1. The University of Lethbridge - Faculty of Management
Management Finance

2. FUNDAMENTALS OF CORPORATE FINANCE
TRANSPARENCY ACETATES
to accompany
FUNDAMENTALS OF CORPORATE FINANCE
Fourth Canadian Edition
Stephen A. Ross Randolph W. Westerfield Bradford D. Jordan Gordon S. Roberts
Prepared by Thomas J. Cottrell
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Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson,Ltd.

3. Outline of the Text 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
Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd.

4. Table of Contents Chapter 1 Introduction to Corporate Finance
Chapter 2 Financial Statements, Taxes, and Cash Flow
Chapter 3 Working with Financial Statements
Chapter 4 Long-Term Financial Planning and Corporate Growth
Chapter 5 Introduction to Valuation: The Time Value of Money
Chapter 6 Discounted Cash Flow Valuation
Chapter 7 Interest Rates and Bond Valuation
Chapter 8 Stock Valuation
Chapter 9 Net Present Value and Other Investment Criteria
Chapter 10 Making Capital Investment Decisions
Chapter 11 Project Analysis and Evaluation
Chapter 12 Some Lessons from Capital Market History
Chapter 13 Return, Risk, and the Security Market Line
Chapter 14 Cost of Capital
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Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd.

5. Table of Contents (continued)
Chapter 15 Raising Capital
Chapter 16 Financial Leverage and Capital Structure Policy
Chapter 17 Dividends and Dividend Policy
Chapter 18 Short-Term Finance and Planning
Chapter 19 Cash and Liquidity Management
Chapter 20 Credit and Inventory Management
Chapter 21 International Corporate Finance
Chapter 22 Leasing
Chapter 23 Mergers and Acquisitions
Chapter 24 Risk Management: An Introduction to Financial Engineering
Chapter 25 Options and Corporate Securities
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6. Chapter 1 Introduction to Corporate Finance
Chapter Organization
1.1 Corporate Finance and the Financial Manager
1.2 Forms of Business Organization
1.3 The Goal of Financial Management
1.4 The Agency Problem and Control of the Corporation
1.5 Financial Markets, Financial Insts, & the Corporation
1.6 Trends in Financial Markets & Financial Mgmt.
1.7 Outline of the Text
1.8 Summary and Conclusions
T1.1 Chapter Outline
Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc. 1999

7. T1.2 The Four Basic Areas of Finance - Corporate Finance
Long-term investments
Capital Budgeting
Long-term financing
Capital Structure
Short-term financing
Working Capital Management
Risk management
Derivative securities
The text only talks to the first 3 - yet they now have an introductory chapter on Risk Management - a still fairly new area in business or at least an evolving area.
These four areas could be seen as the main areas or what defines corporate finance and financial management
the capital budgeting decision is the prioritization of investments in the company - typically co’s have more investment opportunities than capital (discuss anomalies - certain industries at certain times, generate so much cash that they look at things like buying back their own shares)
long term financing is about the capital structure of the firm - the mix of equity and debt that is used to finance the firm’s investments considering all the implications debt and equity and the various forms of each - ie many forms of debt and equity and so called debt/equity hybrids.
Working capital management is about managing the short term cash flows in and out of the firm - cash mgt,, receivables inventories and payables
Risk management - often comes down to the hedging process for finance staff but risk mgt. Is much more than than.
Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd.

8. T1.2 A Simplified Organizational Chart (Figure 1.1)
Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
President and Chief
Operations Officer (COO)
Vice President
Marketing
Vice President
Finance (CFO)
Vice President
Production
Treasurer
Controller
Cash Manager
Credit Manager
Cost Accounting
Manager
Tax Manager
Capital
Expenditures
Financial
Planning
Financial
Accounting
Manager
Data Processing
Manager

9. T1.3 Forms of Organization
Sole Proprietorship
Partnership
General Partnership / Limited Partnership
Corporation
Limited Liability Company
Legal Considerations
How do owners’ roles differ across organizational forms?
Economic Considerations
Why are corporations generally larger than other forms of business?
the sole propriertorship
simplest form of business to start and by definition is owned by one person
profits accrue to the owner and are taxed as personal income
unlimited liability is the main disadvantage - the owners personal assets are at risk
Partnerships - two forms a) general and b) limited
a general partnership - one where all partners share in gains or losses and all have unlimited liability for all partnership debts.
limited partnership - one or more general partners have unlimited liability and run the partnership on behalf of one or more limited partners who are not active in running the business and whose liability is limited to the amount contributed to the partnership - common in real estate ventures
( real estate trusts an example??)
Corporation
separate legal entity from its owners,
limited liability for shareholders, ease of transferring ownership, unlimited life...ownership constantly changes without affecting the business
main ‘disadvantage’ is the issue of double taxation

