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FUNDAMENTALS OF CORPORATE FINANCE Fourth Canadian Edition Stephen A. Ross Randolph W. Westerfield Bradford D. Jordan Gordon S. Roberts CLICK MOUSE OR HIT SPACEBAR TO ADVANCE Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson,Ltd.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc The University of Lethbridge - Faculty of Management Management 3040Y - Finance Terry D. Harbottle
Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd. Part I:Overview of Corporate Finance Part II:Financial Statements and Long-Term Financial Planning Part III:Valuation of Future Cash Flows Part IV:Capital Budgeting Part V:Risk and Return Part VI:Cost of Capital and Long-Term Financial Policy Part VII:Short-Term Financial Planning and Management Part VIII:Topics in Corporate Finance Part IX:Derivative Securities and Corporate Finance Outline of the Text
Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd. Chapter 1Introduction to Corporate Finance Chapter 2Financial Statements, Taxes, and Cash Flow Chapter 3Working with Financial Statements Chapter 4Long-Term Financial Planning and Corporate Growth Chapter 5Introduction to Valuation: The Time Value of Money Chapter 6Discounted Cash Flow Valuation Chapter 7Interest Rates and Bond Valuation Chapter 8Stock Valuation Chapter 9Net Present Value and Other Investment Criteria Chapter 10Making Capital Investment Decisions Chapter 11Project Analysis and Evaluation Chapter 12Some Lessons from Capital Market History Chapter 13Return, Risk, and the Security Market Line Chapter 14Cost of Capital Table of Contents
Chapter 15Raising Capital Chapter 16Financial Leverage and Capital Structure Policy Chapter 17Dividends and Dividend Policy Chapter 18Short-Term Finance and Planning Chapter 19Cash and Liquidity Management Chapter 20Credit and Inventory Management Chapter 21International Corporate Finance Chapter 22Leasing Chapter 23Mergers and Acquisitions Chapter 24Risk Management: An Introduction to Financial Engineering Chapter 25Options and Corporate Securities Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd. Table of Contents (continued)
T1.1 Chapter Outline Chapter 1 Introduction to Corporate Finance Chapter Organization 1.1Corporate Finance and the Financial Manager 1.2Forms of Business Organization 1.3The Goal of Financial Management 1.4The Agency Problem and Control of the Corporation 1.5Financial Markets, Financial Insts, & the Corporation 1.6Trends in Financial Markets & Financial Mgmt. 1.7Outline of the Text 1.8Summary and Conclusions Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 1999
T1.2 The Four Basic Areas of Finance - Corporate Finance Corporate Finance Long-term investments Capital Budgeting Long-term financing Capital Structure Short-term financing Working Capital Management Financial Risk management Derivative securities Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc Capital Budgeting ‘The Process of planning and managing a firm’s long term investments’ evaluating the size, timing and risk of future cash flows are the key components of capital budgeting overall objective is to identify and invest in projects & assets that will generate a return greater than the firm’s cost of capital
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc Cqpital Structure ‘addresses the the question of how a firm should obtain and manage the long term financing needed to support its long term investments and’ it is the specific mixture of long term debt and equity capital the decision on how much debt vs. Equity impacts the risk level for the firm and the firm’s
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc Working Capital Management Working capital refers to a firms short term assets and short term liabilities includes accounts receivable, inventory and accounts payable how much cash to keep on hand, inventory to carry, credit terms to offer to customers are examples of working capital management decisions
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc Financial Risk Management The process of identifying, quantifying and decisions to manage certain types of risk: currency risks interest rate risks commodity price risk Other risks such as strategic, operating and commerical risks need to be considered by the firm as a whole - ideally looking at risk on an enterprise wide basis (holistic risk management)
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc T1.2 A Simplified Organizational Chart (Figure 1.1) Chairman of the Board and Chief Executive Officer (CEO) Board of Directors President and Chief Operations Officer (COO) Vice President Marketing Vice President Finance (CFO) Vice President Production Treasurer Controller Cash Manager Credit Manager Tax Manager Cost Accounting Manager Capital Expenditures Financial Planning Financial Accounting Manager Data Processing Manager
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc Forms of Organization Sole Proprietorship Partnership General Partnership / Limited Partnership Corporation Limited Liability Company
