Principles of Corporate
Finance Summary
EC2PCF
,Inhoudsopgave
2
,Chapter 1: Goals and
Governance of the Corporation
1.1: Investment and Financing Decisions
The investment (Capital Budgeting) Decision
Capital budgeting or capital expenditure (CAPEX) decisions: decision to invest in tangible or
intangible assets.
Tangible assets assets that you can touch and kick
Intangible assets R&D, advertising, design of computer software
Investments can have very-long-term consequences. Other investments may pay off in only
a few months.
Business is competitive, corporations prosper only if they can keep launching new products
or services. Most investments decisions are small (purchase of truck, machine tool,
computer system). Corporations make thousands of those investments. The cumulative
amount of these investments can be as large as a jumbo investment.
No free guarantees in finance.
The Financing Decision
Financial manager’s second main responsibility is to raise the money that the firm requires
for its investments and operations Financing Decision
The choice between debt and equity financing is often called the Capital Structure Decision.
When the firm invests, it acquires real assets, which are used to produce the firm’s goods
and services.
What are the two major decisions made by financial managers?
Financial management can be broken down into (1) he investment or capital budgeting
decision and (2) the financing decision. The firm has to decide (1) which real assets to invest
in and (2) how to raise the funds necessary to pay for those investments.
Capital budgeting: decision to invest in tangible or intangible assets. Also called capital
expenditure (CAPEX) decision. Tangible assets assets that you can touch and kick.
Intangible assets R&D, advertising, design of computer software
Financing decision: Decision on the sources and amounts of financing.
What does “real asset” mean?
Real assets include all assets used in the production or sale of the firms’ products or
services. They can be tangible or intangible. In contrast, financial assets (such as stocks or
bonds) are claims on the income generated by real assets.
Financial assets: Financial claims to the income generated by the firm’s real assets.
3
, What are the advantages and disadvantages of forming a
corporation?
Corporations are distinct, permanent legal entities. They allow for separation of ownership
and control, and they can continue operating without disruption even as management or
ownership changes. They provide limited liability to their owners. On the other hand,
managing the corporation’s legal machinery is costly. Also, corporations are subject to
double taxation because they pay taxes on their profits and the shareholders are taxed again
when they receive dividends or sell their shares at a profit.
Corporation: A business organized as a separate legal entity owned by stockholders
Limited liability: The owners of a corporation are not personally liable for its obligations.
Who are the principal financial managers in a corporation?
Almost all managers are involved to some degree in investment decisions, but some
managers specialize in finance, for example, the treasurer, controller, and CFO. The
treasurer is most directly responsible for raising capital and maintaining relationships with
banks and investors that hold the firm’s securities. The Controller is responsible for
preparing financial statements and managing budgets. In large firms, a chief financial officer
oversees both the treasurer and the controller and is involved in financial policymaking and
corporate planning.
Treasurer: Responsible for financing, cash management, and relationships with banks and
other financial institutions.
Controller: Responsible for budgeting, accounting, and taxes.
CFO: Supervises all financial functions and sets overall financing strategy.
Why does it make sense for corporations to maximize shareholders
wealth?
Value maximization is the natural financial goal of the firm. Shareholders can invest or
consume the increased wealth as they wish, provided that they have access to well-
functioning financial markets.
What is the fundamental trade-off in investment decisions?
Companies either can invest in real assets or can return the cash to shareholders, who can
invest it for themselves. The return that shareholders can earn for themselves is called the
opportunity cost of capital. Companies create value for shareholders whenever they can
earn a higher return on their investments than the opportunity cost of capital.
Opportunity cost of capital: The minimum acceptable rate of return on capital investment is
set by the investment opportunities available to shareholders in financial markets.
How do corporations ensure that managers act in the interest of
stockholders?
Conflicts of interest between managers and stockholders can lead to agency problems and
agency costs. Agency problems are kept in check by financial controls, by well-designed
compensation packages for managers, and by effective corporate governance.
