Cf chap 1 final

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Salman Masood Sheikh
M.Com, MBA, M.Phil, Ph.D (Scholar),
FCMA, FPFA, ACPA, AITM, CA (Int)
Associate Dean / Director Quality Assurance
Faculty of Management Sciences, Superior University Lahore
Professional Experience: 7 Years as Manager Finance
Academic Experience: 13 Years (Teaching)
Contact # 0300-6337009
E-mail ID: directorqa@superior.edu.pk
Resource Person Introduction

McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
11
Introduction To
Corporate Finance
Salman Masood Sheikh
M.Com, MBA, M.Phil, Ph.D (Scholar),
FCMA, FPFA, ACPA, AITM, CA (Int)
Director Quality Assurance
Superior University Lahore

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Key Concepts and SkillsKey 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

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Chapter OutlineChapter Outline
 Corporate Finance and the
Financial Manager
 Forms of Business Organization
 The Goal of Financial Management
 The Agency Problem and Control
of the Corporation
 Financial Markets and the
Corporation

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Corporate (Company)Corporate (Company)
 Corporations are the most common form of business
organization, and one which is chartered by a state and given
many legal rights as an entity separate from its owners. This
form of business is characterized by the limited liability of its
owners, the issuance of shares of easily transferable stock,
and existence as a going concern. The process of becoming
a corporation, called incorporation, gives the company
separate legal standing from its owners and protects those
owners from being personally liable in the event that the
company is sued (a condition known as limited liability).
 A company is defined as an artificial judicial person, having a
perpetual secession and a common seal with the limited
liability upto the shares of the owners invested in amount.

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FinanceFinance??
 A branch of economics concerned with resource allocation
as well as resource management, acquisition and
investment. Simply, finance deals with matters related to
money and the markets.
 A foremost concept in finance concerns how individuals
interact in order to allocate resources (capital) and/or shift
consumption across time by borrowing or investing.

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Financial ManagerFinancial Manager
 The top financial manager within a firm is
usually the Chief Financial Officer (CFO)
 Treasurer – oversees cash management, credit
management, capital expenditures, and
financial planning
 Controller – oversees taxes, cost accounting,
financial accounting and data processing

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Figure 1.1 Hypothetical OrganizationFigure 1.1 Hypothetical Organization
ChartChart
Cash Manager Credit Manager
Capital Expenditures Financial Planning
Treasurer
Tax Manager Cost Accounting
Manager
Financial Accounting
Manager
Data Processing
Manager
Controller
Vice President and
Chief Financial Officer (CFO)
President and Chief
Operations Officer (COO)
Chairman of the Board and
Chief Executive Officer (CEO)
Board of Directors

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Duties of Finance ManagerDuties of Finance Manager
 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?

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Corporate Finance DecisionsCorporate Finance 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?

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

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FirmFirm
Current Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders’
Equity
Current
Liabilities
Long-Term
Debt
What long-
term
investments
should the
firm engage
in?
The Capital Budgeting Decision
(Investment Decision)

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FirmFirm
How can the
firm raise the
money for the
required
investments?
The Capital Structure Decision
(Financing Decision)
Current Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders’
Equity
Current
Liabilities
Long-Term
Debt

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FirmFirm
How much
short-term cash
flow does a
company need
to pay its bills?
The Net Working Capital Investment Decision
(Financial Decision)
Net
Working
Capital
Shareholders’
Equity
Current
Liabilities
Long-Term
Debt
Current Assets
Fixed Assets
1 Tangible
2 Intangible

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Forms of Business OrganizationForms of Business Organization
 Three major forms of Business
Organization
 Sole proprietorship
 Partnership
 General
 Limited
 Corporation

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Sole ProprietorshipSole Proprietorship
 Advantages
 Easiest to start
 Least regulated
 Single owner keeps
all the profits
 Taxed once as
personal income
 Disadvantages
 Limited to life of
owner
 Equity capital limited
to owner’s personal
wealth
 Unlimited liability
 Difficult to sell
ownership interest

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PartnershipPartnership
 Advantages
 Two or more owners
 More capital available
 Relatively easy to
start
 Income taxed once as
personal income
 Disadvantages
 Unlimited liability
 Partnership dissolves
when one partner dies
or wishes to sell
 Difficult to transfer
ownership

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CorporationCorporation
 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 taxed at the
corporate rate and
then dividends taxed
at the personal rate)

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Most Important Goal Of CompanyMost Important Goal Of Company
 What should be the goal of a corporation?
 Survival?
 Avoid Financial distress and Bankruptcy?
 Maximize profit?
 Minimize costs?
 Maximize market share?
 Maximize the current value of the company’s
stock?

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Market Vs. Intrinsic valuesMarket Vs. Intrinsic values
 Market values are what investors are willing to
either buy or sell an asset for, based on
investors’ expectations of future performance.
 Market values are very often publicly observed, e.g.,
the transactions in the stock markets.
 In contrast, intrinsic values are usually
considered as private estimates of what
something, e.g., a common stock, is actually
worth.
 Intrinsic value is not something that you can prove.
 If ten analysts are asked to value IBM stock, then
there will likely be ten different intrinsic value
estimates!

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Financial goals of the corporationFinancial goals of the corporation
 The primary financial goal is shareholder wealth
maximization — a function of future cash flow and risk.
 In reality, this is maximizing intrinsic value
 For now we will assume that this is synonymous with
maximizing the market value, i.e., stock price maximization.

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The Agency Concept and ControlThe Agency Concept and Control
of Corporationof Corporation
 Agency relationship
 Principal hires an agent to represent his/her
interests
 Stockholders (principals) hire managers
(agents) to run the company
 Agency problem
 Conflict of interest between principal and agent
a) For example: Investment with Increase in
market share and Risk

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 Agency Cost
 Cost of conflict of interest between stockholders
and management.
 Types of Agency Cost
1) Direct
a) Corporate Expenditure that benefits the Management
but costs the shareholders
b) Expense that arise from the need to monitor
Management Actions
2) Indirect
a) Lost Opportunity
Management Goals &Management Goals &
Agency CostAgency Cost

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Managing ManagersManaging 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
 Hiring and firing of Managers through Elections
 The threat of a takeover may result in better
management
 Other stakeholders

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Code of CorporateCode of Corporate
GovernanceGovernance

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Financial MarketsFinancial Markets
 Money Market
 Deals with Short Term Investments
 Capital Market
 Deals with Long Term Investments
 Primary Market
 Deals with Initial Public Offering
 Secondary market
 Deals with Invested Securities

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Cash Flows between the Firm &Cash Flows between the Firm &
The Financial MarketsThe Financial Markets
Taxes
Firm Invests
in assets
(B)
Current assets
Fixed assets
Cash flow
from firm (C)
Financial
markets
Short-term debt
Long-term debt
Equity shares
Government
(D)
Firm issues securities (A)
Retained
cash flows (E)
Dividends and
debt payments (F)

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Work the Web ExampleWork the Web Example
 The Internet provides a wealth of
information about individual companies
 One excellent site is finance.yahoo.com
 Click on the web surfer to go to the site,
choose a company and see what
information you can find!

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Quick QuizQuick Quiz
 What are the three types of financial management
decisions and what questions are they designed
to answer?
 What are the three major forms of business
organization?
 What is the goal of financial management?
 What are agency problems and why do they exist
within a corporation?
 What is the difference between a primary market
and a secondary market?

McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
11
End of Chapter
Thank You for
Your Attention

Cf chap 1 final

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