Transcript Corporate Finance

OBJECTIVES
• UNDERSTANDING OF THE NATURE AND ROLE OF
FINANCIAL MANAGEMENT.
• UNDERSTANDING OF THE GENERAL FINANCIAL
ENVIRONMENT AND THE OPERATION OF
FINANCIAL SYSTEMS
• TO DEVELOP THE STUDENT’S ABILITY TO APPLY
• TO DEVELOP A WORKING KNOWLEDGE AND
UNDERSTANDING OF THE THEORETICAL
FRAMEWORK AND ANALYTICAL TECHNIQUES
INVOLVED IN:
• INVESTMENT AND FINANCING DECISIONS
• WORKING CAPITAL MANAGEMENT
THE TOOLS OF FINANCIAL ANALYSIS AND
INTERPRET RESULTS.
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ASSESSMENT CRITERIA
• ASSIGNMENT
• CLASS TEST
• MID-TERM EXAM
• FINAL EXAM
10%
10%
20%
60%
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SYLLABUS
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2.
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AN OVERVIEW OF CORPORATE
FINANCE AND FINANCIAL MODELLING
FINANCIAL ENVIRONMENT
6. STOCK VALUATION
7. COST OF CAPITAL
SOURCES OF FINANCE
8. CAPITAL BUDGETTING
THE TIME VALUE OF MONEY
9. RISK AND RETURN
BOND VALUATION
10. DIVIDEND POLICY
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WHY ARE YOU TAKING CORPORATE
FINANCE?
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PREPARE FOR THE WORKPLACE OF TOMORROW.
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USE AND UNDERSTAND FINANCIAL TERMINOLOGY AND
CONCEPTS IN TEAM COMMUNICATION.
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DEVELOPING CROSS-FUNCTIONAL CAPABILITIES.
BROADENING EXPECTATIONS OF FINANCIAL KNOWLEDGE AND
SKILLS.
CRITICAL THINKING.
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“IF YOU DON’T KNOW WHERE YOU ARE
GOING, IT DOESN’T MATTER HOW YOU
GET THERE”
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CHAPTER 1 WILL TEACH YOU TO EXPLAIN
THE FOLLOWING:
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WHAT IS CORPORATE FINANCE
THE GOAL OF THE FIRM
CORPORATE GOVERNANCE
ORGANIZATION OF THE FINANCIAL MANAGEMENT FUNCTION
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WHAT IS CORPORATE FINANCE?
GENERALLY DEFINED AS THE ACTIVITIES INVOLVED IN
MANAGING CASH FLOWS (MONEY) IN A BUSINESS
ENVIRONMENT
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THE 5 BASIC CORPORATE FINANCE
FUNCTIONS
Financial
Management
Financing
(Raising Capital)
Risk Management
Capital
Budgeting
Corporate
Governance
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Risk Management
Managing firms
’exposures to all types
of risk, both insurable
and uninsurable,
in order to maintain
optimum risk return
trade-off s and
thereby maximize
shareholder value.
Financial Management
Managing firms’ internal cash flows
and its mix of debt and equity
financing, both 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.
Financing(Raising Capital)
Raising capital to support
companies’ operations and
investment programs.
Capital Budgeting
Selecting the best projects in which
to invest the resources of the firm,
based on
each project’s perceived risk and
expected return.
Corporate Governance
Developing ownership and corporate
governance structures for companies
that ensure that managers behave
ethically and make decisions that
benefit shareholders.
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The three decisions in Financial
Management
Investment Financing
Decisions Decisions
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Dividend
Decisions
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INVESTMENT DECISIONS
Most important of the three decisions
• WHAT IS THE OPTIMAL FIRM SIZE?
• WHAT SPECIFIC ASSETS SHOULD BE ACQUIRED?
• WHAT ASSETS (IF ANY) SHOULD BE REDUCED OR ELIMINATED?
These are decisions that have to do with the firm deciding on what
investments it wishes to make. It also includes determining what
assets to invest in. The decision making process involves selecting
viable projects by applying investment appraisal techniques
depending on the nature of business the firm is involved in
 The Hurdle Rate – reflects the
riskiness of the investment and
the mix od debt and equity
used to fund it.
 The Return – reflects the
magnitude and timing of the
cashflows as well as all side
effects
(E.g. Mining, retail, manufacturing or tourism.
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FINANCING DECISIONS
• WHAT IS THE BEST TYPE OF FINANCING?
