Week 1: Lecture

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 What is Corporate Finance /
Financial Management?
Corporate Finance or Financial management brings
together the many facets of business studies,
including: business mathematics, business statistics,
management accounting, taxation, corporations law,
commercial law and budgeting. As such, it provides a
broad spectrum of knowledge applicable to commerce,
industry and government.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.

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 Why study Finance?
Marketing
Budgets, marketing research, marketing financial products
Accounting
Dual accounting and finance function, preparation of financial
statements
Management
Strategic thinking, job performance and profitability
Personal finance
Budgeting, retirement planning, university planning, day-to-day
cash flow issues

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.

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 Forms of Organization
Sole proprietorship
Partnership
General
Limited
Company
Limited liability company
Publicly listed
Private company
Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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 Sole 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 owners personal wealth
Unlimited liability
Difficult to sell ownership interest
Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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Partnership
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

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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Company
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
Taxation of company profits can be an issue

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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Goals of Firms
Firms are referred to as any business organization, irrespective of it
being large, medium or small, as far as it is involved in making
financial decisions.

The primary goals of business include:

Maximizing the wealth for owners;
Maximizing profit;
Achieving higher income growth (for managers who is given
incentives based on achieving growth goals)
Larger market share;
High reputation for product quality and service;
Good employee relations and employment policies a good place to
work.
Minimal or no harm to the natural environment no pollution or
land degradation.
Ethical treatment to parties associated with the business a good
corporate citizen.
Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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Continued
Maximizing the wealth of owners
The principle goal of a firm lies with the objective of
maximizing the wealth of owners. It implies that the business
is managed so that the present and future cash flows
discounted at an appropriate rate will give a present value
(PV) which is maximized. A goal of maximizing wealth leads
to a long-term view that considers future cash flows, the time
value of money and risk. Thus, maximizing wealth is superior
to a goal of profit maximization.

Maximizing profit
This implies that the business is managed in a way that
maximizes the difference between the revenues earned during
the financial period and the expenses of that period.
Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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Continued
Achieving higher income growth
This usually refers to the goals of managers who are
responsible for boosting sales for the business in-order
to maximize revenues. These managers are usually
driven with incentives to achieve higher growth in
income or revenues.

Larger market share

Larger the size of market share the firm has, greater the
power to sustain competition and survive in the industry,
and influence demand and supply in the market.
Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
10
Continued
High reputation for product quality and service
Business firms are usually concerned with the reputation of
their goods and services. Thus, business firms establish this
goal to ensure the good quality and good reputation of
their goods and services. This will enable the firms to have
good customer base and help maximize profit and wealth.

Good employee relations and employment policies

This will enable a good working environment which is vital
for teamwork and excellent performance by those
delegated with the responsibility of maximizing the wealth
for owners and maximizing profit for the business.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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Continued
Minimal or no harm to the natural environment
This goal is basically developed to protect the environment and the natural
surroundings. However, this goal is usually neglected because profit is
maximized mostly at the expense of environment and social costs. It is
difficult to achieve this goal in the era of modern business.

Ethical treatment to parties associated with the business

Leadership has less to do with any single individualthan it does with the
culture, norms, and values of the institution itself.
This goal delegates the responsibility of a good corporate citizenship which
is a fundamental business practice that recognizes the business
responsibility of respecting individuals, the community and the
environment by implementing business strategies that adheres to rules,
regulations, laws and high ethical standards.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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 Roles of Financial Managers
A striking feature of large corporations is that the
owners (the shareholders or equity-holders) are
usually not directly involved in making business
decisions particularly on a day-to-day basis. Instead,
the corporation employs managers to represent the
owners interests and making decisions on their
behalf.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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Continued
The roles and tasks of the financial manager may include
overseeing or undertaking the following:

The accounting and reporting functions;

Managing cash and other short-term assets, raising funds,
and managing excess funds;
Taxation management, including compliance, forecasts
and planning
Risk management
Developmental financial analyses of projected investments
and projects and capital restructures
Forecasting the impact of financial decisions
Audit management, both internal and external
Investor relations, including share registers and advise to
shareholders and dividend policy
Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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The principal-agent problem
Although the goal of the firm is maximization of
shareholder wealth, in reality the agency problem
may interfere with the implementation of this
goal, particularly in large companies.
The agency problem (or the principal-agent
problem) refers to the fact that a firms managers
will not work to maximize benefits to the firms
owners unless it is in the managers interest to do
so. This problem is the result of a separation of the
management and the ownership of the firm.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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Continued
For instance, a large firm may be run by professional
managers who have little or no ownership position in the
firm. As a result of this separation of the decision makers
and the owners, managers may make decisions that not in
line with the goals of maximization of shareholder wealth.
They may approach work with little enthusiasm and
attempt to benefit themselves in terms of salary and
perquisites at the expense of shareholders.

Agency Costs- the costs such as reduced share price,

associated with potential conflict between managers and
investors when these two groups are not the same.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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Ethics in business

Ethics are moral principles or rules of conduct that

indicate the acceptability of behavior within a
community.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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Continued
Ethics has become an increasingly growing concern in the
discipline of accounting following collapses of Arthur Anderson
(one of the top five big accounting firms), Enron (corporate
collapse), and WorldCom (corporate collapse) in the U.S. and so
forth.

Petty et al.2006 states that beyond the question of ethics is the

question of social responsibility. Corporate social responsibility
is defined on Petty et. al, 2006 pp. 8 as a corporations
responsibility to the society at large, beyond the maximization of
shareholders wealth.

However, mostly in practice the managers have a degree of

discretion over the running of the firm and its goals (agency
problem-discussed above).
Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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 Ethics in business
Corporate social responsibility

Corporate social responsibility (CSR) means that the

firm has wider responsibilities in relation to objectives
and people apart from the owners or shareholders.
Objectives often associated with CSR include a
responsibility to manage natural assets sustainably and
not to pollute by chemical discharge, smell, noise, dust or
other irritants; fair treatment of employees and; ethical
attitude towards clients.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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 Challenges facing modern firms

Firms face rapid change in all facets of their business dealings.

Change affects businesses by means of:
the external environment
advancing technology
social advances and the expectations of customers and the
community
Globalization has led to an increasingly interconnected world
where national economies are becoming more and more
dependent on each other.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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 Challenges facing modern firms

Deregulation of the financial markets has seen an increase in

market efficiency and competition, the introduction of many new
financial products and the pricing of financial products much
more in line with the true market prices.
A further consequence of deregulation is the rapid introduction
and adoption of improved technology in the financial markets.
Advancing technology allows businesses to do things better and
cheaper.
Views of what is right and acceptable within a society or
community are continually changing.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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 How being a person affects decision making
The nature of rationality

Rational behavior implies decisions are made after an amount of

reasoning so that ultimate decisions are not foolish or absurd, and
are based on the desire to satisfy objectives and maximize or at
least optimize outcomes.
In traditional academic literature, rational wealth maximizers
always have the objective of increasing their wealth as much as
possible because they, rationally, prefer to have more dollars to
less.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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 How being a person affects decision making
The nature of rationality

Rational wealth maximisers do systematic and comprehensive

analysis before they make decisions, and the choices they make
are always in favour of the option that is most likely to increase
their wealth by the largest amount possible.
However, unlike economists, psychologists perceive rationality in
terms of the process employed to make a decision, whether or not
it happens to lead to the best results.

Beal D., Goyen M. and Shamsuddin A. (2008). Introducing Corporate Finance,2nd ed., chapter 1, Australia: Wiley.
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