Introduction To Corporate Finance

1. Introduction To Corporate Finance

2. 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

3. Chapter 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

4. Corporate Finance • 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?

5. 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, credit management, capital expenditures, and financial planning • Controller – oversees taxes, cost accounting, financial accounting and data processing

6. 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?

7. Forms of Business Organization • Three major forms in the United States • Sole proprietorship • Partnership • General • Limited • Corporation • S-Corp • Limited liability company

8. 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 Sole Proprietorship

9. Advantages Two or more owners More 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 Partnership

10. 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) Corporation

11. Goal Of Financial Management • 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?

12. The Agency Problem • 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 • Management goals and agency costs

13. 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 • Other stakeholders

14. Work 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!

15. Financial Markets • Cash flows to the firm • Primary vs. secondary markets • Dealer vs. auction markets • Listed vs. over-the-counter securities • NYSE • NASDAQ

16. Primary Markets v/s Secondary Markets • Primary Markets: • A market that issues new securities on an exchange. Companies, governments and other groups obtain financing through debt or equity based securities. Primary markets are facilitated by underwriting groups, which consist of investment banks that will set a beginning price range for a given security and then oversee its sale directly to investors.  Also known as "new issue market" (NIM).

17. Secondary Markets • A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. The national exchanges - such as the New York Stock Exchange and the NASDAQ are secondary markets.

18. Dealer and Auction Markets • What Does Auction Market Mean?A market in which buyers enter competitive bids and sellers enter competitive offers at the same time. The price a stock is traded represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to sell at. Matching bids and offers are then paired together and the orders are executed. 

19. An example of Auction Market • The New York Stock Exchange (NYSE) is an example of an auction market. Auction markets differ from over the counter where trades are negotiated. For example, 4 buyers want to buy a share of XYZ and make the following bids: $10.00, 10.02, 10.03 and $10.06. Conversely, there are 4 sellers that desire to sell XYZ and they submitted offers to sell their shares at the following prices: $10.06, 10.09, 10.12 and $10.13. In this scenario, the individuals that made bids/offers for XYZ at $10.06 will have their orders executed. All remaining orders will not immediately be executed and the current price of XYZ will then be $10.06.

20. Dealer Markets • What Does Dealer Market Mean? • A market where dealers are assigned for specific securities. The dealers create liquid markets by purchasing and selling against personal inventory.

21. An example of Dealer Market • An example of Dealer MarketUnlike auction markets, the benefit of this type of market is the rapid access that investors have to buyers and sellers of a particular security. The best example of a dealer market is the Nasdaq.

22. Listed v/s Over-the-Counter Securities • OTC Securities: • A security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, etc. The phrase "over-the-counter" can be used to refer to stocks that trade via a dealer network as opposed to on a centralized exchange. • It also refers to debt securities and other financial instruments such as derivatives, which are traded through a dealer network.

23. A Quick note on Nasdaq • Although Nasdaq operates as a dealer network, Nasdaq stocks are generally not classified as OTC because the Nasdaq is considered a stock exchange. As such, OTC stocks are generally unlisted stocks which trade on the Over the Counter Bulletin Board (OTCBB) or on the pink sheets. • Be very wary of some OTC stocks, however; the OTCBB stocks are either penny stocks or are offered by companies with bad credit records.

24. Quick 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?

25. End of Chapter