10. T1.4 Limited Liability Companies
Limited Liability Companies (LLCs)
Created by state law
Governed by the “operating agreement” (rather than articles of incorporation)
Ownership interests - may or may not be evidenced by ownership shares
Legal and Economic Considerations
LLC “members” (i.e., owners) have limited liability
LLC is treated as a partnership for tax purposes
Source: LLCs - A Summary: by David S. Neufeld
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11. T1.5 The Goal of Financial Management
What are firm decision-makers hired to do?
“General Motors is not in the business of making automobiles. 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
these financial mgt goals are really the same as the overall corporate goal of maximizing shareholder value
authors argue that if you maximize shareholder value you probably have done well for other stakeholders in the business - employees, suppliers, communities etc. (the residual owner concept)
maximization of profits is too narrow - what time frame - cutting costs in the short run to improve profits may not be the best in the longer run.....this sets up the dilema that we see in the market place around the emphasis on quarterly earnings - more opportunity to discuss this
shareholder value encompasses not only the value of the stock but dividends - cash generation to pay dividends then is something for the financial mgr to focus on. - why I like the concept of shareholder value as opposed to the firm’s value
maximizing the share price only works for publicly traded firms - what about private firms - focus on maximizing shareholders equity

12. The Agency Problem and Control of the Firm
T1.7 The Agency Problem
The Agency Problem and Control of the Firm
Agency Relationships and Management Goals
potential for conflict - is their too much emphasis on corporate survival and job security?
Do managers Act in the Shareholders’ interests?
Management actions in take-over situations
Mechanisms to ensure Managers are acting in shareholders’ interest:
Managerial compensation Proxy Contest
Board of directors Institutional Investors
Takeover activity
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13. 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
Agency Costs
See the handout on Moore Corporation - good example of conflict of interest and associated costs.
Despite the falling market share, deteriorating financial condition of the company - late the company still had 25 Vice Presidents
an R&D centre that cost more than US $12 million which had failed to generate a new product in 10 years
Control
examples - the text uses Stephen Jobs and Apple Computer, Moore is another example

14. Conflict of Interest
Will Managers work in the Shareholder’s best interest?
Mechanisms to ensure Managers are acting in shareholders’ interest:
Managerial compensation Proxy Contest
Board of directors Institutional Investors
Takeover activity

15. Financial Institutions, Markets and the Corporation
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
Direct Finance
funds are supplied directly from the supplier to the user - they do not pass through an intermediary - bond issue, t-bills, bankers acceptances
the financial institutions earn fees for this process of securitization
Indirect Finance
funds are supplied through an intermediary - like a deposit with a chartered bank - goes onto the bank’s balance sheet and then is turned into loans - the banks are earning a spread on the interest they pay on the deposit vs what they charge on the loan
Table 1.4 in the text shows the top fin. Institutions in Canada
what is going on with our Canadian banks today - large corps but are small by world standards - trend in banking today is the mega corp e.g. Citibank and ???/ , recent merger of Chase and Chemical Bank, Japanese banks - recent Bank Act
what is going on with Insurance companies today - demutualization where they have moved from ownership by policyholders to the traditional corporate shareholder form of organization and ownership
.....lots going on in Canadian and int’l mkts

16. 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
Money Mkt.
money mkt. Instruments are essentially short term IOU’s
bankers acceptance - IOU by a corporation
Treasury Bill - Govt. IOU
money market has not physical location like the TSE - rather it is a collection of dealers who are electronically connected
‘Dealer’ - someone who buys/sells something and takes ownership and risk vs. the broker concept.
Capital Market
longer term debt and equity instruments
characterized by actual physical mkt. Locations like the TSE for equity securities but like the money mkt. The bond mkt. Is a collection of dealers who take ownership positions in bonds
possible change coming here with the TSE considering the trading of bonds.

17. 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
Public Offering
typically underwritten by the investment dealer - buys the securities from the company and then seeks to make a profit by selling them at a higher price to the public.....take on certain risks
interest rate movements
credit risk of the issuing company
public offering can also take the form of a ‘best efforts’ deal where the dealer does not actually buy the securities but only acts as an agent and sells as much of the issue as possible but can return any unsold shares....more on this in Chapter 15
Private Placement
debt and equity instruments are sold directly to pension funds, insurance companies and mutual funds (concept of matching here with need for long term funds being matched with the supply of longer terms funds)
why - avoid regulartory req’ts and costs of public issues

18. 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?
Auction Market
physical location - Bay Street or Wall Street
exchanges match buyers and sellers
OTC or Dealer Market
most of the buying and selling is done by the dealer (money mkt. Concept) where the dealers are again connected electronically
Financial Markets and Society
channel savings into investment - increases the efficiency of allocating savings among the many competing uses for this capital
produce and transmit information on returns and risk - via interest rates and securities prices - both reflect supply & demand factors and risk factors
transaction prices on fin. Markets continually reflect investors evaluations of market alternatives
they pay for this info thru fees to analysts and other sellers of this info as well as thru the bid ask spread in transactions
provide a media and a payments system
moved from exchanging one commodity to accepting paper claims

19. 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
savings - increases the efficiency of of allocating savings among the many competing uses for this capital
produce and transmit info:- via interest rates and security prices - both reflect supply and demand factors and risk factors
transaction prices on fin. Mkts continually reflect investors evaluations of market alternatives
they pay for this via direct fees to analysts and other sellers of this info and thru the bid-ask spread in transactions
media & payments system - moved from exchanging one commodity for another to accepting paper claims
Shifting the timing of consumption over a life cycle
borrowing and lending facilitated by fin. Mkts allows people to shift the timing of their use or consumption of lifetime incomes and wealth.
managing risk
various forms of insurance
hedging opportunities
diversification of portfolios

20. T Financial Markets and the Corporation - Cash Flows Between the Firm and the Financial Markets (Figure 1.2)
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21. 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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