• WHAT IS THE BEST FINANCING MIX?
• WHAT IS THE BEST DIVIDEND POLICY (E.G.,
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DIVIDEND-PAYOUT RATIO)?
HOW WILL THE FUNDS BE PHYSICALLY
ACQUIRED?
 The Optimal mix of debt and equity maximizes
firm value
 The Right Kind of debt matches the tenor of your
assets
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These are decisions regarding, how the investment(s)
selected will be financed. Firms have three options
regarding where they source finances. They can source
them internally by using retained earnings, borrowing
from the debt capital market or issuing stocks (ordinary
shares).
The decision to use a specific source of finance is
determined by the period of investment (long-term of
short-term),use of funds for either capital investment or
working capital requirements and desired capital structure
for a given firm. That is, the balance between equity and
debt used in financing the assets of the firm.
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DIVIDEND DECISIONS
• These decisions involve determining a dividend
policy for the firm which describes how the returns
from the investment are distributed to shareholders
as dividends. The policy describes when and how
much of the profits are distributed as dividends
including the mode of payment.
• As the finance manager performs these functions
 How much cash you can
return depends upon
current & potential
investment opportunities
 How you chose to return
cash to the owners will
depend whether they
prefer dividends or
buybacks
the overriding goal is to ensure that the firm’s value
is maximized.
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WHAT IS THE GOAL OF THE FIRM?
• POSSIBLE GOALS:
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AVOID BANKRUPTCY AND FINANCIAL DISTRESS
MINIMIZE COSTS
MAXIMIZE SALES
MAXIMIZE PROFITS
• THE BEST GOAL OF A PUBLICLY TRADED FIRM:
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MAXIMIZE SHARE PRICE (MAXIMIZATION OF SHAREHOLDER WEALTH)
VALUE CREATION OCCURS WHEN WE MAXIMIZE THE SHARE PRICE FOR CURRENT
SHAREHOLDERS.
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WHY TRADITIONAL CORPORATE FINANCIAL
THEORY FOCUSES ON MAXIMIZING
STOCKHOLDER WEALTH
• Stock prices are easily observable and constantly updated (unlike other performance
measures)
• Stock prices reflect the wisdom of decisions, short and long term and instantaneously
• The objective of stock price performance provides theory on:
• Allocation of resources across scarce uses
• How to finance these investments
• How much to pay in dividends
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STRENGTHS OF SHAREHOLDER WEALTH
MAXIMIZATION
• Takes account of:
• Current and future profits
• The timing, duration, and risk of profits
• Dividend policy and
• All other relevant factors.
• Share price serves as a barometer for business performance.
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SHORTCOMINGS OF PROFIT MAXIMIZATION
( MAXIMIZING EARNINGS AFTER TAXES )
Problems
• Could increase current profits while
harming firm (e.g., defer maintenance)
• Ignores changes in the risk level of the
firm(Ignores risk)
• Does not fully consider cash flow
timing
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THE MODERN CORPORATION
Modern Corporation
Shareholders
Management
THERE EXISTS A SEPARATION BETWEEN OWNERS AND MANAGERS.
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ROLE OF MANAGEMENT
Management acts as an agent for
the owners (shareholders) of the
firm.
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AN AGENT IS AN INDIVIDUAL AUTHORIZED BY
ANOTHER PERSON, CALLED THE PRINCIPAL, TO ACT
IN THE LATTER’S BEHALF.
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THE AGENCY PROBLEM
• This is defined as a potential conflict of interest between the principals
(shareholders) and the agents (managers).This is created when managers act in
contrast to the expectations of the shareholders regarding the objective of
wealth maximization. It is necessary for shareholders to put in place incentives
to ensure that managers maximize shareholder wealth.
• One agency problem is that managers can use corporate funds for non-value
maximizing purposes.
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MANAGERIAL INCENTIVES TO
MAXIMIZE SHAREHOLDER WEALTH
To ensure that managers act in line with shareholder expectation agency
costs are incurred by firms. These costs take several forms:
• Expenditure to monitor managerial actions. E.G external audits
• Expenditure to structure the organization so that the possibility of
undesirable managerial behavior will be limited.
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MECHANISM APPLIED TO FORCE MANAGERS TO ACT IN THE SHAREHOLDERS
BEST INTEREST INCLUDE
• The threat of being fired.
