Course Introduction Corporate Finance: MBAC 6060 Spring 2003 Professor Jaime Zender

Course Overview: Purpose and Focus Review of the syllabus. Course objectives and learning goals. Course prerequisites. Course materials. Course policies. Grading guidelines. Review sessions. Course schedule/assignments.

Corporate Finance Decisions Financial analysis and planning. Assess the strengths and weaknesses of the firm via the Statement of Cash Flow, ratio analysis, and common sized financial statements. Pro forma financial statements.  Cash flow for valuation.

Corporate Finance Decisions Capital budgeting. Decisions that involve what fixed assets the firm should acquire.  “Investment” decisions.  “Left-hand side” decisions. Need an objective function.  This will lead to rules to follow. The value of any asset is a function of:  The size of the future cash flows.  The timing of the future cash flows.  The risk of the future cash flows.

Corporate Finance Decisions Risk versus return. Not exactly a decision but so integral that it deserves separate mention. A key and difficult issue is exactly how to measure risk. Once we have a handle on measuring risk we need to explain how measured risk translates to required or expected returns. This leads us to a study of asset pricing models.  This will affect our capital budgeting decisions but also our capital structure decisions (as explained next).

Corporate Finance Decisions Capital structure. Decisions that determine how to raise the money to buy our assets.  Financing decisions.  “Right-hand side” decisions. Capital structure of the firm is a portfolio of assets, a portfolio chosen to minimize the total financing cost. The financial claims of a firm are contingent claims, their value derives solely from the “left- hand side” of the firm. We do need asset pricing models! The dividend decision falls under this topic!??

Corporate Finance Decisions Working capital management. A subset of the investment and financing decisions of the firm.  Both sides affected.  Concentrates on current assets and liabilities.  Intimately tied with FAP. Net working capital balance is an asset that must be financed through long-term sources of funds.

Valuation An important goal for us will be to value different assets. It is often helpful to see where we are headed: Discounted cash flow valuation: We can actually see some of where we are going from this seeming gibberish. Can use this to keep in mind why we are doing things.

Corporate Objectives Principal – Agent relationship. Managers as agents that specialize in decision-making. Stockholders as principals who specialize in risk bearing. What is a reasonable objective?

Corporate Objectives Possible objectives: Maximize profits? Maximize earnings per share? Size maximization? Market share maximization? Compensation (managerial) maximization?

Corporate Objectives Appropriate objective: Shareholder wealth maximization.  Clearly what the shareholders want!  Is it socially irresponsible?  This is only appropriate under conditions that imply maximizing shareholder wealth and maximizing total firm value are equivalent. We discuss this later.

Agency Problems Conflicts of interest between owners and managers. Managers wish to maximize their own welfare.  Managerial effort  Managerial versus shareholder risk aversion  Managerial versus shareholder time horizon  Managerial tendency to over-retain funds within the firm

Agency Problems Mechanisms to solve these conflicts: Market (external) control mechanisms  Market for corporate control  Managerial labor market  Product and factor markets Firm (internal) control mechanisms  Compensation contracts  Financial contracts  Block holder monitoring  Shareholder lawsuits

Agency Problems We will assume that these problems are solved in this course. This is an important base line to establish.  Can’t tell what is going wrong if you don’t know how things should work. In later courses this is an important and very interesting issue that you will discuss often.  Deal makers have said to me: “if you don’t know what everyone in the room is interested in and what they might know, leave.”

Finance and Other Functional Areas Regardless of your concentration this is an important subject area. Keep in mind how finance interacts with other functional areas. Business schools division of the curriculum into separate areas (so we can design self contained classes) is misleading and only through the integration of the areas can a successful business be run. Statistics demonstrate that poor financial management is the leading cause of business failure. A mastery of this material is very difficult but can also provide great benefits in your personal life.

Next Time Review (very, very brief) of financial accounting and development of cash flow from accounting statements. Read: Ch. 1,2 of HIG, Teaching notes: Financial Analysis and Planning, Statement of Cash Flow, and Valuation Cash Flow. Prepare: Case of the Unidentified Industries to be handed in and for discussion in class Problems: in RWJ (see syllabus)