Introduction to Corporate Finance Chapter 1 Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Notes to the Instructor: The PowerPoints are designed for an introductory finance class for undergraduates with the emphasis on the key points of each chapter Each chapter’s PowerPoint is designed for active learning by the students in your classroom Not everything in the book’s chapter is necessarily duplicated on the PowerPoint slides There are two finance calculators used (when relevant). You can delete the slides if you don’t use both TI and HP business calculators Animation is used extensively. You can speed up, slow down or eliminate the animation at your discretion. To do so just open a chapter PowerPoint and go to any slide you want to modify; click on “Animations” on the top of your PowerPoint screen tools; then click on “Custom Animations”. A set of options will appear on the right of your screen. You can “change” or “remove” any line of that particular slide using the icon on the top of the page. The speed is one of the three options on every animation under “timing”. Effort has been made to maintain the basic “7x7” rule of good PowerPoint presentations. Additional problems and/or examples are available on McGraw-Hill’s Connect. McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Outline Chapter Outline Corporate Finance and the Financial Manager Forms of Business Organization The Goal of Financial Management The Agency Problem and Control of the Corporation Financial Markets and the Corporation

Chapter Outline Chapter Outline Corporate Finance and the Financial Manager Forms of Business Organization The Goal of Financial Management The Agency Problem and Control of the Corporation Financial Markets and the Corporation

Corporate Finance Some important questions that are answered using finance: What long-term investments should the firm take on? 2. Where will we get the long-term financing to pay for the investment? 3. How will we manage the everyday financial activities of the firm?

Financial Managers Chief Financial Officer (CFO):The top financial manager within a firm Treasurer: Oversees cash management, credit management, capital expenditures, and financial planning Controller: Oversees taxes, cost accounting, financial accounting and data processing

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?

Chapter Outline Corporate Finance and the Financial Manager Forms of Business Organization The Goal of Financial Management The Agency Problem and Control of the Corporation Financial Markets and the Corporation

Forms of Business Organization in the U.S. Sole Proprietorship Single Owner Partnership General Limited Corporation C-Corporation S-Corporation Limited Liability Company (LLC)

Forms of Business Organization in the U.S. Sole Proprietorship Single Owner Partnership General Limited Corporation C-Corporation S-Corporation Limited Liability Company (LLC)

Sole Proprietorship Advantages: Easiest to start Least regulated Single owner keeps all the profits Taxed once as personal income

Sole Proprietorship Disadvantages: Limited to life of owner Equity capital limited to owner’s personal wealth Unlimited liability Difficult to sell ownership interest

Forms of Business Organization in the U.S. Sole Proprietorship Single Owner Partnership General Limited Corporation C-Corporation S-Corporation Limited Liability Company (LLC)

Partnership Advantages: Two or more owners More capital available Relatively easy to start Income taxed once as personal income

Partnership Disadvantages: Unlimited liability General partnership Limited partnership Partnership dissolves when one partner dies or wishes to sell Difficult to transfer ownership

Forms of Business Organization in the U.S. Sole Proprietorship Single Owner Partnership General Limited Corporation C-Corporation S-Corporation Limited Liability Company (LLC)

Corporation Advantages: Limited liability Unlimited life Separation of ownership and management Transfer of ownership is easy Easier to raise capital

Corporation Disadvantages: Separation of ownership and management Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)

Chapter Outline Corporate Finance and the Financial Manager Forms of Business Organization The Goal of Financial Management The Agency Problem and Control of the Corporation Financial Markets and the Corporation

Goal of Financial Management What should be the goal of a corporation? Maximize profits? 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?

Chapter Outline Corporate Finance and the Financial Manager Forms of Business Organization The Goal of Financial Management The Agency Problem and Control of the Corporation Financial Markets and the Corporation

The Agency Problem Agency relationship Principal hires an agent to represent his/her interests Stockholders (principals) hire managers (agents) to run the company Agency problem Conflict of interest between principal and agent Management goals and agency costs

Managing Managers Managerial compensation Corporate control 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 Other stakeholders

Work the Web Example The Internet provides a wealth of information about individual companies One excellent site is finance.yahoo.com Click on the web surfer to go to the site, choose a company and see what information you can find!

Chapter Outline Corporate Finance and the Financial Manager Forms of Business Organization The Goal of Financial Management The Agency Problem and Control of the Corporation Financial Markets and the Corporation

________ ______ Financial Markets ________ ______ Financial Markets Cash flows to the firm Primary vs. secondary markets Dealer vs. auction markets Listed vs. over-the-counter securities NYSE NASDAQ Video Note: This video discusses how capital is raised in financial markets and shows an open-outcry market at the Chicago Board of Trade. Discuss the cash flows to the firm. You might have students turn to Figure 1.2 in their book to see an illustration of the cash flows. The main point is that cash comes into the firm from the sale of debt and equity. The money is used to purchase assets. Those assets generate cash that is used to pay stakeholders, reinvest in additional assets, repay debtholders, and pay dividends to stockholders. The Lecture Tip in the IM provides an interesting example of full disclosure in a firm’s IPO prospectus. Students are often confused by the fact that the NASDAQ is an OTC market. Explain that the NASDAQ market site is just a convenient place for reporters to show how stocks are moving, but that trading does not actually take place there. You may wish to note the evolution of these particular markets, e.g., moving to publicly traded firms, emergence of electronic trading, and increased industry consolidation. www: Click on the NYSE and NASDAQ hyperlinks to go to their respective web sites

Ethics Issues Is it ethical for tobacco companies to sell a product that is known to be addictive and a danger to the health of the user? Is it relevant that the product is legal? Should boards of directors consider only price when faced with a buyout offer? Is it ethical to concentrate only on shareholder wealth, or should stakeholders as a whole be considered? Should firms be penalized for attempting to improve returns by stifling competition (e.g., Microsoft)? These Ethics Issues can be addressed throughout the chapter or as a dedicated discussion as given here. The second issue relates to the buyout offer for Gillette that was rejected due to information regarding the launch of the highly successful “Sensor” razor.

Terminology Sole Proprietorship Partnership CFO (Chief Financial Officer) Sole Proprietorship Partnership C-, S-, and LLC Corporations “Agency” Problem

Key Concepts and Skills Role of the financial manager Corporation classifications Goal of financial management Potential conflicts between financial managers and shareholders

What are the most important topics of this chapter? The CFO’s role in a corporation. 2. Why does the corporation classification matter? Corporate manager’s possible conflicting goal with the owners of the company.

Questions?