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Introduction to Corporate Finance

Introduction to Corporate Finance. 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. Income Statement. Financial Management Goal?. Maximize the value of the firm or

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Introduction to Corporate Finance

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  1. Introduction to Corporate Finance Introduction to Corporate Finance

  2. 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 Introduction to Corporate Finance

  3. Income Statement Introduction to Corporate Finance

  4. 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 Introduction to Corporate Finance

  5. General Valuation Model Introduction to Corporate Finance

  6. 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 Introduction to Corporate Finance

  7. 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 Introduction to Corporate Finance

  8. 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 Introduction to Corporate Finance

  9. Rules: More cash is preferred to less cash Stock A’s price is $150 Stock B’s price is $300 Which stock is a better buy? Introduction to Corporate Finance

  10. Rules: More cash is preferred to less cash Novell closed at $10.25 TenFold closed at $30.00 Which stock is a better buy? Introduction to Corporate Finance

  11. Rules: Cash sooner is preferred to cash later Interest rates are 10 percent T-Bill is worth $100 T-Note is worth $75 $75 = $100/ 1.13 Which Treasury is a better buy? Introduction to Corporate Finance

  12. Rules: Less risky cash is preferred to more risky cash Chevron closed at $77 5/16 Wild Cat closed at $51.1/4 Which stock is a better buy? Introduction to Corporate Finance

  13. Total Value of Assets: Total Firm Value to Investors: Current Liabilities Current Assets Long-Term Debt Fixed Assets Tangible Intangible Shareholders’ Equity The Balance-Sheet Model of the Firm Introduction to Corporate Finance

  14. 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 Introduction to Corporate Finance

  15. 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 Introduction to Corporate Finance

  16. 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 Introduction to Corporate Finance

  17. Forms of Organization Proprietorship - single owner Partnership - co-owners Corporation - stockholders Introduction to Corporate Finance

  18. Forms of Organization Introduction to Corporate Finance

  19. Sole Proprietorship • Easy or “cheap” to form • No corporate taxes--taxed as individual • Unlimited liability • Limited life • Limited equity investment Introduction to Corporate Finance

  20. 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 Introduction to Corporate Finance

  21. Corporation • Difficult to form • Limited liability • Ease of ownership transfer • Unlimited life • Corporation pays taxes • Access to financing Introduction to Corporate Finance

  22. International Versions of Corporations Company Origin In Original Language Translated Haier China 有限公司 Corporation limited LG Korea 주식회사 Limited liability company Introduction to Corporate Finance

  23. 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 Introduction to Corporate Finance

  24. Differences in Small Company Structures Introduction to Corporate Finance

  25. Corporations Introduction to Corporate Finance

  26. Treasurer: • Cash management • Banking and securities • Capital budgeting • Financial analysis • Planning • Controller: • Accounting • Taxes • Credit claims and receivables • Payroll • Data processing Introduction to Corporate Finance

  27. Taxes • Progressive • Marginal vs. Average Rate • Interest vs. Dividend Deductibility • Depreciation & Cash Flow Introduction to Corporate Finance

  28. Marginal versus Average Corporate Tax Rate Introduction to Corporate Finance

  29. Marginal vs Average Tax Rate for Singles and Married Introduction to Corporate Finance

  30. Interest vs. Dividends ($20 interest)(.34 tax)=$7 Introduction to Corporate Finance

  31. Role of Financial Assets and Markets in the Economy • Consumption Timing • Allocation and Elimination of Risk • Separation of Ownership • Liquidity Introduction to Corporate Finance

  32. The Firm and the Financial Markets Firm Financialmarkets Government Firm issues securities (A) Investsin assets(B) Retained cash flows (F) Cash flowfrom firm (C) Dividends anddebt payments (E) Short-term debt Long-term debt Equity shares Current assetsFixed 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. Introduction to Corporate Finance

  33. 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 Introduction to Corporate Finance

  34. 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) Stock and Bond Markets Introduction to Corporate Finance

  35. The Capital Formation Process Introduction to Corporate Finance

  36. 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) Introduction to Corporate Finance

  37. 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) Introduction to Corporate Finance

  38. Financial Intermediaries • Maturity spreading • Risk pooling • Packaging economies • Disintermediation of the ‘70s • Financial innovation • Securitization and credit enhancement Introduction to Corporate Finance

  39. Some Short-term Interest Bearing Securities • CD’s • Commercial Paper • T-Bills • Fed. Funds • Call Money • Banker’s Acceptance Introduction to Corporate Finance

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