Corporate Finance Lecture 1 Dr. Solt Eszter BME 2017

The Structure of the Learning Material The financial environment of business Time value of money, risk and return calculation, financial institutions Investment decisions of the company, risk analysis Financing decisions of the company Capital budgeting, capital structure and the value of the company

The value of the company The Balance Sheet Modell ASSETS LIABILITIES Fixed Assets Property, plant and equipment Long term investments Intangible assets Current assets Inventory Accounts receivable Short term investments Cash Owner’s equity Long-term liabilities long term debt deferred income tax Short term liabilities accounts payable Short term loans

Goal: maximizing owner’s value Decisions STRATEGIC DECISIONS What specific assets should the firm invest in? capital budgeting How should the cash required for an investment be raised? capital structure Dividend policy Goal: maximizing owner’s value

Goal: to ensure liquidity Decisions OPERATIONAL DECISIONS How to manage cash inflows/outflows in the short run? Current asset management Goal: to ensure liquidity

Decisions INVESTMENT DECISIONS FINANCING DECISIONS How to shape the structure of the assets? real/financial fixed/current Financing the operation Other financing (acquisition) Equity (E)/Debt(D) ratio Dividend policy:paying cash dividend at present or increased dividend at a later stage

Types of businesses Sole proprietor: No partners, no stockholders Unlimited liability Well-suited for a small company with an informal business structure

Types of businesses Partnership : to pool money and expertise Each partner has unlimited liability for all the business’ debt e.g. consulting firms, investment banks until their financial requirements have grown too large to continue as partnerships

Types of businesses Corporations: Business is owned by stockholders who are not personally liable for the business’s liabilities Limited liability: the most a stockholder can lose is the amount invested in the stock Separation of ownership and management Elected board of directors

Advantages and drawbacks of different forms of business Partners and sole proprietors: Advantage: taxed only once as personal income, smaller costs Drawback: smaller profit potential with unlimited liabilities Corporations: Advantage: larger profit potential with limited liabilities Drawback: as separate legal entities taxed on profits and dividends

Hybrid forms of businesses Limited partnerships: General partner manages the business and has unlimited personal liability for the business’s debts Limited partner has a restricted role in the management and has the liability only for the money they contribute to the business

Hybrid forms of businesses LLC or LLP ( limited liability partnerships): All partners have limited liability AND The tax advantage of partnerships: taxed as personal income These forms suit rather for small and medium- sized companies

To maximize the value of the firm to its The goal of the company One approach: „Maximizing profits” drawbacks: Different ways of calaculation Explicit/implicit costs Which year’s profit? The other approach: To maximize the value of the firm to its stockholders

Cash-flow Net amount of cash moving into or out of business during a definite period of time Its direction: + (in) or – (out) Investments: cashflow at the first period(s): - (out) later: + (in) Financing: cashflow at the first period(s): + (in) later: - (out)

The Principal-Agent Problem Do managers really maximize firm value? Reason: managers’ (agent) and owners’ interests (principal) differ Managers’preferences: Their own „well being” Stability Independence