Summary Fundamentals of Corporate Finance
Hillier, Clachler, Ross, Westerfield & Jordan
European Edition
,Chapter 1
1.1 CORPORATE FINANCE AND THE FINANCIAL MANAGER
What is Corporate Finance?
When wanting to start your own business, you would have to answer the following
three questions in some form or another:
1. What long-term investments should you make?
2. Where will you get the long-term financing to pay for your investment?
3. How will you manage your everyday financial activities, such as collecting
from customers and paying suppliers?
Corporate finance is the study of ways to answer these three questions.
The financial manager
The corporation employs managers to represent the owners’ interests and make
decisions on their behalf. In a large corporation, the financial manager would be in
charge of answering the three questions above. The financial management function
is usually associated with a top officer of the firm such as a finance director (FD) or
chief financial officer (CFO).
The finance director coordinates the activities of the treasurer and the controller.
The controller’s office handles cost and financial accounting, tax payments, and
management information systems. The treasurer’s office is responsible for managing
the firm’s cash and credit, its financial planning, and its capital expenditures.
The accounting function takes all the financial information and data that arises as a
result of ongoing business activities, and presents this in a way that allow
management to assess the performance and risk of their firm (financial accounting)
and make informed decisions on future corporate activity (management
accounting). The finance function of the firm is related to the three general
questions raised earlier.
Financial Management decisions
Capital budgeting
The first question concerns the firm’s long-term investments. The process of
planning and managing a firm’s long-term investments is called capital budgeting. In
capital budgeting the financial manager tries to identify investment opportunities
that are worth more to the firm than the cost to acquire.
The types of investment opportunities that would typically be considered depend in
part on the nature of the firm’s business. Financial managers must not only be
concerned with how much cash they receive, but also when they expect to receive
it, and how likely they are to receive it. Evaluating the size, timing, and risk of future
cash flows is the essence of capital budgeting.
Capital structure
The second question for the financial manager concerns ways in which the firm
obtains and manages the long-term financing it needs to support its long-term
investments. A firm’s capital structure is the specific mixture of long-term debt and
equity the firm uses to finance its operations. The mixture chosen will affect both
the risk and the value of the firm. In addition to deciding on the financing mix, the
financial manager has to decide exactly how and where to raise the money. The
, expenses associated with raising long-term financing can be considerable, so
different possibilities must be carefully evaluated.
Working capital management
The third question concerns working capital management. The term working capital
refers to a firm’s short-term assets, such as inventory, and its short-term liabilities,
such as money owed to suppliers. Managing the firm’s working capital is a day-to-
day activity which ensures that the firm has sufficient resources to continue its
operations and avoid costly interruptions. Some questions about working capital that
must be answered are the following:
How much cash and inventory should we keep on hand?
Should we sell on credit?
How will we obtain any needed short-term financing?
1.2 THE GOAL OF FINANCIAL MANAGEMENT
The main goal of financial management is to make money or add value for the
owners.
Possible goals
If we were to consider possible financial goals, we might come up with some ideas
like the following:
Survive
Avoid financial distress and bankruptcy
Beat the competition
Maximize sales or market share
Minimize costs
Maximize profits
Maintain steady earnings growth
Profit maximization would probably be the most commonly cited goal, but even this
is not a precise objective. The goal of maximizing profits may refer to some sort of
long-run or average profit but it’s still unclear exactly what this means.
The goals listed are all different, but tend to fall into two classes. The first of these
relates to profitability. The goals involving sales, market share and cost control, all
relate to different ways of earning or increasing profits. The goals in the second
group relate in some way to controlling risk.
The goal of financial management
The financial manager in a corporation makes decisions for the shareholders of the
firm. The question that needs to be answered therefore is: from the shareholders’
point of view, what is a good financial management decision?
It follows that the financial manager acts in the shareholders’ best interests by
making decisions that increase the value of the equity. The appropriate goal for the
financial manager can thus be stated quite easily:
The goal of financial management is to maximize the current value per share of the
existing equity.
