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Introduction to corporate

finance

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Forms of B.O.: Limited (LLC.’s,

Ltd.’s, etc.) vs. unlimited• Limited vs. unlimited

 – Limited liailit! s"are capital firms

• Limited ! #uarantee

• Limited ! capital

 – $nlimited liailit! s"are capital firms

• Common forms of (for profit) usiness or#anisation – %ole &roprietors"ip

 – &artners"ip ('* an+in# '* ot"ers: I&-, /')

 – Limited Liailit! &artners"ip ('unlimited: LL& -ct, '**0) – Limited Compan! (''** for &vt. Ltd. Compan! 1 or more for a

&ulic Ltd. Compan! IC- 234'*/)

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Financial mana#ement

• Fundamental financial t"eories "ave een

developed around decisions ta+en in t"e

corporate settin# (Corporate Finance

5ecisions) t"ou#" t"e underl!in# lo#ic is

#eneric and applicale to similar decision

settin#s 6"et"er corporate or an! ot"er

form of usiness or#anisation (Financial7ana#ement 5ecisions).

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8"at is Corporate Finance9

Corporate Finance addresses t"e follo6in#four uestions:

. 8"at lon#term investments s"ould t"e firm

c"oose9

'. ;o6 s"ould t"e firm raise funds for t"e selected

investments9

/. 8"et"er to reinvest surplus or return to t"e

investors9

<. ;o6 s"ould s"ortterm assets e mana#ed and

financed9

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="e Capital Bud#etin# or

Investment 5ecision

Current

Assets

Fixed Assets

1 Tangible

  2 Intangible

Shareholders

’ Equity

Current

Liabilities

Long-Termebt

What long-terminvestmentsshould the firmchoose?

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="e Capital %tructure or

Financin# 5ecision

How should the

firm raise funds

for the selected

investments?

Current

Assets

Fixed Assets

1 Tangible

  2 Intangible

Shareholders

’ Equity

Current

Liabilities

Long-Termebt

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Capital %tructure

The value of the firm can be

thought of as a pie

The goal of the manager is

to increase the si!e of the

 pie

The "apital #tructure

decision can be viewed as

how best to slice the pie

If how $ou slice the pie affects the si!e of the pie%

then the capital structure decision matters

&'(

)ebt

&'(

*+uit$

,&(

)ebt

&(

*+uit$

'(

)ebt.'(

*+uit$

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Cas" flo6from firm (C)

="e Firm, Financial 7ar+ets and

="e 5ividend 5ecision

   =  a  >  e  s

     (     D     )

?overnment

@etainedcas" flo6s (F)

5ividends anddet pa!ments (E)

/ltimatel$% the firm

must be a cash

 generating activity.

The cash flows from

the firm must e0ceed

the cash flows from

the financial mar1ets.

FirmInvestors invests in assets (B)

Financial

markets

Firms issue %ecurities (-)

Current assetsFixed assets

Short-term debt

Long-term debt

Equity shares

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Liuidit! vs. &rofitailit! and t"e

%"ort=erm -sset 7ana#ement

5ecision

How should

short-term assets be managed andfinanced?

 2et

Wor1ing"apital

Shareholders

’ Equity

Current

Liabilities

Long-Termebt

Current

Assets

Fixed Assets

1 Tangible

  2 Intangible

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@ole of Financial 7ana#er 

="e Financial 7ana#er’s primar! #oal is to

increase t"e value of t"e firm !:

. %electin# value creatin# proAects

'. 7a+in# smart financin# decisions

/. 5ecidin# on pa!out and its form

<. 5ecidin# on 8C and its efficientmana#ement

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Finance in or#aniational structure(;!pot"etical Or#aniation C"art)

Chairman of the Board andChief Executive Officer CEO!

"resident and ChiefO#erating Officer COO!

$ice "resident andChief Financial Officer CFO!

%reasurer Controller  

Cash &anager 

Ca#ital Ex#enditures

Credit &anager 

Financial "lanning

%ax &anager 

Financial 'ccounting

Cost 'ccounting 

(ata "rocessing 

Board of (irectors

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="e ?oal of Financial 7ana#ement

• 8"at is t"e correct #oal9

 – 7a>imie profit9

 – 7inimie costs9

 – 7a>imie mar+et s"are9

 – 7a>imie s"are"older 6ealt"9

• ;o6 to ma+e sure t"at t"e s"are"older

6ealt" is #ettin# ma>imied9

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 -#enc! prolem

• %eparation of o6ners"ip and mana#ement (information

as!mmetr!)

•  -#enc! prolem arises 6"en a#ents (mana#ers) "ave a

conflict of interest a#ainst principals (o6ners)

• It results in suoptimal e"aviour of mana#ers 6"o ma! "ave

an incentive (moral "aard) to en#a#e in activities 6"ic" ma!decrease or destro! firm value (adverse selection) or limit

action on opportunities for en"ancement of firm value (ris+

aversion)

•  -#enc! prolem results in loss in firm value eit"er due to

suoptimal e"aviour mana#er or due to cost of monitorin#

orn to control suoptimal e"aviour.

• Corporate #overnance

• >ecutive compensation and performance measurement