text alternative for these images

© McGraw Hill 10
 The Financial Goal of the Corporation 1

Stockholders want three things.

• To maximize current wealth.
• To transform wealth into most desirable time pattern of
consumption.
• To manage risk characteristics of chosen consumption
plan.
How can the financial manager help the shareholder?
• Maximize Wealth (Fisher Separation Theorem)

© McGraw Hill 11
 The Financial Goal of the Corporation 2

Profit maximization.
Not a well-defined financial objective.
• Which year’s profits?
• Shareholders will not welcome higher short-term profits if
long-term profits are damaged.
• Company may increase future profits by cutting year’s
dividend, investing freed-up cash in firm.
• Not in shareholders’ best interest if company earns less than
opportunity cost of capital.

© McGraw Hill 12
 Agency Problem 1

Agency problem.
• Managers are agents for stockholders and are tempted to
act in their own interests rather than maximizing value.
Agency cost.
• Value lost from agency problems or from the cost of
mitigating agency problems.

© McGraw Hill 13
 Agency Problem 2

Do managers maximize shareholder wealth or manager

wealth?
Corporate governance.
• The laws, regulations, institutions, and corporate practices
that protect shareholders and other investors.

© McGraw Hill 14
 Should Managers Maximize Shareholder Wealth?

Managers have many constituencies or stakeholders.

Stakeholder: Other parties affected by the company, such as
customers, employees, suppliers, the environment,
communities, and taxpayers.
Should managers work for shareholders or stakeholders?

© McGraw Hill 15
 Investment Trade-Off
The investment trade-off.
Hurdle rate/cost of capital.
• Minimum acceptable rate of return on investment.

Opportunity cost of capital.

• Investing in a project eliminates other opportunities to use
invested cash.

© McGraw Hill 16
 Figure 1.2 Investment Trade-Off

Arrows represent possible cash flows or transfers.

Access the text alternative for these images

© McGraw Hill 17
 Key Questions in Finance 1

• How do I calculate the rate of return?

• Is a higher rate of return on investment always better?
• What determines value in financial markets?
• What are the cash flows?

© McGraw Hill 18
 Key Questions in Finance 2

• How does the financial manager judge whether cash flow

forecasts are realistic?
• How do we measure risk?
• How does risk affect the opportunity cost of capital?
• Where does financing come from?
• How do companies issue new debt or equity?

© McGraw Hill 19
 Key Questions in Finance 3

• How does the company’s payout policy affect shareholder

wealth?
• Debt or equity? Does it matter?
• How do we ensure that managers act in shareholders’
interest?
• Should managers maximize shareholder wealth or social
value?

© McGraw Hill 20
 End of Main Content

Because learning changes everything. ®

[Link]

© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.