Corporate Finance

1. Corporate Finance FINA1003, Fall 2009 Xiaohui Gao Faculty of Business and Economics University of Hong Kong Corporate Finance, Xiaohui Gao

2. Chapter 1: Introduction to Corporate Finance What is corporate finance Forms of business organization Role and goal of the financial manager Agency Problems Financial markets and the corporation Corporate Finance, Xiaohui Gao

3. What is Corporate Finance? What long-term investments should the firm take on? (Capital budgeting) Where will we get the long-term financing to pay for the investment? (Capital structure) How will we manage the everyday financial activities of the firm? (Working capital) Corporate Finance, Xiaohui Gao

4. Business Organizations In terms of organization, business falls into the following four categories: Sole Proprietorships Partnerships Corporations Hybrids forms (of the above basic 3 types) They differ in their ownership, taxation form, the liability limitation, and the ability to raise cash. Corporate Finance, Xiaohui Gao

5. Sole Proprietorships Manager is the sole owner; bears all the costs and keeps all the profits after taxes Personal liability for the business activity is unlimited Firm profit is taxed only once This type of the firm is easy to establish Corporate Finance, Xiaohui Gao

6. Partnerships Several entrepreneurs come together to set up a business, by pooling money and expertise A partnership agreement sets out how management decisions are taken, profits are shared etc. General partner; limited partner Unlimited personal liability Firm profit is taxed only once This type of the firm is easy to establish Corporate Finance, Xiaohui Gao

7. Corporation A legal entity separate from its owners (shareholders) Limited liability for the business activity from its owners, ownership transfer is easy Firm profit is double taxed This type of the firm is difficult and expensive to establish Separation of ownership and management Corporate Finance, Xiaohui Gao

8. Corporate Structure Unlimited liability Personal tax on profits Sole Proprietorships Partnerships Limited liability Corporate tax on profits + Personal tax on dividends Corporations Corporate Finance, Xiaohui Gao

9. Who is the Financial Manager Financial manager: responsible for a significant corporate investment or financing decision. The financial managers in large corporations: Chief Financial Officer (CFO): financial policy, corporate planning Treasurer: cash management, raising capital, banking relationships Controller: preparation of financial statement, accounting, taxes Corporate Finance, Xiaohui Gao

10. Financial Management Decisions • Capital Budgeting Decision (investment decision) • Determine the size, timing, and risk of future cash flows that can be generated by investments • Financing Decision • Determine how to raise the money needed • Determining the mix and tenure of the security to be issued • Working Capital Management • Manage day-to-day finances of the firm. Corporate Finance, Xiaohui Gao

11. Questions Are the following capital budgeting or financing decisions? Issuing shares of stock to finance the construction of a new manufacturing plant. Buying the rights to use NFL logos on clothing. Borrowing money from the bank to repurchase shares of stock in the secondary market. Hiring a new researcher at an automobile company. Corporate Finance, Xiaohui Gao

12. Goals of a Corporation • Shareholders value maximization • This is the only clear and unambiguous objective on which most shareholders agree • Do managers always maximize value? • The answer is NOT ALWAYS. • How closely are management goals aligned with stockholder goals? (compensation) • Is the manager easy to be replaced? (control) Corporate Finance, Xiaohui Gao

13. Agency Problems Agency relationship between shareholders and managers Managers are Agents Agency problems are represented by agency costs (direct or indirect) How do agency costs affect firm value (and shareholder wealth)? Corporate Finance, Xiaohui Gao

14. Management Behavior • Agents have considerable freedom to act • Personal Benefits and corporate perks • Management is constrained by numerous forces. • Compensation Plans • Board of Directors Oversight • Takeovers • Specialist (Analyst) Monitoring • Financial Market Discipline Corporate Finance, Xiaohui Gao

15. Financial Markets The Purpose of Financial Markets Issue Debt Issue Equity Company Investors Cash Corporate Finance, Xiaohui Gao

16. Financial Markets • Consist of Primary and Secondary markets • Primary markets: where a new issue of securities (primary issue) takes place • Secondary markets: where investors trade securities among themselves • Exchange markets- NYSE, AMEX, NASDAQ • Over-the-counter (OTC) – OTCBB, pink sheets • A primary issue, such as an IPO, increases the amount of securities held by the public, and also the cash within the issuing company • Trading in the secondary market usually does not generate cash inflows or outflows for the company Corporate Finance, Xiaohui Gao

17. Careers in Finance • Corporate Finance • Financial analyst • Financing decision and investment decision • Financial Institutions • Banks • Insurance Companies • Finance Companies and Mortgage Banking • www.careers-in-business.com Corporate Finance, Xiaohui Gao

18. What you should be capable of now Explain the advantages and disadvantages of the most common forms of business organization. Cite the major business functions and decisions that the firm’s financial managers are responsible for and understand some of the possible career choice in finance. Explain why it makes sense for corporations to maximize their market values. Show why conflicts of interest may arise in large organizations and discuss how corporations can provide incentives for everyone to work toward a common end. Explain the role of financial markets. Corporate Finance, Xiaohui Gao

19. After-class Notes Get the textbook and a financial calculator (if you haven’t done so). Read Chapter 1 together with the lecture notes. Work on the concept questions at the end of Chapter 1. Corporate Finance, Xiaohui Gao