1 Corporate Finance: Introduction Professor Scott Hoover Management 221

2 What must a financial manager understand?What must a financial manager understand? –…must understand how to value future cash flows (time value of money) important factorsimportant factors –…must understand how to evaluate the health of a firm ability to repay debt / ability to take on more debtability to repay debt / ability to take on more debt profitabilityprofitability efficiencyefficiency Source of informationSource of information –financial statements –press releases –news event “expert” analyses“expert” analyses

3 –…must understand how to forecast and plan accordingly Why?Why? –investment decisions (long-term decisions) –operational decisions (day-to-day decisions) –growth management –financing decisions

4 –…must understand how to identify optimal financing arrangements instrumentsinstruments leverage vs. riskleverage vs. risk tax effectstax effects –…must understand how to evaluate potential investments risk vs. returnrisk vs. return relevant cash flowsrelevant cash flows

5 Firm managersFirm managers –the ideal goal of firm managers maximize income?…nomaximize income?…no maximize profits?…nomaximize profits?…no –Why not? ignores timingignores timing ignores riskignores risk ignores dividend (to maximize profits, we would never pay dividends)ignores dividend (to maximize profits, we would never pay dividends) maximize firm value?…nomaximize firm value?…no maximize shareholder wealth?…yes!maximize shareholder wealth?…yes!

6 –Agency problems: Do firm managers always act to maximize shareholder wealth?…no Example: GMExample: GM  agency costs  agency costs –monitoring expenditures –expenditures for “preventive” structuring of the firm (so that managers have reduced incentives to act against the shareholders’ best interests –lost profits due to missed opportunities mitigating factorsmitigating factors –performance-based salaries –shareholder intervention (including firing firm managers) –possible takeovers