Transcript Essentials of Corporate Finance

Chapter
1
Introduction To Corporate
Finance
Prepared by Anne Inglis
McGraw-Hill Ryerson
© 2013 McGraw-Hill Ryerson Limited
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
and financial institutions
• Understand current trends in Canadian financial
markets
© 2013 McGraw-Hill Ryerson Limited
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LO1
Corporate Finance 1.1
• 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?
© 2013 McGraw-Hill Ryerson Limited
1-2
Parallels in Personal Life
• What long term investments should we
take?
• Go to graduate school? Get CGA designation?
• How to pay for our investments?
• From parents? Student loan? Work?
• How to manage everyday income and
spending?
• It is often easier than in firms for you don’t
have to argue with others. But you might lack
discipline.
1-3
LO1
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,
capital expenditures and financial planning
• Controller – oversees taxes, cost accounting,
financial accounting and data processing
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LO1
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?
© 2013 McGraw-Hill Ryerson Limited
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Capital Structure in Our Life
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Capital: Equity and debt
Children: Financed by equity or debt?
University: Equity or debt?
After earning income: credit card and
mortgage
• Equity or debt?
• Raising children: Distribute dividend
• Old age: direction of wealth flow?
1-6
LO2
Forms of Business Organization 1.2
• Three major forms in Canada
• Sole proprietorship
• Partnership
• General
• Limited
• Corporation
• In other countries, corporations are also called joint
stock companies, public limited companies and
limited liability companies
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LO2
Sole Proprietorship
A business owned by a single individual.
• Disadvantages
• Advantages
• Easiest to start
• Least regulated
• Single owner keeps all
the profits
• Taxed once as personal
income
• Unlimited liability
• Limited to life of owner
• Equity capital limited to
owner’s personal
wealth
• Difficult to sell
ownership interest
© 2013 McGraw-Hill Ryerson Limited
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Partnership
LO2
A business formed by two or more co-owners.
• Advantages
• Disadvantages
• Two or more owners
• More human and
financial capital
available
• Relatively easy to start
• Income taxed once as
personal income
© 2013 McGraw-Hill Ryerson Limited
• Unlimited liability
• General partnership
• Limited partnership
• Partnership dissolves
when one partner dies
or wishes to sell
• Difficult to transfer
ownership
• Possible disagreements
between partners
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Corporation
LO2
A business created as a distinct legal entity
owned by one or more individuals or entities.
• Advantages
• Disadvantages
• Limited liability
• Unlimited life
• Separation of
ownership and
management
• Transfer of ownership is
easy
• Easier to raise capital
• Separation of
ownership and
management
• Double taxation
(income is taxed at the
corporate rate and then
dividends are taxed at
the personal rate)
© 2013 McGraw-Hill Ryerson Limited
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LO2
Work the Web Example
• The Internet can help people to get
information about how to start a new
business
• One excellent site is
www.canadabusiness.ca
• Click on the web surfer to go to the site and
see what information you can find!
© 2013 McGraw-Hill Ryerson Limited
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LO3
Goal Of Financial Management 1.3
• What should be the goal of a corporation?
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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?
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LO4
The Agency Problem 1.4
• Agency relationship
• Principal hires an agent to represent their
interests
• Stockholders (principals) hire managers (agents)
to run the company
• Agency problem
• Conflicts of interest can exist between the
principal and the agent
• Agency costs
• Direct agency costs
• Indirect agency costs
© 2013 McGraw-Hill Ryerson Limited
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LO4
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
• Conflicts with other stakeholders
© 2013 McGraw-Hill Ryerson Limited
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LO5
Social Responsibility and Ethical
Investing
• Investors are increasingly demanding that
corporations behave responsibly
• Issues include how a corporation treats the
community in which it operates, their
customers, corporate governance, their
employees, the environment and human
rights
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• Controversial business activities include
alcohol, gaming, genetic engineering,
nuclear power, pornography, tobacco and
weapons
• The increase of these business activities
indicate that ethical investing is not really
what we practice, although it is what we
preach.
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LO5
Work the Web Example
• The Internet provides a wealth of
information about individual companies
• One excellent site is ca.finance.yahoo.com
• Click on the web surfer to go to the site,
choose a company and see what
information you can find!
© 2013 McGraw-Hill Ryerson Limited
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What is the role of financial markets in
corporate finance? 1.5
LO5
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Cash flows to and from the firm
Money vs. capital markets
Primary vs. secondary markets
One excellent site for information on
Canadian companies that trade in
secondary markets is www.tmx.com
• Click on the web surfer to go to the site,
choose a company and see what
information you can find!
© 2013 McGraw-Hill Ryerson Limited
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LO5
Financial Institutions 1.6
• Financial institutions act as intermediaries
between suppliers and users of funds
• Institutions earn income on services
provided:
• Indirect finance – Earn interest on the spread
between loans and deposits
• Direct finance – Service fees (i.e. bankers
acceptance and stamping fees)
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LO5
Trends in Financial Markets and
Management 1.7
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Financial Engineering
Derivative Securities
Advances in Technology – i.e. E-business
Deregulation
Corporate Governance Reform
Hedge Funds
Sub-prime Market
© 2013 McGraw-Hill Ryerson Limited
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