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The Scope of Corporate

Finance

What Companies Do
Prior to the iPads launch, financial experts at Apple:
evaluated the potential market for such a device,
estimated the cost of producing it,
calculated the unit volume that the company would
have to achieve to earn a satisfactory rate of return,
developed a plan to manage the risks that Apple would
confront when making transactions in foreign
currencies.

Corporate Finance in Modern Business

When contemplating all business decisions,
managers should ask:
Does this action create value for the
firms shareholders?
By taking actions that generate benefits in
excess of costs, firms generate wealth for their
investors.
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Career Opportunities in Finance

Corporate
Finance

Budgeting, financial forecasting, cash

management, credit administration,
investment analysis, fund procurement

Commercial
Banking

Consumer banking
Corporate banking

Investment
Banking

High income potential

Very competitive industry

Money
Management

Opportunities in investment advisory firms,

mutual fund companies, pension funds,
investment arms of financial departments

Consulting

Advise on business practices and strategies

of corporate clients
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Corporate Finance Functions

External Financing

Capital Budgeting

Corporate
Finance
Functions

Financial Management

Corporate Governance

Risk Management
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The External Financing Function

Raising capital to support companies
operations and investment programs
externally, from
either shareholders (equity) or
creditors (debt).

Corporations can raise equity capital privately,

or they may go public by conducting an initial
public offering (IPO) of stock.

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The Financial Management Function

Managing firms internal cash flows,
and its mix of debt and equity financing,
to maximize the value of the debt and equity
claims on firms, and
to ensure that companies can pay off their
obligations when they come due.
Involves obtaining seasonal financing, managing
inventories, paying suppliers, collecting from
customers, and investing surplus cash
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The Capital Budgeting Function

Capital Budgeting selecting the

best projects in which to invest
the resources of the firm, based
on each projects perceived risk
and expected return.

Select investments for which the marginal benefits exceed

the marginal costs.
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The Risk Management Function

Managing firms exposures to all types of risk,
both insurable (such as loss caused by fire or
flood) and uninsurable,
in order to maintain optimum risk-return tradeoffs and thereby maximize shareholder value.
Modern risk management focuses on adverse
interest rate movements, commodity price
changes, and currency value fluctuations.

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The Corporate Governance Function

Developing ownership and corporate governance
structures for companies that ensure that managers
behave ethically and make decisions that benefit
shareholders.
Dimensions of
corporate
governance

Boards of directors
Compensation packages
Auditors
Countrys legal environment - in
U.S., Sarbanes-Oxley Act of 2002

The takeover market disciplines firms that do not

govern themselves.
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What Companies Do

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Debt & Equity: Two Flavors of Capital

Debt
Capital

Equity
Capital

Borrowed money.
The borrower is obliged to pay interest,
at a specified annual rate, on the full
amount borrowed, as well as to repay
the principal amount at the debts
maturity.
An ownership interest usually in the
form of common or preferred stock.
Common stockholders receive returns
on their investments only after
creditors and preferred stockholders
are paid in full.
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Financial Intermediation
Financial
Intermediary

An institution that raises capital by

issuing liabilities against itself, and
then lends that capital to corporate
and individual borrowers.
Examples: insurance companies,
savings and loan institutions, credit
unions, commercial banks, pension
funds, mutual funds.

Pension funds and mutual funds, have surged to

prominence as corporate finance shifts towards
greater reliance on market-based external
funding.
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Business Organizational Forms

Sole
Proprietorships

No distinction between business and

person
Easy to set up, operate; taxed as
personal income
Personal liability, limited life, difficult to
transfer

Partnerships

Two or more business owners

Partners - liable for every partners
actions

Limited
Partnerships

One or more general partners & many

limited partners
Limited liability of corporation, tax
benefits of partnership
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Business Organizational Forms

Corporations

Legal entity with all the economic rights

and responsibilities of a person
Incorporation occurs at state level; based
on state law
Strengths - limited liability for investors,
unlimited business life

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The Finance
Function
in the
Organizational
Structure
of a Typical
Large
Corporation

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The Corporate Financial Managers Goals

What should a financial manager try
to maximize?
Maximize profit?
Earnings reflect past performance, rather than current
or future performance.
Ignores the timing of the profits.
Ignores cash flows.
Ignores risk.

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The Corporate Financial Managers Goals

What should a financial manager try
to maximize?
Maximize shareholder wealth?
As measured by the market price of the firms stock.
A firms stock price reflects the timing, magnitude,
and risk of the cash flows that investors expect a firm
to generate over time.
Shareholders are the residual claimants of a firm.

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The Corporate Financial Managers Goals

What should a financial manager try
to maximize?
Focus on stakeholders?
Many firms seek to preserve the interests of other
stakeholders, such as employees, customers, tax
authorities, and the communities where the firms
operate.
Doing so provides long-term benefits to shareholders
and is in line with the primary goal of maximizing
shareholder wealth.
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Agency Costs in Corporate Finance

Agency Problems

The conflict between the goals of a

firms owners and its managers.

To overcome agency problems:

Rely on market forces to exert managerial discipline;
Incur monitoring and bonding costs to supervise
managers; and
Structure executive compensation packages to align
managers interests with stockholders interests.
The actual workings of many compensation plans have
been harshly criticized in recent years.
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Ethics in Corporate Finance

Today, society in general and the financial
community in particular are developing and
enforcing higher ethical standards.
The U.S. Congress passed the Sarbanes-Oxley
Act in 2002 to enforce higher ethical standards
and increase penalties for violators.

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The Scope of Corporate Finance

Financial managers should seek to maximize
shareholders wealth.
How?
By performing the five basic duties of corporate finance:
External financing, capital budgeting, financial
management, risk management, corporate governance.

Select investments for which the marginal

benefits exceed the marginal costs.

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