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc Corporations A corporation is a legal entity separate and distinct from its owners has many of the same rights, duties and privileges of an actual person: borrow money can own property can enter into contracts shareholders and management are usually separate in most larger corporations the sharedolders elect the board of directors the board then selects the senior managers who in theory are charged with running the affairs in the interests of the shareholders
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc Advantages/Dis-advantages of the Corporate Form Advantages ownership (shares) can be readily transferrred life of the corporation is not limited limited liability makes this form attractive to investors all of the above make it easy to raise cash - sells new stock Dis-advantages double taxation of its profits
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc The Goal of Financial Management What are firm decision-makers hired to do? “General Motors is not in the business of makingautomobiles. General Motors is in the business of making money.” Alfred P. Sloan Possible goals Maximize profits Maximize shareholder wealth/value Maximize share price Maximize firm value
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc The Agency Problem and Control of the Firm Agency Relationships and Management Goals potential for conflict - is their too much emphasis on corporate survival, job security and (more recently) with mangement wealth creation? Do managers Act in the Shareholders’ interests? They are influenced by: how they are compensated - does their compensation encourage them to make decisions that will enhance shareholder value how easily are they replaced if they do not pursue shareholder goals - control here is with the board of directors
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc T1.6 The Agency Problem Continued Agency costs Agency Costs - defined as the costs associated with the conflict of interests : Direct agency costs Indirect agency costs Impact of Agency Costs on Shareholder Wealth or Value direct - expenditures benefiting Management e.g. the unneeded corporate jet or direct - monitoring costs e.g. outside auditors indirect - lost opportunity where Management is not acting in the best interests of its shareholders e.g. costly acquisitions driven more by desire for power and prestige
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc Conflict of Interest Will Managers work in the Shareholder’s best interest? Mechanisms to ensure Managers are acting in shareholders’ interest: managerial compensation active and knowledgable iboard of directors Active institutional investors Takeover activity
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc T1.7 Financial Markets Financial Institutions, Markets and the Corporation Financial Institutions Act as intermediaries between investors and firms raising funds - banks, trust companies, investment dealers, insurance companies, etc. direct finance indirect finance
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc T1.7 Financial Markets Continued Financial Markets - brings buyers and sellers of debt and equity securities together How do financial markets differ? Type of securities traded/how trading is conducted and who the buyers and sellers are Money markets and capital markets money market - short term debt securities capital market - long term debt and equity
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc T1.7 Financial Markets Continued Primary vs. secondary markets Primary Market- where the original sale of issue of a security by a government or corporation occurs public offering - underwritten by an investment dealer and registered with provincial securities commissions private placement - debt and equity sold directly to a buyer - typically life insurance companies and, pension funds
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc T1.7 Financial Markets Continued Secondary Market - trading of securities subsequent to the initial sale - enables the transfer of ownership auction market - TSE dealer market - ‘over the counter (OTC) ‘ How do financial markets benefit society?
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc Financial Markets and Society what is the benefit to society? Channel savings into investment produce and transmit information on returns and risk provide a media and a payments system enable the shifting of the timing of consumption over a life cycle enable the management of risk enable the diversification of portfolios
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc T1.9 Financial Markets and the Corporation - Cash Flows Between the Firm and the Financial Markets (Figure 1.2)
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc T1.9 Chapter 1 Quick Quiz Quick Quiz 1. Who performs the financial management function in the typical corporation? 2. What are the major advantages and disadvantages of the corporate form of organization? 3. Why is shareholder wealth maximization a more appropriate goal than profit maximization?
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