0. Principles of Corporate Finance
Session 1 & 2
Unit I: INTRODUCTION

1. Why study Managerial Finance?
Prepare for the workplace of tomorrow.
Broadening expectations of financial knowledge and skills.
Use and understand financial terminology and concepts in team communication.
Developing cross-functional capabilities.
Critical thinking.

2. Career Opportunities in Finance
Capital Budgeting Analyst
Project Finance Manager
Cash Manager
Banking & Financial Institutions
Personal Financial Planning
Investments
Pension Fund Manager
Real Estate
Insurance
Financial Analyst

3. What is Finance? Finance is the art and science of managing money.
Finance affects all individuals, businesses, and governments in the process of the transfer of money through institutions, markets, and instruments.

4. Managerial Finance
Managerial finance is concerned with the duties of the financial manager in the business firm.
The financial manager actively manages the financial affairs of any type of business, whether private or public, large or small, profit-seeking or not-for- profit.
Increasing globalization has complicated the financial management function.
Changing economic and regulatory conditions also complicate the financial management function.

5. Principles of Corporate Finance
Session 3

6. Firm and its Legal forms
A Firm is a transformation unit, which transforms inputs ( 5 M’s) into Outputs (Goods & Services)

7. Firm and its Legal forms
Four basic forms of business organization (Firm):
Sole Proprietorships
Partnerships (general and limited)
Corporations
Limited liability companies

8. Sole Proprietorship
A business form for which there is one owner. This single owner has unlimited liability for all debts of the firm.
Oldest form of business organization.

9. Summary for Sole Proprietorship
Advantages
Simplicity
Low setup cost
Quick setup
Single tax filing on individual form
Disadvantages
Unlimited liability
Hard to raise additional capital
Transfer of ownership difficulties

10. Partnership
A business form in which two or more individuals act as owners.
Types of Partnerships
General Partnership – all partners have unlimited liability and are liable for all obligations of the partnership.
Limited Partnership – limited partners have liability limited to their capital contribution (investors only). At least one general partner is required and all general partners have unlimited liability.

11. Summary for Partnership
Advantages
Can be simple
Low setup cost, higher than sole proprietorship
Relatively quick setup
Limited liability for limited partners
Disadvantages
Unlimited liability for the general partner
Difficult to raise additional capital, but easier than sole proprietorship
Transfer of ownership difficulties

12. Corporation A business form legally separate from its owners.
An artificial entity that can own assets and incur liabilities.

13. Summary for Corporation
Advantages
Limited liability
Easy transfer of ownership
Unlimited life
Easier to raise large quantities of capital
Disadvantages
Double taxation
More difficult to establish
More expensive to set up and maintain

14. Limited Liability Companies
A business form that provides its owners (called “members”) with corporate-style limited personal liability and the federal-tax treatment of a partnership.

15. Principles of Corporate Finance
Session 4 & 5

16. The Managerial Finance Function
Relationship to Economics
The primary economic principal used by financial managers is marginal analysis which says that financial decisions should be implemented only when benefits exceed costs.

17. The Managerial Finance Function
Relationship to Accounting
One major difference in perspective and emphasis between finance and accounting is that accountants generally use the accrual method while in finance, the focus is on cash flows.
The significance of this difference can be illustrated using the following simple example.

18. The Managerial Finance Function
Relationship to Accounting
The Zasloff Corporation experienced the following activity last year:
Sales: $100,000 (50% still uncollected)
Cost of Goods: $ 60,000 (all paid in full under supplier terms)
Expenses: $ 30,000 (all paid in full)
Now contrast the differences in performance under the accounting method versus the cash method.

19. The Managerial Finance Function
Relationship to Accounting
INCOME STATEMENT SUMMARY
ACCRUAL CASH
Sales $100, $ 50,000
-COGS (60,000) (60,000)
Gross Margin $ 40, $(10,000)
-Expenses (30,000) (30,000)
Net Profit/(Loss) $ 10, $(40,000)

20. Principles of Corporate Finance
Session 6

21. Key Activities of the Financial Manager

22. Most important of the three decisions.
Investment Decisions
Most important of the three decisions.
What is the optimal firm size?
What specific assets should be acquired?
What assets (if any) should be reduced or eliminated?

23. Financing Decisions
Determine how the assets (LHS of balance sheet) will be financed (RHS of balance sheet).
What is the best type of financing?
What is the best financing mix?
What is the best dividend policy (e.g., dividend-payout ratio)?
How will the funds be physically acquired?

24. Asset Management Decisions
How do we manage existing assets efficiently?
Financial Manager has varying degrees of operating responsibility over assets.
Greater emphasis on current asset management than fixed asset management.

25. Principles of Corporate Finance
Session 7

26. Goal of the Financial Manager
Profit maximization (profit after tax)
Shareholder’s Wealth Maximization

27. Goal of the Financial Manager
Profit Maximization
Maximizing the Rupee Income of Firm
Resources are efficiently utilized
Appropriate measure of firm performance
Serves interest of society also

28. Objections to Profit Maximization
Goal of the Financial Manager
Objections to Profit Maximization
It is Vague
It Ignores the Timing of Returns
It Ignores Risk
Assumes Perfect Competition
In new business environment profit maximization is regarded as
Unrealistic
Difficult
Inappropriate
Immoral.

29. level & timing of cash flows
Goal of the Financial Manager
Maximize Shareholder Wealth!!!
Why?
Because maximizing shareholder wealth properly considers cash flows, the timing of these cash flows, and the risk of these cash flows.
This can be illustrated using the following simple valuation equation:
level & timing of cash flows
Share Price = Future Dividends
Required Return
risk of cash flows

30. Goal of the Financial Manager
What About Other Stakeholders?
Stakeholders include all groups of individuals who have a direct economic link to the firm including:
Employees
Customers
Suppliers
Creditors
Owners
The "Stakeholder View" prescribes that the firm make a conscious effort to avoid actions that could be detrimental to the wealth position of its stakeholders.
Such a view is considered to be "socially responsible."

31. Principles of Corporate Finance
Session 8

32. Risk-return Trade-off
Risk and expected return move in tandem; the greater the risk, the greater the expected return.
Financial decisions of the firm are guided by the risk-return trade-off.
The return and risk relationship: Return = Risk-free rate + Risk premium
Risk-free rate is a compensation for time and risk premium for risk.

33. The Agency Issue The Problem
Whenever a manager owns less than 100% of the firm’s equity, a potential agency problem exists.
In theory, managers would agree with shareholder wealth maximization.
However, managers are also concerned with their personal wealth, job security, fringe benefits, and lifestyle.
This would cause managers to act in ways that do not always benefit the firm shareholders.

34. The Agency Issue Resolving the Problem
Market Forces such as major shareholders and the threat of a hostile takeover act to keep managers in check.
Agency Costs may be incurred to ensure management acts in shareholders interests.
Structure management compensation to make
shareholder interests their own