• The threat of take over which takes the form a hostile takeover. When a new firm takeover another
company managers are usually replaced by these appointed by the new board. Management would
want to avoid a takeover for fear of losing their jobs to competition.
• Structured managerial incentives, which include executive share options, where executive, are given
an opportunity to buy share in the future at some discounted price and performance shares awarded
on the basis of performance using some criteria.
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CORPORATE SOCIAL
RESPONSIBILITY
•Wealth maximization does not preclude the firm from
being socially responsible at the corporate level.
•Assume we view the firm as producing both private and
social goods.
•Then shareholder wealth maximization remains the
appropriate goal in governing the firm.
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CORPORATE GOVERNANCE
•Corporate governance: represents the system by which
corporations are managed and controlled.
• Includes shareholders, board of directors, and senior
management.
•Then shareholder wealth maximization remains the
appropriate goal in governing the firm.
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BOARD OF DIRECTORS
• Typical responsibilities:
• Set company-wide policy;
• Advise the CEO (chief executive officer) and other senior
executives;
• Hire, fire, and set the compensation of the CEO;
• Review and approve strategy, significant investments, and
acquisitions; and
• Oversee operating plans, capital budgets, and financial reports to
common shareholders.
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Forms of Business
Organizations
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THE THREE BASIC FORMS OF BUSINESS
ORGANIZATION
• SOLE PROPRIETORSHIPS
• PARTNERSHIPS (GENERAL AND LIMITED)
• CORPORATIONS
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THE BUSINESS
ENVIRONMENT
Sole Proprietorship – A business form
for which there is one owner. This
single owner has unlimited liability
for all debts of the firm.
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OLDEST FORM OF BUSINESS ORGANIZATION.
BUSINESS INCOME IS ACCOUNTED FOR ON YOUR PERSONAL INCOME TAX FORM.
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SOLE PROPRIETORSHIP
ADVANTAGES
• EASIEST TO START
• LEAST REGULATED
• SINGLE OWNER KEEPS ALL
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THE PROFITS
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INDIVIDUAL FORM
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• SINGLE TAX FILING ON
DISADVANTAGES
UNLIMITED LIABILITY
HARD TO RAISE ADDITIONAL
CAPITAL
TRANSFER OF OWNERSHIP
DIFFICULTIES
LIMITED TO LIFE OF OWNER
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PARTNERSHIP
Partnership – A business form in
which two or more individuals act
as owners.
• BUSINESS INCOME IS ACCOUNTED FOR ON EACH PARTNER’S PERSONAL
INCOME TAX FORM.
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TYPES OF PARTNERSHIPS
General Partnership – all partners have unlimited
liability and are liable for all obligations of the
partnership.
Limited partnership – limited partners have liability
limited to their capital contribution (investors only).
At least one general partner is required and all
general partners have unlimited liability.
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PARTNERSHIP
ADVANTAGES
• CAN BE SIMPLE
• LOW SETUP COST, HIGHER
THAN SOLE PROPRIETORSHIP
• RELATIVELY QUICK SETUP
• LIMITED LIABILITY FOR
LIMITED PARTNERS
DISADVANTAGES
• UNLIMITED LIABILITY FOR THE
GENERAL PARTNER
• DIFFICULT TO RAISE ADDITIONAL
CAPITAL, BUT EASIER THAN SOLE
PROPRIETORSHIP
• TRANSFER OF OWNERSHIP
DIFFICULTIES
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CORPORATION
Corporation – A business form
legally separate from its owners.
• An artificial entity that can own assets and incur liabilities.
• Business income is accounted for on the income tax form of the corporation.
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CORPORATION
ADVANTAGES
DISADVANTAGES
• LIMITED LIABILITY
• DOUBLE TAXATION
• EASY TRANSFER OF OWNERSHIP
• MORE DIFFICULT TO
• UNLIMITED LIFE
• EASIER TO RAISE LARGE
QUANTITIES OF CAPITAL
ESTABLISH
• MORE EXPENSIVE TO SET UP
AND MAINTAIN
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TAKE AWAY
RESEARCH THE REQUIREMENTS NEEDED TO LIST A COMPANY.
CHOSE A COMPANY YOU WOULD LIKE TO BASE YOUR ASSIGNMENT ON. EMAIL ME:
• NAME
• COMPANY CHOSEN – MUST BE LISTED ON A MARKET
FIRST COME, FIRST SERVE.
EVERYONE HAS TO CHOSE A DIFFERENT COMPANY
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