A more general goal
Hillier, Clachler, Ross, Westerfield & Jordan
European Edition
,Chapter 1
1.1 CORPORATE FINANCE AND THE FINANCIAL MANAGER
What is Corporate Finance?
When wanting to start your own business, you would have to answer the following
three questions in some form or another:
1. What long-term investments should you make?
2. Where will you get the long-term financing to pay for your investment?
3. How will you manage your everyday financial activities, such as collecting
from customers and paying suppliers?
Corporate finance is the study of ways to answer these three questions.
The financial manager
The corporation employs managers to represent the owners’ interests and make
decisions on their behalf. In a large corporation, the financial manager would be in
charge of answering the three questions above. The financial management function
is usually associated with a top officer of the firm such as a finance director (FD) or
chief financial officer (CFO).
The finance director coordinates the activities of the treasurer and the controller.
The controller’s office handles cost and financial accounting, tax payments, and
management information systems. The treasurer’s office is responsible for managing
the firm’s cash and credit, its financial planning, and its capital expenditures.
The accounting function takes all the financial information and data that arises as a
result of ongoing business activities, and presents this in a way that allow
management to assess the performance and risk of their firm (financial accounting)
and make informed decisions on future corporate activity (management
accounting). The finance function of the firm is related to the three general
questions raised earlier.
Financial Management decisions
Capital budgeting
The first question concerns the firm’s long-term investments. The process of
planning and managing a firm’s long-term investments is called capital budgeting. In
capital budgeting the financial manager tries to identify investment opportunities
that are worth more to the firm than the cost to acquire.
The types of investment opportunities that would typically be considered depend in
part on the nature of the firm’s business. Financial managers must not only be
concerned with how much cash they receive, but also when they expect to receive
it, and how likely they are to receive it. Evaluating the size, timing, and risk of future
cash flows is the essence of capital budgeting.
Capital structure
The second question for the financial manager concerns ways in which the firm
obtains and manages the long-term financing it needs to support its long-term
investments. A firm’s capital structure is the specific mixture of long-term debt and
equity the firm uses to finance its operations. The mixture chosen will affect both
the risk and the value of the firm. In addition to deciding on the financing mix, the
financial manager has to decide exactly how and where to raise the money. The
, expenses associated with raising long-term financing can be considerable, so
different possibilities must be carefully evaluated.
Working capital management
The third question concerns working capital management. The term working capital
refers to a firm’s short-term assets, such as inventory, and its short-term liabilities,
such as money owed to suppliers. Managing the firm’s working capital is a day-to-
day activity which ensures that the firm has sufficient resources to continue its
operations and avoid costly interruptions. Some questions about working capital that
must be answered are the following:
How much cash and inventory should we keep on hand?
Should we sell on credit?
How will we obtain any needed short-term financing?
1.2 THE GOAL OF FINANCIAL MANAGEMENT
The main goal of financial management is to make money or add value for the
owners.
Possible goals
If we were to consider possible financial goals, we might come up with some ideas
like the following:
Survive
Avoid financial distress and bankruptcy
Beat the competition
Maximize sales or market share
Minimize costs
Maximize profits
Maintain steady earnings growth
Profit maximization would probably be the most commonly cited goal, but even this
is not a precise objective. The goal of maximizing profits may refer to some sort of
long-run or average profit but it’s still unclear exactly what this means.
The goals listed are all different, but tend to fall into two classes. The first of these
relates to profitability. The goals involving sales, market share and cost control, all
relate to different ways of earning or increasing profits. The goals in the second
group relate in some way to controlling risk.
The goal of financial management
The financial manager in a corporation makes decisions for the shareholders of the
firm. The question that needs to be answered therefore is: from the shareholders’
point of view, what is a good financial management decision?
It follows that the financial manager acts in the shareholders’ best interests by
making decisions that increase the value of the equity. The appropriate goal for the
financial manager can thus be stated quite easily:
The goal of financial management is to maximize the current value per share of the
existing equity.
A more general goal
