This module provides a preview to corporate finance by explaining the major role and tasks of the financial executive. The module describes the criteria the financial executive uses when making decisions within each organizational form. Real-world market imperfections, however, create conflicts of interest. The essentials of the financial system are reviewed and each major type of security is explored. The module also describes how corporations issue new securities to raise capital. Finally, it analyzes the effect of the tax environment on the financial executive’s decisions. Module 1 Introduction to corporate finance

Define and explain the major role and tasks of the financial executive. The financial executive’s major tasks include n controllership functions (use of working capital) n treasury functions (raising new financial capital) n capital budgeting functions (investing in real or productive assets)

Explain the criteria that the financial executive uses when making decisions within each organizational form. n For a corporation, the executive maximizes shareholder wealth by maximizing the price of the firm’s common shares. n For a sole proprietorship or partnership, the executive maximizes owner’s or partners’ wealth by maximizing the firm’s net income.

Examine the real-world market imperfections that may engender conflicts of interest. Conflicts of interest can arise between 1.Shareholders and creditors n Creditors must monitor corporate borrowers’ actions through reviews and audits of financial statements. 2.Managers and shareholders n Shareholders must monitor managers’ investment choices. n Shareholders must monitor managers in order to avoid excessive expense accounts, excessive salaries, and other perquisites.

…continued 3.Shareholders and government with respect to taxes and social responsibility n Governments must perform random tax audits to discourage cheating. n Governments must impose regulations to discourage environmental polluters and corporate security frauds.

Apply a consistent method of analyzing ethical choices. In analyzing a case involving ethical issues: n Identify the problem areas and issues. n List the concerned parties. n Summarize all the ethical issues from each party’s point of view. n Analyze each ethical issue. n Recommend an action.

Explain the basic working of the financial system. n Markets increase consumer opportunities through trade. n Financial assets are evidence of a promise of future cash flows. n Unrestricted trade of financial assets allows an efficient allocation of current income between consumption and investment. n Financial intermediaries accumulate funds from individual investors to invest as an aggregate amount, thereby reducing transaction costs.

Define financial securities, explain their main features, where they are traded, and who owns them. n Bonds, preferred shares, and common shares represent a promise of future cash flow to the investor. n Short-term securities: u Short-term securities are debt instruments having a maturity of less than one year, such as federal government treasury bills, commercial paper, bankers’ acceptances, and certificates of deposit. u Short-term securities are traded in the over-the- counter (OTC) market, which does not have a physical location. u The major participants are governments, corporations, and banks.

… continued n Bonds: u A bond is a debt instrument having a date of maturity of more than one year. u An indenture is a bond contract that may include provisions covering a repayment schedule, collateral, and so on. u A retractable bond allows the bondholder to sell it back to the borrower at face value at some date prior to the maturity date. u An extendible bond allows the bondholder to extend the maturity of the bond.

… continued n Bonds: u A call provision allows the borrower the option of buying back the bond at a fixed price at some date prior to the maturity date. u The bond market is an OTC market in which the major participants are bond dealers, insurance companies, pension plans, and individual investors. u The yield to maturity of a bond is what investors would earn if they bought the bond and held it to maturity.

… continued n Preferred and common shares: u Equity securities represent direct ownership certificates that pay dividends. u Preferred shares have a stated dividend rate. Dividends are discretionary and are usually cumulative. u Dividends of common shares are also discretionary and expected to grow over the years as the firm’s profits grow. u Common shareholders participate in the growth of the company while preferred shareholders do not.

… continued u Shares are traded in either organized exchanges or through OTC markets, each of these being a communication network of dealers capable of computerized trading. u The major participants in trading shares are mutual funds pension funds insurance companies individuals

Describe how and where corporations issue new securities to raise capital. n New financial capital is raised either through private placements or through public offerings. n Private placements involve selling all of the new securities to a large financial intermediary. n Public offerings involve the sale of the new securities to the public and typically are facilitated by an underwriter. n A lead underwriter, such as a major brokerage firm, organizes an underwriting syndicate to sell the issuing firm’s new securities.

… continued n The underwriting agreement is one of two types: u firm commitment u best efforts n In general, the underwriter serves three basic functions: u risk bearing (firm commitment only) u consulting u marketing

Describe how and where various financial securities are traded between investors. n Bonds are traded OTC. n Stocks are traded through a brokerage firm that has a seat on the stock exchange where the stock is listed. n Other financial markets such as forward contracts, futures contracts, and options can be used for risk management.

Analyze the effect of the tax environment on the financial executive’s decisions. Corporate taxes in Canada: n The corporate tax liability is obtained by multiplying taxable income by a flat tax rate. n Interest payments and issuing expenses of new securities are tax deductible. Dividend payments are not deductible. n CCA (capital cost allowance) is a taxation concept that is similar to amortization expense in the financial statements.

… continued Personal taxes in Canada: n Interest income is fully taxable. n Dividends received from a public Canadian corporation qualify for a dividend tax credit and are effectively taxed at a lower rate than interest and employment incomes. n 1/2 of capital gains are taxable.

…continued n Investors facing a marginal federal tax rate of 22% or lower prefer dividends, capital gains, and interest income in that order because dividends attract the lowest taxes followed by capital gains. n At federal marginal tax rates of 23% and higher, the ranking becomes capital gains, dividends, and then interest income.

Presentation complete!