Corporate Financial Management
Chapter 1: Introduction to Corporate Finance
1.1 What is Corporate Finance?
Balance sheet: financial snapshot of the firm
- Left side: assets
o Short-term (current)
inventory
o Long-term (non-current), will last a long time
Machinery and equipment (tangible)
Patents and trademarks (intangible)
- Right side: funding:
o Firm must otain financing (raise money for investments).
o A firm will sell bonds or shares.
o Liabilities:
Short-term debt is a current liability
These are loans and other obligations. To be repaid within one year.
Non-current liabilities
Debt that does not have to be repaid within one year.
- Shareholders’ equity represents the difference between the value of the firm’s assets and
liabilities and the residual claim on the firm’s assets
-
Capital budgeting: the process of planning and managing a firms long-term investments
Capital structure: the mixture of long-term debt and equity maintained by the firm.
- The people or institutions that lend money to the firm are called creditors, bondholders or
debtholders.
- The holders of equity are called shareholders.
- The capital structure might initially be more debt than equity by having invested heavily. Now it
can consider changing the mix by issuing more equity and using the proceeds to buy back some
of the debt.
- The value of the firm can be written as:
, o V=D+E
o D = market value of the debt (bonds)
o E = market value of the equity (shares)
Net working capital: current assets minus current liabilities. Short-term cash flow problems come from
the mismatching of cash inflows and outflows.
The financial manager:
- The treasurer and financial controller report to the chief financial officer (CFO).
- The treasurer handles cash flows, manages capital expenditure decisions and makes financial
plans.
- The financial controller handles the accounting function, which includes taxes, financial and
management accounting and information systems
- This is the case in large firms. Smaller firms a single employee covers most of these tasks.
If the cash paid to the shareholders and bondholders is greater than the cash raised in the financial
markets, value will be created.
Individuals prefer to receive cash flows earlier rather than later. One euro received today is worth more
than one euro received next year.
The risk of cash flows, the amount and timing is often not certain.
1.2 The goal of financial management
The goal of financial management: to maximize the value of a company’s equity shares.
What is the goal if the firm has no shares:
- If the company is a for-profit business, the total value of the shares in a corporation is equal to
the value of the owner’s equity. The goal: maximize the market value of the existing owners’
equity.
The triple bottom line:
- Shareholder value maximization has attracted criticism because it ignores other important factors
like employees (social) and sustainability (environmental).
- Asks companies to maximize also the contribution to society and environment
, - The financial manager best serves shareholders by making decisions that are valued by
shareholders, who reflect the broader societal and environmental concerns of the general
population.
1.3 Financial markets
Debt securities: contractual obligations to repay corporate borrowing
Equity securities: ordinary shares or common stock.
Money markets: sebt securities that will pay off in the short-term (less than one year).
Capital markets: long-term debt (for longer than a year) and equities.
Financial markets:
- Primary market: sell securities:
o Public offerings
The underwriting syndicate buys new securities from the firm and resells for a
higher price. Publicly issues debt and equity must be registered
Incurs legal, accounting and other costs
o Private placements
To avoid these costs, these offerings are sold to large financial institutions.
These are not registered with the regulatory authorities
- Secondary market
o One owner or creditor selling to another
o Two types:
Dealer market: buy and sell for themselves at their own risk. Buying and selling is
done by the dealer
Auction market: has a physical location. The purpose is to match those who wish
to sell with those who want to buy.
- Peer-to-peer investing platforms:
o SME financing. Investors from the world lend to a company using an electronic platform.
o Lower transaction costs. Need to research the company
o Smaller amount to borrow
o Borrowing period is short (up to five years)
Shares that trade on an organized exchange are said to be listed on that exchange. To be listed a firm
must meet certain requirements.
Chapter 2 Corporate governance
2.1 The corporate firm
Sole proprietorship: a business owned by one person.
Important factors for sole proprietorship:
- Cheapest business to form. No formal charter, articles or memoranda of association.
