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Introduction to Corporate Finance
9/17/2018 Introduction to Corporate Finance Introduction to Corporate Finance
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Financial Management Goal?
Maximize profit Risk Timing Measuring Maximize the depth of the carpet in Finance V.P.’s office Maximize donations to worthy causes 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Income Statement 9/17/2018 Introduction to Corporate Finance
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Financial Management Goal?
Maximize the value of the firm or Maximize the wealth of the firm’s shareholders Wealth or value is the risk-adjusted present value of all current and future cash flows to be received 9/17/2018 Introduction to Corporate Finance
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General Valuation Model
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Shareholders vs. Stakeholders
Is maximizing shareholder wealth inconsistent with social welfare? Employees Customers Suppliers Society Maximizing shareholder wealth in fact requires a careful balancing of interests 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Business Goals vs. Individual Goals Businesses maximize wealth = f{CFt, r} Individuals maximize eternal utility = f{f2, s2} “But before ye seek for riches, seek ye first the kingdom of God” Jacob 2:18 “For the love of money is the root of all evil…” Jacob 2:18 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Maximizing Value or Wealth Value or wealth = f { cash, risk } Simple rules: More cash is preferred to less cash Cash sooner is preferred to cash later Less risky cash is preferred to more risky cash Also, DON’T RUN OUT OF CASH 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Rules: More cash is preferred to less cash 1 2 3 4 5 Stock A $10 Stock B $20 Stock A’s price is $150 Stock B’s price is $300 Which stock is a better buy? 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Rules: More cash is preferred to less cash 1 2 3 4 5 Novell (NOVL) $.60 $.63 $.66 $.69 $.73 5% growth TenFold (TENF) $.79 $.91 $1.05 15 % growth Novell closed at $10.25 TenFold closed at $30.00 Which stock is a better buy? 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Rules: Cash sooner is preferred to cash later Interest rates are 10 percent 1 2 3 T-Bill $100 $0 T-Note T-Bill is worth $100 T-Note is worth $75 $75 = $100/ 1.13 Which Treasury is a better buy? 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Rules: Less risky cash is preferred to more risky cash 1 2 3 4 5 Chevron Corp. (CHV) $4.25 $4.46 $4.69 $4.92 $5.17 +/- 50 cents Wild Cat +/- 7 dollars Chevron closed at $77 5/16 Wild Cat closed at $51.1/4 Which stock is a better buy? 9/17/2018 Introduction to Corporate Finance
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The Balance-Sheet Model of the Firm
Current Assets Fixed Assets Tangible Intangible Total Value of Assets: Shareholders’ Equity Current Liabilities Long-Term Debt Total Firm Value to Investors: 9/17/2018 Introduction to Corporate Finance
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The Balance-Sheet Model of the Firm
The Capital Budgeting Decision Current Liabilities Current Assets Long-Term Debt Fixed Assets Tangible Intangible What long-term investments should the firm engage in? (is the return on assets greater than the cost of capital?) Shareholders’ Equity 9/17/2018 Introduction to Corporate Finance
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The Balance-Sheet Model of the Firm
The Capital Structure Decision Current Liabilities Current Assets How can the firm raise the money for the required investments? (Financing is nothing but an exchange of a sum of money today for a promise to return more money in the future) Long-Term Debt Fixed Assets Tangible Intangible Shareholders’ Equity 9/17/2018 Introduction to Corporate Finance
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The Balance-Sheet Model of the Firm
The Net Working Capital Investment Decision Current Liabilities Current Assets Net Working Capital Long-Term Debt Is the firm liquid? How much cash, accounts receivable, and inventory are needed. How much accounts payable and commercial paper is appropriate? Fixed Assets Tangible Intangible Shareholders’ Equity 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Forms of Organization Proprietorship - single owner Partnership - co-owners Corporation - stockholders 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Forms of Organization 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Sole Proprietorship Easy or “cheap” to form No corporate taxes--taxed as individual Unlimited liability Limited life Limited equity investment 9/17/2018 Introduction to Corporate Finance
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Partnership (General & Limited)
Not hard to form Limited partners have limited liability Difficult to transfer ownership Dissolves when a general partner dies or withdraws Limited equity investment No corporate taxes, taxed as individual income 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Corporation Difficult to form Limited liability Ease of ownership transfer Unlimited life Corporation pays taxes Access to financing 9/17/2018 Introduction to Corporate Finance
