1. Theory of Corporate Finance
RWJ-Chapter 1

2. What is Corporate Finance?
What long-term investments should the firm engage in?
Capital Budgeting: The process of planning and managing a firm’s long- term investments
Investment opportunities: value vs. cost of these opportunities
What do we need to learn?
How can the firm raise money for the required investments?
Capital Structure: The mixture of debt and equity to support long-term investments
What do we know? And Why is important?
How much short-term cash flow does a company need to pay its bills?
Working Capital Management: Capital required for the firm’s day to day activities (current assets and liabilities)
What do we know? And why is it important?
We need to know valuation (company, projects) and risks
Stock and bond valuation? We need to know how the mixture affect the both risk and value of the firm. We need to understand which one is the least expensive
How much cash and inventory should we keep in hand? Should we sell on credit? How will get any needed short term financing

3. What is our Strategy? We learn:
The basic tools to answer these questions
Financial Statements
Cost of Equity
Cost of Debt
Project Evaluation
Firm and Bond Valuations
To link these tools in our 3 fundamental questions
Moreover, corporate finance is a very important tool for investments? Why?

4. Let’s examine these questions in a Balance-Sheet Model
The Capital Budgeting Decision
Current Liabilities
Current Assets
Long-Term Debt
What long-term investments should the firm engage?
Fixed Assets
1. Tangible
2. Intangible
Shareholders’ Equity

5. The Capital Structure Decision
Current Liabilities
Current Assets
How can the firm raise the money for the required investments?
Long-Term Debt
Fixed Assets
1. Tangible
2. Intangible
Shareholders’ Equity

6. The Net Working Capital Investment Decision
Current Liabilities
Current Assets
Net
Working
Capital
Long-Term Debt
How much short-term cash flow does a company need to pay its bills?
Fixed Assets
1. Tangible
2. Intangible
Shareholders’ Equity

7. Goals of Financial Management
Maximize the current value of the firm.
How can a financial manager do it?
Identify the best investments
Find the best financial arrangements (i.e., best capital structure)
Who are the owners of the firm?
Shareholders: “Residual Owners”
What is the residual owners: they are only entitled to what is left after employees, suppliers, debtholders are paid. Residual proportion of the firm

8. Agency Problem and Agency Cost
Agency problem exists whenever the principal hires another agent to represent his/her interest
Two types of agency problems:
Between shareholders and managers (equity-related agency problems)
Between shareholders and bondholders (debt-related agency problems)
Agency costs: the costs of devising appropriate incentives for managers and then monitoring their behavior

9. Agency Problem between Shareholders and Managers
Managerial goals may be different from shareholder goals
Expensive perquisites
Risk aversion (managers might be more risk averse)
Free cash related problems (Hubris)
How can shareholders control managerial behavior?
Directors (Board of Directors)
BOD can devise compensation plan to align the management incentives
BOD can also fire badly performing managers