Introduction to Corporate Finance

2 Corporate Finance addresses the following three questions: 1. What long-term investments should the firm choose? 2. How should the firm raise funds for the selected investments? 3. How should short-term assets be managed and financed?

3 Balance Sheet Model of the Firm Current Assets Fixed Assets 1 Tangible 2 Intangible Total Value of Assets: Shareholders’ Equity Current Liabilities Long-Term Debt Total Firm Value to Investors:

4 How a Business Can Organize The Sole Proprietorship  The single owner who also runs the business The Partnership  A small group owns and runs the business General Partnership  Like a sole proprietorship, but with several owners Limited Partnership  Bears limited financial risk, and does not help run the business The Corporation  Managers run the business; Equity owns it Separates ownership and control  Used when you need a lot of capital

Agency Issues Shareholders own the firm Managers run the firm for the shareholders  This is an agency relationship Other Ex. Real Estate Agents, Mutual Funds If they do not agree on objectives then we have a problem 5

Historical Example When Washington was building Mt. Vernon, all everything had to come from England So he would write a letter describing what he wanted and send it to London London agent would then “fill order”  “Good enough for America” Washington’s goal? Agent’s goal? 6

7 What is the should managers do? Maximize profit? Minimize costs? Maximize market share? Maximize shareholder wealth?

8 Different Goals Shareholders:  Want big returns on their investments Managers:  Expensive perquisites Private jet, golf memberships, cars, etc.  Company Survival  Independence

9 Managing Managers Managerial compensation  Incentives are used to align management and stockholder interests Ex. Stock Options, Performance Bonuses  The incentives need to be structured carefully to make sure that they achieve their intended goal Corporate control  The threat of a takeover force managers to act in stockholder interest

10 Financial Markets Primary Market  Company issues securities for the first time and keeps the money from their sale Secondary Markets  Individuals buying and selling securities  Company receives no money from these transactions  Examples: NYSE, NASDAQ, London & Tokyo Exchange

11 Financial Markets Firms Investors Secondary Market money securities SueBob Stocks and Bonds Money Primary Market

12 Quick Quiz 1. What are the three basic questions Financial Managers must answer? 2. What are the three major forms of business organization? 3. What is the goal of financial management? 4. What are agency problems, and why do they exist within a corporation? 5. What is the difference between a primary market and a secondary market?