- No corporate income tax
- Unlimited liability for business debts and obligations
, - Life of the business is tied to the owner
- Limited by personal wealth
Partnership: a business formed by two or more individuals or entities. Two categories:
- General partnerships: all partners agree to provide some fraction of the work and cash, and share
the profits and losses of the firm. Each partner is liable for the debts of the partnership
o Unlimited liability
o Terminated when a general partner dies or withdraws.
- Limited partnerships: permit the liability of some partners to be limited to the amount of cash
each has contributed to the partnership. Require: one partner to be general partner, the limited
partner do not manage.
o Liability limited to contribution
o May sell their interest in a business
- Inexpensive and easy to form. Difficult to acquire cash. Personal income tax
Corporation: a business created as a distinct legal entity composed of one or more individuals or entities.
Complicated tot start. Incorporators must prepare
- Articles of incorporation:
o Name of corporation, intended life, purpose, no of shares, rights, number of members
- Memorandum of association: the rules to be used by the corporation to regulate its own
existence.
Public vs. private limited corporations:
- Private limited: start small, families are the major shareholders
o Three interests: the shareholders, the directors and senior management, the firm’s
stakeholders
- Ownership can be transferred. Business has unlimited life. Liability is limited to the amount
invested in the ownership shares.
- Tax corporate income.
2.2 The agency problem and control of the corporation
Agency relationships: dispersion of ownership and how it influences management.
Type 1 agency relationships: the relationship between shareholders (principal) and management (agent).
There may be a conflict of interest between the principal and agent.
Agency cost: the cost of a conflict of interest between shareholders and management.
- Indirect agency cost: lost opportunity
- Direct agency cost:
o Corporate expenditure that benefits management but costs the shareholders.
o Expense that comes from the need to monitor management actions. Paying outside
auditors to assess the accuracy of financial statement information.
- Management may tend to prioritize organizational survival to protect job security
Managerial compensation:
Chapter 1: Introduction to Corporate Finance
1.1 What is Corporate Finance?
Balance sheet: financial snapshot of the firm
- Left side: assets
o Short-term (current)
inventory
o Long-term (non-current), will last a long time
Machinery and equipment (tangible)
Patents and trademarks (intangible)
- Right side: funding:
o Firm must otain financing (raise money for investments).
o A firm will sell bonds or shares.
o Liabilities:
Short-term debt is a current liability
These are loans and other obligations. To be repaid within one year.
Non-current liabilities
Debt that does not have to be repaid within one year.
- Shareholders’ equity represents the difference between the value of the firm’s assets and
liabilities and the residual claim on the firm’s assets
-
Capital budgeting: the process of planning and managing a firms long-term investments
Capital structure: the mixture of long-term debt and equity maintained by the firm.
- The people or institutions that lend money to the firm are called creditors, bondholders or
debtholders.
- The holders of equity are called shareholders.
- The capital structure might initially be more debt than equity by having invested heavily. Now it
can consider changing the mix by issuing more equity and using the proceeds to buy back some
of the debt.
- The value of the firm can be written as:
, o V=D+E
o D = market value of the debt (bonds)
o E = market value of the equity (shares)
Net working capital: current assets minus current liabilities. Short-term cash flow problems come from
the mismatching of cash inflows and outflows.
The financial manager:
- The treasurer and financial controller report to the chief financial officer (CFO).
- The treasurer handles cash flows, manages capital expenditure decisions and makes financial
plans.
- The financial controller handles the accounting function, which includes taxes, financial and
management accounting and information systems
- This is the case in large firms. Smaller firms a single employee covers most of these tasks.
If the cash paid to the shareholders and bondholders is greater than the cash raised in the financial
markets, value will be created.
Individuals prefer to receive cash flows earlier rather than later. One euro received today is worth more
than one euro received next year.
The risk of cash flows, the amount and timing is often not certain.