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International Versions of Corporations
Company Origin In Original Language Translated Haier China 有限公司 Corporation limited LG Korea 주식회사 Limited liability company 9/17/2018 Introduction to Corporate Finance
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Limited Liability Companies (LLC’s)
Created by state law Governed by the “operating agreement” (rather than by articles of incorporation) Ownership interests - may or may not be evidenced by ownership shares Legal and Economic Considerations LLC “members” (i.e., owners) have limited liability LLC is treated as a partnership for tax purposes 9/17/2018 Introduction to Corporate Finance
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Differences in Small Company Structures
S corp C corp Partnership Limited liability company Limited liability YES NO Double taxation Shareholder restrictions Transferability of shares 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Corporations 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Treasurer: Cash management Banking and securities Capital budgeting Financial analysis Planning Controller: Accounting Taxes Credit claims and receivables Payroll Data processing 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Taxes Progressive Marginal vs. Average Rate Interest vs. Dividend Deductibility Depreciation & Cash Flow 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Marginal versus Average Corporate Tax Rate 9/17/2018 Introduction to Corporate Finance Introduction to Corporate Finance
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Marginal vs Average Tax Rate for Singles and Married
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Introduction to Corporate Finance
Interest vs. Dividends ($20 interest)(.34 tax)=$7 9/17/2018 Introduction to Corporate Finance
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Role of Financial Assets and Markets in the Economy
Consumption Timing Allocation and Elimination of Risk Separation of Ownership Liquidity 9/17/2018 Introduction to Corporate Finance
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The Firm and the Financial Markets
Firm issues securities (A) Financial markets Invests in assets (B) Retained cash flows (F) Cash flow from firm (C) Dividends and debt payments (E) Short-term debt Long-term debt Equity shares Current assets Fixed assets Taxes (D) The cash flows from the firm must exceed the cash flows from the financial markets. Ultimately, the firm must be a cash generating activity. Government 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Financial Markets Money Market vs. Capital Market Primary Market vs. Secondary Market Spot Market vs. Futures Market Stock Market vs. Bond and Mortgage Markets Direct vs. Indirect 9/17/2018 Introduction to Corporate Finance
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Introduction to Corporate Finance
Stock and Bond Markets Stock markets New York Stock Exchange (NYSE) Nasdaq American Stock Exchange (AMEX) Over-the-counter (OTC) markets Smaller regional markets Bond markets Over-the-counter (OTC) markets New York Stock Exchange (NYSE) 9/17/2018 Introduction to Corporate Finance
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The Capital Formation Process
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The Financial Market Economy: Example
Consider a dentist who earns $200,000 per year and chooses to consume $80,000 per year. She has $120,000 in surplus money to invest. She could loan $30,000 to each of 4 college seniors. They each promise to pay her back with interest after they graduate in one year. $30,000×(1+r) Student #1 $30,000 $30,000×(1+r) Dentist Student #2 $30,000 $30,000 Student #3 $30,000×(1+r) $30,000 Student #4 $30,000×(1+r) 9/17/2018 Introduction to Corporate Finance
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The Financial Market Economy: Example
Rather than performing the credit analysis 4 times, he could loan the whole $120,000 to a financial intermediary in return for a promise to repay the $120,000 in one year with interest. The intermediary in turn loans $30,000 to each of the 4 college seniors. $30,000×(1+r) $120,000 Student #1 $30,000 Dentist Bank $30,000×(1+r) Student #2 $30,000 Student #3 $30,000 $30,000×(1+r) Student #4 $120,000×(1+r) $30,000 $30,000×(1+r) 9/17/2018 Introduction to Corporate Finance
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Financial Intermediaries
Maturity spreading Risk pooling Packaging economies Disintermediation of the ‘70s Financial innovation Securitization and credit enhancement 9/17/2018 Introduction to Corporate Finance
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Some Short-term Interest Bearing Securities
CD’s Commercial Paper T-Bills Fed. Funds Call Money Banker’s Acceptance 9/17/2018 Introduction to Corporate Finance
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