Chapter 1 FC

Introduction to Corporate Finance

CHAPTER 1

• Corporate Finance and the Financial Manager

• Forms of Business Organization

• The Goal of Financial Management

• The Agency Problem and Control of the Corporation

• Financial Markets and the Corporation

Chapter Outline

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).

• Other financial managers include:
• 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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Financial Management Decisions

How do we manage the day-to-day finances of the firm?

Working capital management

How should we pay for our assets? Should we use debt or equity?

Capital structure

What long-term investments or projects should the business take on?

Capital budgeting

Capital budgeting

Capital structure

Working capital management

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Forms of Business Organization

Limited Liability Company

Corporation

General Limited

Partnership

Sole Proprietorship

Disadvantages

• Limited to life of owner
• Equity capital limited to owner’s personal wealth
• Unlimited liability
• Difficult to sell ownership interest

Sole Proprietorship

Advantages

• Easiest to start
• Least regulated
• Single owner keeps all the profits
• Taxed once as personal income

Disadvantages

• Unlimited liability

General partnership Limited partnership

• Partnership dissolves when one partner dies or wishes to sell
• Difficult to transfer ownership

Partnership

Advantages

• Two or more owners
• More capital available
• Relatively easy to start
• Income taxed once as personal income

Disadvantages

• Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)

Corporation

Advantages

• Limited liability
• Unlimited life
• Separation of ownership and management
• Transfer of ownership is easy
• Easier to raise capital

The business life cycle

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?

The Agency Problem

Agency relationship

• Principal hires an agent to represent his/her interests
• Stockholders (principals) hire managers (agents) to run the company

Agency problem

• Conflict of interest between principal and agent

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Managing Managers

Managerial compensation

• Incentives can be used to align management and stockholder interests.
• The incentives need to be structured carefully to make sure that they achieve their goal.

Corporate control

• The threat of a takeover may result in better management.
• Other stakeholders

• Is it ethical for tobacco companies to sell a product that is known to be addictive and a danger to the health of the user? Is it relevant that the product is legal?
• Should boards of directors consider only price when faced with a buyout offer?
• Is it ethical to concentrate only on shareholder wealth, or should stakeholders as a whole be considered?
• Should firms be penalized for attempting to improve returns by stifling competition (e.g., Microsoft)?

Ethics Issues

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Financial Markets

• Cash flows to and from the firm
• Primary vs. secondary markets

Dealer vs. auction markets Listed vs. over-the-counter securities NYSE NASDAQ

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Primary MarketsDealer vs. auction markets

Secondary MarketsListed vs. over-the-counter securities

Quick Quiz

• What are the three types of financial management decisions and what questions are they designed to answer?
• What are the three major forms of business organization?
• What is the goal of financial management?
• What are agency problems and why do they exist within a corporation?
• What is the difference between a primary market and a secondary market?

Chapter 1

End of chapter