1.2 The goal of financial management
The goal of financial management: to maximize the value of a company’s equity shares.
What is the goal if the firm has no shares:
- If the company is a for-profit business, the total value of the shares in a corporation is equal to
the value of the owner’s equity. The goal: maximize the market value of the existing owners’
equity.
The triple bottom line:
- Shareholder value maximization has attracted criticism because it ignores other important factors
like employees (social) and sustainability (environmental).
- Asks companies to maximize also the contribution to society and environment
, - The financial manager best serves shareholders by making decisions that are valued by
shareholders, who reflect the broader societal and environmental concerns of the general
population.
1.3 Financial markets
Debt securities: contractual obligations to repay corporate borrowing
Equity securities: ordinary shares or common stock.
Money markets: sebt securities that will pay off in the short-term (less than one year).
Capital markets: long-term debt (for longer than a year) and equities.
Financial markets:
- Primary market: sell securities:
o Public offerings
The underwriting syndicate buys new securities from the firm and resells for a
higher price. Publicly issues debt and equity must be registered
Incurs legal, accounting and other costs
o Private placements
To avoid these costs, these offerings are sold to large financial institutions.
These are not registered with the regulatory authorities
- Secondary market
o One owner or creditor selling to another
o Two types:
Dealer market: buy and sell for themselves at their own risk. Buying and selling is
done by the dealer
Auction market: has a physical location. The purpose is to match those who wish
to sell with those who want to buy.
- Peer-to-peer investing platforms:
o SME financing. Investors from the world lend to a company using an electronic platform.
o Lower transaction costs. Need to research the company
o Smaller amount to borrow
o Borrowing period is short (up to five years)
Shares that trade on an organized exchange are said to be listed on that exchange. To be listed a firm
must meet certain requirements.
Chapter 2 Corporate governance
2.1 The corporate firm
Sole proprietorship: a business owned by one person.
Important factors for sole proprietorship:
- Cheapest business to form. No formal charter, articles or memoranda of association.
- No corporate income tax
- Unlimited liability for business debts and obligations
, - Life of the business is tied to the owner
- Limited by personal wealth
Partnership: a business formed by two or more individuals or entities. Two categories:
- General partnerships: all partners agree to provide some fraction of the work and cash, and share
the profits and losses of the firm. Each partner is liable for the debts of the partnership
o Unlimited liability
o Terminated when a general partner dies or withdraws.
- Limited partnerships: permit the liability of some partners to be limited to the amount of cash
each has contributed to the partnership. Require: one partner to be general partner, the limited
partner do not manage.
o Liability limited to contribution
o May sell their interest in a business
- Inexpensive and easy to form. Difficult to acquire cash. Personal income tax
Corporation: a business created as a distinct legal entity composed of one or more individuals or entities.
Complicated tot start. Incorporators must prepare
- Articles of incorporation:
o Name of corporation, intended life, purpose, no of shares, rights, number of members
- Memorandum of association: the rules to be used by the corporation to regulate its own
existence.
Public vs. private limited corporations:
- Private limited: start small, families are the major shareholders
o Three interests: the shareholders, the directors and senior management, the firm’s
stakeholders
- Ownership can be transferred. Business has unlimited life. Liability is limited to the amount
invested in the ownership shares.
- Tax corporate income.
2.2 The agency problem and control of the corporation
Agency relationships: dispersion of ownership and how it influences management.
Type 1 agency relationships: the relationship between shareholders (principal) and management (agent).
There may be a conflict of interest between the principal and agent.
Agency cost: the cost of a conflict of interest between shareholders and management.
- Indirect agency cost: lost opportunity
- Direct agency cost:
o Corporate expenditure that benefits management but costs the shareholders.
o Expense that comes from the need to monitor management actions. Paying outside
auditors to assess the accuracy of financial statement information.
- Management may tend to prioritize organizational survival to protect job security
Managerial compensation:
