Chapter

Brealey, Myers, and Allen

Principles of Corporate Finance
11th Global Edition
INTRODUCTION TO
CORPORATE FINANCE
1
Copyright 2014 by The McGraw-Hill Companies, I nc. All rights reserved. McGraw-Hill Education
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1-1 CORPORATE INVESTMENT AND FINANCING
DECISIONS
Real Assets
Used to produce goods and services
Financial Assets/Securities
Financial claims on income generated by firms
real assets
Capital Budgeting/Capital Expenditure
(CAPEX)
Decision to invest in tangible or intangible
assets
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1-1 CORPORATE INVESTMENT AND FINANCING
DECISIONS
Investment Decision
Purchase of real assets
Financing Decision
Sale of financial assets
Capital Structure
Choice between debt and equity financing
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1-1 CORPORATE INVESTMENT AND FINANCING
DECISIONS
Capital Budgeting Examples
Tangible Assets
i.e. Expanding stores
Intangible Assets
i.e. Research and development for new drug
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TABLE 1.1 RECENT INVESTMENT/ FINANCING
DECISIONS
Company Recent Investment Decisions Recent Financing Decisions
Boeing (U.S.) Delivers first Dreamliner after investing a
reported $30 billion in development costs.
Reinvests $1.7 billion of profits.
ExxonMobil
(U.S.)
Spends $7 billion to develop oil sands at Fort
McMurray in Alberta.
Spends $12 billion buying back shares.
GlaxoSmith-
Kline (UK)
Spends $4 billion on research and
development for new drugs.
Pays $3.2 billion as dividends.
LVMH (France) LVMH acquires the Italian Jeweler, Bulgari,
for $5 billion.
Pays for the acquisition with a mixture of cash and
shares.
Procter &
Gamble (U.S.)
Spends $8 billion on advertising. Raises 100 billion Japanese yen by an issue of 5-
year bonds.
Tata Motors
(India)
Opens a plant in India to produce the world's
cheapest car, the Nano. The facility costs
$400 million.
Raises $400 million by the sale of new shares.
Union Pacific
(U.S.)
Invests $330 million in 100 new locomotives
and 10,000 freight cars and chassis.
Repays $1.4 billion of debt.
Vale (Brazil) Opens a copper mine at Salobo in Brazil. The
project cost nearly $2 million.
Maintains credit lines with its banks that allow the
company to borrow at any time up to $1.6 billion.
Walmart (U.S.) Invests 12.7 billion, primarily to open 458
new stores around the world.
Issues $5 billion of long-term bonds in order to
repay short-term commercial paper borrowings.
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1-1 CORPORATE INVESTMENT AND FINANCING
DECISIONS
What Is a Corporation?
Legal entity, owned by shareholders
Can make contracts, carry on business, borrow,
lend, sue, and be sued
Shareholders have limited liability and cannot
be held personally responsible for corporations
debts
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FIGURE 1.1 CASH FLOW BETWEEN FINANCIAL
MARKETS AND FIRMS OPERATIONS
Financial
manager
Firm's
operations
Financial
markets
(1) Cash raised from investors
(1)
(2) Cash invested in firm
(2)
(3) Cash generated by operations
(3)
(4a) Cash reinvested
(4a)
(4b) Cash returned to investors
(4b)
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1-2 THE FINANCIAL GOAL OF THE CORPORATION
Stockholders Want Three Things
To maximize current wealth
To transform wealth into most desirable time
pattern of consumption
To manage risk characteristics of chosen
consumption plan
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1-2 THE FINANCIAL GOAL OF THE CORPORATION
Profit Maximization
Not a well-defined financial objective
Which years profits?
Shareholders will not welcome higher short-term
profits if long-term profits are damaged
Company may increase future profits by
cutting years dividend, investing freed-up
cash in firm
Not in shareholders best interest if company earns
less than opportunity cost of capital


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1-2 THE FINANCIAL GOAL OF THE CORPORATION
Shareholders desire wealth maximization
Managers have many constituencies,
stakeholders
Agency Problems represent the conflict of
interest between management and owners

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1-2 THE FINANCIAL GOAL OF THE CORPORATION
The Investment Trade-off
Hurdle Rate/Cost of Capital
Minimum acceptable rate of return on
investment
Opportunity Cost of Capital
Investing in a project eliminates other
opportunities to use invested cash
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FIGURE 1.2 THE INVESTMENT TRADE-OFF
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1-2 THE FINANCIAL GOAL OF THE CORPORATION
Agency Problems
Managers, acting as agents for stockholders,
may act in their own interests rather than
maximizing value
Stakeholder
Anyone with a financial interest in the firm

Agency ProblemsOwnership versus
Management
Difference in
Information
Stock prices and returns
Issues of shares and
other securities
Dividends
Financing
Different Objectives
Managers vs.
stockholders
Top mgmt vs. operating
mgmt
Stockholders vs. banks
and lenders

1-2 THE FINANCIAL GOAL OF THE CORPORATION
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1-2 THE FINANCIAL GOAL OF THE CORPORATION
Agency costs are incurred when:
Managers do not attempt to maximize firm
value
Shareholders incur costs to monitor managers
and constrain their actions

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1-2 THE FINANCIAL GOAL OF THE CORPORATION
Tools to Ensure Management Pays
Attention to the Value of the Firm
Managers actions subject to the scrutiny of
board of directors
Shirkers are likely to find they are ousted by
more energetic managers
Financial incentives provided, such as stock
options