4
Finance Summary
EC2PCF
,Inhoudsopgave
2
,Chapter 1: Goals and
Governance of the Corporation
1.1: Investment and Financing Decisions
The investment (Capital Budgeting) Decision
Capital budgeting or capital expenditure (CAPEX) decisions: decision to invest in tangible or
intangible assets.
Tangible assets assets that you can touch and kick
Intangible assets R&D, advertising, design of computer software
Investments can have very-long-term consequences. Other investments may pay off in only
a few months.
Business is competitive, corporations prosper only if they can keep launching new products
or services. Most investments decisions are small (purchase of truck, machine tool,
computer system). Corporations make thousands of those investments. The cumulative
amount of these investments can be as large as a jumbo investment.
No free guarantees in finance.
The Financing Decision
Financial manager’s second main responsibility is to raise the money that the firm requires
for its investments and operations Financing Decision
The choice between debt and equity financing is often called the Capital Structure Decision.
When the firm invests, it acquires real assets, which are used to produce the firm’s goods
and services.
What are the two major decisions made by financial managers?
Financial management can be broken down into (1) he investment or capital budgeting
decision and (2) the financing decision. The firm has to decide (1) which real assets to invest
in and (2) how to raise the funds necessary to pay for those investments.
Capital budgeting: decision to invest in tangible or intangible assets. Also called capital
expenditure (CAPEX) decision. Tangible assets assets that you can touch and kick.
Intangible assets R&D, advertising, design of computer software
Financing decision: Decision on the sources and amounts of financing.
What does “real asset” mean?
Real assets include all assets used in the production or sale of the firms’ products or
services. They can be tangible or intangible. In contrast, financial assets (such as stocks or
bonds) are claims on the income generated by real assets.
Financial assets: Financial claims to the income generated by the firm’s real assets.
3
, What are the advantages and disadvantages of forming a
corporation?
Corporations are distinct, permanent legal entities. They allow for separation of ownership
and control, and they can continue operating without disruption even as management or
ownership changes. They provide limited liability to their owners. On the other hand,
managing the corporation’s legal machinery is costly. Also, corporations are subject to
double taxation because they pay taxes on their profits and the shareholders are taxed again
when they receive dividends or sell their shares at a profit.
Corporation: A business organized as a separate legal entity owned by stockholders
Limited liability: The owners of a corporation are not personally liable for its obligations.
Who are the principal financial managers in a corporation?
Almost all managers are involved to some degree in investment decisions, but some
managers specialize in finance, for example, the treasurer, controller, and CFO. The
treasurer is most directly responsible for raising capital and maintaining relationships with
banks and investors that hold the firm’s securities. The Controller is responsible for
preparing financial statements and managing budgets. In large firms, a chief financial officer
oversees both the treasurer and the controller and is involved in financial policymaking and
corporate planning.
Treasurer: Responsible for financing, cash management, and relationships with banks and
other financial institutions.
Controller: Responsible for budgeting, accounting, and taxes.
CFO: Supervises all financial functions and sets overall financing strategy.
Why does it make sense for corporations to maximize shareholders
wealth?
Value maximization is the natural financial goal of the firm. Shareholders can invest or
consume the increased wealth as they wish, provided that they have access to well-
functioning financial markets.
What is the fundamental trade-off in investment decisions?
Companies either can invest in real assets or can return the cash to shareholders, who can
invest it for themselves. The return that shareholders can earn for themselves is called the
opportunity cost of capital. Companies create value for shareholders whenever they can
earn a higher return on their investments than the opportunity cost of capital.
Opportunity cost of capital: The minimum acceptable rate of return on capital investment is
set by the investment opportunities available to shareholders in financial markets.
How do corporations ensure that managers act in the interest of
stockholders?
Conflicts of interest between managers and stockholders can lead to agency problems and
agency costs. Agency problems are kept in check by financial controls, by well-designed
compensation packages for managers, and by effective corporate governance.
4
