1. Corporate Finance, 2e by Smart, Megginson, Gitman
© 2007 Thomson South-Western

2. Chapter 1 The Scope Of Corporate Finance
Professor XXXXX
Course Name / Number
© 2007 Thomson South-Western

3. What is Corporate Finance?
The activities involved in managing cash flows in a business environment

4. The Core Principles of Finance
The time value of money
The opportunity to earn a return on invested funds means that a dollar today is worth more than a dollar in the future.
Compensation for risk
Investors expect compensation for bearing risk.

5. The Core Principles of Finance
Don’t put your eggs in one basket
Investors can achieve a more favorable trade-off between risk and return by diversifying their portfolios.
Markets are smart
Competition for information tends to make markets efficient.
No arbitrage
Arbitrage opportunities are extremely scarce.

6. The 5 Basic Corporate Finance Functions
Financing
(Capital-Raising)
Capital Budgeting
Financial Management
Risk Management
Corporate Governance

7. The Financing Function
Businesses can raise money in 2 ways:
externally from investors or creditors
IPOs
Primary market transactions
Secondary market transactions
internally by retaining operating cash flows
Most common method

8. Raising Capital: Key Facts
Most financing from internal rather than external sources
Most external financing is debt
Primary vs. secondary market transactions or offerings
Financial intermediaries declining as a source of capital for large firms
Securities markets growing in importance

9. The Total Value of Primary (Capital-Raising) Corporate Security Issues, 1990 –2004

10. Growth in Global Security Issues

11. The Capital Budgeting Function
Capital Budgeting – selecting the best projects in which to invest the firm’s resources

12. The Capital Budgeting Function
The capital budgeting process consists of three steps.
Step 1 - identifying potential investments
Step 2 - analyzing those investments to identify which will create shareholder value
Step 3 - implementing and monitoring the investments selected in step 2

13. The Financial Management Function
Managing daily cash inflows and outflows
Forecasting cash balances
Building a long-term financial plan
Choosing the right mix of debt and equity

14. The Corporate Governance Function
Hires and promotes qualified, honest people, and structures employees’ financial incentives to motivate them to maximize firm value
In practice the incentives of stockholders, managers, and other stakeholders often conflict.
Dimensions of corporate governance:
Board of directors
Securities and Exchange Commission
Sarbanes-Oxley Act of 2002

15. Value of Global Mergers & Acquisitions

16. The Risk Management Function
Identifying, measuring, and managing all types of risk exposures
Some risks are insurable, and some risks can be reduced through diversification.
Financial instruments like forwards, futures, options, and swaps may also be used to hedge market risks such as interest-rate, price, and currency fluctuations.

17. Business Organizational Forms in the United States
Sole Proprietorships
No Distinction Between Business & Owner
Easy To Set Up, Operate; Business Earnings Taxed As Personal Income
Limited Life, Limited Access to Capital, Unlimited Personal Liability
Partnerships
Two Or More Owners
Joint and Several Liability
Limited Life, Limited Access to Capital, Unlimited Personal Liability
Limited Partnerships
One Or More General Partners with Unlimited Personal Liability
Most Partners are Totally Passive with Limited Liability - Limited Partners; Share of Profits Taxed as Partnership Income

18. Business Organizational Forms in the United States
Separate Legal Entity With Many of the Economic Rights & Responsibilities of Individuals
Unlimited Life, Limited Liability, Separable Contracting, Unlimited Access to Capital
Owned by Shareholders, Who Elect the Board of Directors
In the U.S., Incorporation is Executed At State Level and Governed by State Law
Corporations
Are there any disadvantages for corporations?
YES! Double taxation

19. Taxation of Business Income AFTER the Jobs and Growth Tax Relief Reconciliation Act of 2003

20. Business Organizational Forms in the United States
S Corporations
Shareholders are taxed as partners while still retaining Limited Liability as Corporate Shareholders
Status is Subject to Several Eligibility Requirements
Limited- Liability Companies
Combines the Partnership’s Pass-Through Taxation with the S Corporation’s Limited Liability

21. Forms of Business Organizations Used by Non-U.S. Companies
Limited-Liability Companies
Britain: public limited companies (PLC)
Germany: Aktiengesellschaft (AG)
France: Société Générale
Spain, Mexico, and elsewhere in Latin America: Sociedad Anónima
State-Owned Enterprises
Historically, the telephone, television, utility, airline and railroad companies in many European countries
Privatization programs have reduced the role of the states around the world
How much has been raised through Privatization Programs?

22. Worldwide Privatization Revenues

23. What Should a Financial Manager Try to Maximize?
Maximize Profit?
Earnings per share are backward-looking, dependent on accounting principles,
Do not fully consider cash flow timing
Ignores risk
Maximize Shareholder Wealth?
Maximize stock price, not profits
Shareholders, as residual claimants, have better incentives to maximize firm value.

24. World Stock Market Capitalization

25. Agency Costs
Managers act as agents of the owners who hired them and gave them decision-making authority to manage the firm for the owners’ benefit.
In practice however, self-interests may cause managers to pursue objectives other than shareholder-wealth maximization.
This conflict of goals gives rise to managerial agency problems.

26. How Agency Costs Can Be Controlled
Ways to overcome agency problems:
Takeovers
Monitoring and bonding
Compensation contracts
Executive compensation packages

27. Importance of Ethics
Widespread publicity surrounding numerous ethical violations began with the Enron collapse in late 2001.
Society in general and the financial community in particular are developing and enforcing ethical standards.
Ethical behavior is necessary in order to maximize shareholder’s wealth.