1. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Chapter 1: The Scope Of Corporate Finance Corporate Finance, 3e Graham, Smart, and Megginson PowerPoint Presentation by Jeff Whitworth, University of Houston-Clear Lake

2. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. What is Corporate Finance?  The activities involved in managing cash flows in a business environment 1 - 2

3. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. The 5 Basic Corporate Finance Functions Financing (Raising Capital) Financial Management Capital Budgeting Risk Management Corporate Governance 1 - 3

4. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 1 - 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. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 1 - 5 The Core Principles of Finance  Don’t put all your eggs in one basket.  Investors can achieve a more favorable tradeoff between risk and return by diversifying their portfolios.  Markets are smart.  Competition for information tends to make markets efficient.  No arbitrage  Risk-free money-making opportunities are extremely scarce.

6. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 1 - 6 Sole Proprietorships No distinction between business and owner Easy to set up and operate Business earnings taxed as personal income Limited life, Limited access to capital, Unlimited personal liability Partnerships Similar to sole proprietorship, but has two or more owners Joint and several liability Share of profits taxed as partnership income Limited Partnerships One or more general partners with unlimited personal liability Most owners are limited partners, who are passive investors with limited liability Primary Forms of Business Organization

7. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 1 - 7 Are there any disadvantages for corporations? YES! Double taxation Corporations Separate legal entity with many of the economic rights and responsibilities of individuals Unlimited life, Limited liability, Separable contracting, Improved access to capital Owned by shareholders, who elect the Board of Directors Board appoints a President or CEO to manage day-to-day operations Primary Forms of Business Organization

8. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 1 - 8 What Should a Financial Manager Try to Maximize?  Maximize Profit?  Earnings per share are backward-looking, dependent on accounting principles  Does 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.

9. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 1 - 9 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-interest may cause managers to pursue objectives other than shareholder wealth maximization.  This conflict of goals gives rise to managerial agency problems.

10. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 1 - 10 How Agency Costs Can Be Controlled  Ways to limit agency problems:  Activism by institutional investors  Takeover threat  Monitoring and bonding  Compensation contracts

11. © 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 1 - 11 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.