Chapter McGraw-Hill Ryerson © 2013 McGraw-Hill Ryerson Limited Introduction To Corporate Finance 1 Prepared by Anne Inglis

1-1 Key Concepts and Skills Know the basic types of financial management decisions and the role of the financial manager Know the financial implications of the different forms of business organization Know the goal of financial management Understand the conflicts of interest that can arise between owners and managers Understand the various types of financial markets and financial institutions Understand current trends in Canadian financial markets © 2013 McGraw-Hill Ryerson Limited

1-2 Corporate Finance 1.1 Some important questions that are answered using finance What long-term investments should the firm take on? Where will we get the long-term financing to pay for the investment? How will we manage the everyday financial activities of the firm? LO1 © 2013 McGraw-Hill Ryerson Limited

Parallels in Personal Life What long term investments should we take? Go to graduate school? Get CGA designation? How to pay for our investments? From parents? Student loan? Work? How to manage everyday income and spending? It is often easier than in firms for you don’t have to argue with others. But you might lack discipline. 1-3

1-4 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) Treasurer – oversees cash management, capital expenditures and financial planning Controller – oversees taxes, cost accounting, financial accounting and data processing LO1 © 2013 McGraw-Hill Ryerson Limited

1-5 Financial Management Decisions Capital budgeting What long-term investments or projects should the business take on? Capital structure How should we pay for our assets? Should we use debt or equity? Working capital management How do we manage the day-to-day finances of the firm? LO1 © 2013 McGraw-Hill Ryerson Limited

Capital Structure in Our Life Capital: Equity and debt Children: Financed by equity or debt? University: Equity or debt? After earning income: credit card and mortgage Equity or debt? Raising children: Distribute dividend Old age: direction of wealth flow? 1-6

1-7 Forms of Business Organization 1.2 Three major forms in Canada Sole proprietorship Partnership General Limited Corporation In other countries, corporations are also called joint stock companies, public limited companies and limited liability companies LO2 © 2013 McGraw-Hill Ryerson Limited

1-8 Sole Proprietorship Advantages Easiest to start Least regulated Single owner keeps all the profits Taxed once as personal income Disadvantages Unlimited liability Limited to life of owner Equity capital limited to owner’s personal wealth Difficult to sell ownership interest A business owned by a single individual. LO2 © 2013 McGraw-Hill Ryerson Limited

1-9 Partnership Advantages Two or more owners More human and financial capital available Relatively easy to start Income 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 Possible disagreements between partners A business formed by two or more co-owners. LO2 © 2013 McGraw-Hill Ryerson Limited

1-10 Corporation Advantages Limited liability Unlimited life Separation of ownership and management Transfer of ownership is easy Easier to raise capital Disadvantages Separation of ownership and management Double taxation (income is taxed at the corporate rate and then dividends are taxed at the personal rate) A business created as a distinct legal entity owned by one or more individuals or entities. LO2 © 2013 McGraw-Hill Ryerson Limited

1-11 Work the Web Example The Internet can help people to get information about how to start a new business One excellent site is Click on the web surfer to go to the site and see what information you can find! © 2013 McGraw-Hill Ryerson Limited LO2

1-12 Goal Of Financial Management 1.3 What should be the goal of a corporation? Maximize profit? Minimize costs? Maximize market share? Maximize the current value of the company’s stock? Does this mean we should do anything and everything to maximize owner wealth? LO3 © 2013 McGraw-Hill Ryerson Limited

1-13 The Agency Problem 1.4 Agency relationship Principal hires an agent to represent their interests Stockholders (principals) hire managers (agents) to run the company Agency problem Conflicts of interest can exist between the principal and the agent Agency costs Direct agency costs Indirect agency costs LO4 © 2013 McGraw-Hill Ryerson Limited

1-14 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 Conflicts with other stakeholders LO4 © 2013 McGraw-Hill Ryerson Limited

1-15 Social Responsibility and Ethical Investing Investors are increasingly demanding that corporations behave responsibly Issues include how a corporation treats the community in which it operates, their customers, corporate governance, their employees, the environment and human rights LO5 © 2013 McGraw-Hill Ryerson Limited

Controversial business activities include alcohol, gaming, genetic engineering, nuclear power, pornography, tobacco and weapons The increase of these business activities indicate that ethical investing is not really what we practice, although it is what we preach. 1-16

1-17 Work the Web Example The Internet provides a wealth of information about individual companies One excellent site is ca.finance.yahoo.com Click on the web surfer to go to the site, choose a company and see what information you can find! © 2013 McGraw-Hill Ryerson Limited LO5

1-18 What is the role of financial markets in corporate finance? 1.5 Cash flows to and from the firm Money vs. capital markets Primary vs. secondary markets One excellent site for information on Canadian companies that trade in secondary markets is Click on the web surfer to go to the site, choose a company and see what information you can find! LO5 © 2013 McGraw-Hill Ryerson Limited

1-19 Financial Institutions 1.6 Financial institutions act as intermediaries between suppliers and users of funds Institutions earn income on services provided: Indirect finance – Earn interest on the spread between loans and deposits Direct finance – Service fees (i.e. bankers acceptance and stamping fees) LO5 © 2013 McGraw-Hill Ryerson Limited

1-20 Trends in Financial Markets and Management 1.7 Financial Engineering Derivative Securities Advances in Technology – i.e. E-business Deregulation Corporate Governance Reform Hedge Funds Sub-prime Market LO5 © 2013 McGraw-Hill Ryerson Limited