1. Introduction to Corporate Finance
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Introduction to Corporate Finance
Introduction to Corporate Finance

2. Financial Management Goal?
Maximize profit
Risk
Timing
Measuring
Maximize the depth of the carpet in Finance V.P.’s office
Maximize donations to worthy causes
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Introduction to Corporate Finance

3. Introduction to Corporate Finance
Income Statement
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Introduction to Corporate Finance

4. Financial Management Goal?
Maximize the value of the firm or
Maximize the wealth of the firm’s shareholders
Wealth or value is the risk-adjusted present value of all current and future cash flows to be received
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Introduction to Corporate Finance

5. General Valuation Model
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Introduction to Corporate Finance

6. Shareholders vs. Stakeholders
Is maximizing shareholder wealth inconsistent with social welfare?
Employees
Customers
Suppliers
Society
Maximizing shareholder wealth in fact requires a careful balancing of interests
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Introduction to Corporate Finance

7. Introduction to Corporate Finance
Business Goals vs. Individual Goals
Businesses maximize wealth = f{CFt, r}
Individuals maximize eternal utility = f{f2, s2}
“But before ye seek for riches, seek ye first the kingdom of God” Jacob 2:18
“For the love of money is the root of all evil…” Jacob 2:18
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Introduction to Corporate Finance

8. Introduction to Corporate Finance
Maximizing Value or Wealth
Value or wealth = f { cash, risk }
Simple rules:
More cash is preferred to less cash
Cash sooner is preferred to cash later
Less risky cash is preferred to more risky cash
Also, DON’T RUN OUT OF CASH
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Introduction to Corporate Finance

9. Introduction to Corporate Finance
Rules:
More cash is preferred to less cash 1 2 3 4 5
Stock A
$10
Stock B
$20
Stock A’s price is $150
Stock B’s price is $300
Which stock is a better buy?
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Introduction to Corporate Finance

10. Introduction to Corporate Finance
Rules:
More cash is preferred to less cash 1 2 3 4 5
Novell (NOVL)
$.60
$.63
$.66
$.69
$.73
5% growth
TenFold (TENF)
$.79
$.91
$1.05
15 % growth
Novell closed at $10.25
TenFold closed at $30.00
Which stock is a better buy?
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Introduction to Corporate Finance

11. Introduction to Corporate Finance
Rules: Cash sooner is preferred to cash later
Interest rates are 10 percent 1 2 3
T-Bill
$100 $0
T-Note
T-Bill is worth $100
T-Note is worth $75
$75 = $100/ 1.13
Which Treasury is a better buy?
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Introduction to Corporate Finance

12. Introduction to Corporate Finance
Rules:
Less risky cash is preferred to more risky cash 1 2 3 4 5
Chevron Corp. (CHV)
$4.25
$4.46
$4.69
$4.92
$5.17
+/- 50 cents
Wild Cat
+/- 7 dollars
Chevron closed at $77 5/16
Wild Cat closed at $51.1/4
Which stock is a better buy?
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Introduction to Corporate Finance

13. The Balance-Sheet Model of the Firm
Current Assets
Fixed Assets
Tangible
Intangible
Total Value of Assets:
Shareholders’ Equity
Current Liabilities
Long-Term Debt
Total Firm Value to Investors:
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Introduction to Corporate Finance

14. The Balance-Sheet Model of the Firm
The Capital Budgeting Decision
Current Liabilities
Current Assets
Long-Term Debt
Fixed Assets
Tangible
Intangible
What long-term investments should the firm engage in? (is the return on assets greater than the cost of capital?)
Shareholders’ Equity
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Introduction to Corporate Finance

15. The Balance-Sheet Model of the Firm
The Capital Structure Decision
Current Liabilities
Current Assets
How can the firm raise the money for the required investments? (Financing is nothing but an exchange of a sum of money today for a promise to return more money in the future)
Long-Term Debt
Fixed Assets
Tangible
Intangible
Shareholders’ Equity
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Introduction to Corporate Finance

16. The Balance-Sheet Model of the Firm
The Net Working Capital Investment Decision
Current Liabilities
Current Assets
Net Working Capital
Long-Term Debt
Is the firm liquid?
How much cash, accounts receivable, and inventory are needed. How much accounts payable and commercial paper is appropriate?
Fixed Assets
Tangible
Intangible
Shareholders’ Equity
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Introduction to Corporate Finance

17. Introduction to Corporate Finance
Forms of Organization
Proprietorship - single owner
Partnership - co-owners
Corporation - stockholders
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Introduction to Corporate Finance

18. Introduction to Corporate Finance
Forms of Organization
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Introduction to Corporate Finance

19. Introduction to Corporate Finance
Sole Proprietorship
Easy or “cheap” to form
No corporate taxes--taxed as individual
Unlimited liability
Limited life
Limited equity investment
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Introduction to Corporate Finance

20. Partnership (General & Limited)
Not hard to form
Limited partners have limited liability
Difficult to transfer ownership
Dissolves when a general partner dies or withdraws
Limited equity investment
No corporate taxes, taxed as individual income
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Introduction to Corporate Finance

21. Introduction to Corporate Finance
Corporation
Difficult to form
Limited liability
Ease of ownership transfer
Unlimited life
Corporation pays taxes
Access to financing
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Introduction to Corporate Finance

22. International Versions of Corporations
Company Origin In Original Language Translated
Haier China 有限公司 Corporation limited
LG Korea 주식회사 Limited liability company
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Introduction to Corporate Finance

23. Limited Liability Companies (LLC’s)
Created by state law
Governed by the “operating agreement” (rather than by 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
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Introduction to Corporate Finance

24. Differences in Small Company Structures
S corp
C corp
Partnership
Limited liability company
Limited liability
YES NO
Double taxation
Shareholder restrictions
Transferability of shares
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Introduction to Corporate Finance

25. Introduction to Corporate Finance
Corporations
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Introduction to Corporate Finance

26. Introduction to Corporate Finance
Treasurer:
Cash management
Banking and securities
Capital budgeting
Financial analysis
Planning
Controller:
Accounting
Taxes
Credit claims and receivables
Payroll
Data processing
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Introduction to Corporate Finance

27. Introduction to Corporate Finance
Taxes
Progressive
Marginal vs. Average Rate
Interest vs. Dividend Deductibility
Depreciation & Cash Flow
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Introduction to Corporate Finance

28. Introduction to Corporate Finance
Marginal versus Average Corporate Tax Rate
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Introduction to Corporate Finance
Introduction to Corporate Finance

29. Marginal vs Average Tax Rate for Singles and Married
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Introduction to Corporate Finance

30. Introduction to Corporate Finance
Interest vs. Dividends
($20 interest)(.34 tax)=$7
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Introduction to Corporate Finance

31. Role of Financial Assets and Markets in the Economy
Consumption Timing
Allocation and Elimination of Risk
Separation of Ownership
Liquidity
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Introduction to Corporate Finance

32. The Firm and the Financial Markets
Firm issues securities (A)
Financial markets
Invests in assets (B)
Retained cash flows (F)
Cash flow from firm (C)
Dividends and debt payments (E)
Short-term debt
Long-term debt
Equity shares
Current assets Fixed assets
Taxes (D)
The cash flows from the firm must exceed the cash flows from the financial markets.
Ultimately, the firm must be a cash generating activity.
Government
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Introduction to Corporate Finance

33. Introduction to Corporate Finance
Financial Markets
Money Market vs. Capital Market
Primary Market vs. Secondary Market
Spot Market vs. Futures Market
Stock Market vs. Bond and Mortgage Markets
Direct vs. Indirect
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Introduction to Corporate Finance

34. Introduction to Corporate Finance
Stock and Bond Markets
Stock markets
New York Stock Exchange (NYSE)
Nasdaq
American Stock Exchange (AMEX)
Over-the-counter (OTC) markets
Smaller regional markets
Bond markets
Over-the-counter (OTC) markets
New York Stock Exchange (NYSE)
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Introduction to Corporate Finance

35. The Capital Formation Process
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Introduction to Corporate Finance

36. The Financial Market Economy: Example
Consider a dentist who earns $200,000 per year and chooses to consume $80,000 per year. She has $120,000 in surplus money to invest.
She could loan $30,000 to each of 4 college seniors. They each promise to pay her back with interest after they graduate in one year.
$30,000×(1+r)
Student #1
$30,000
$30,000×(1+r)
Dentist
Student #2
$30,000
$30,000
Student #3
$30,000×(1+r)
$30,000
Student #4
$30,000×(1+r)
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Introduction to Corporate Finance

37. The Financial Market Economy: Example
Rather than performing the credit analysis 4 times, he could loan the whole $120,000 to a financial intermediary in return for a promise to repay the $120,000 in one year with interest.
The intermediary in turn loans $30,000 to each of the 4 college seniors.
$30,000×(1+r)
$120,000
Student #1
$30,000
Dentist
Bank
$30,000×(1+r)
Student #2
$30,000
Student #3
$30,000
$30,000×(1+r)
Student #4
$120,000×(1+r)
$30,000
$30,000×(1+r)
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Introduction to Corporate Finance

38. Financial Intermediaries
Maturity spreading
Risk pooling
Packaging economies
Disintermediation of the ‘70s
Financial innovation
Securitization and credit enhancement
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Introduction to Corporate Finance

39. Some Short-term Interest Bearing Securities
CD’s
Commercial Paper
T-Bills
Fed. Funds
Call Money
Banker’s Acceptance
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Introduction to Corporate Finance