BUAD-6200 || Corporate Finance || Chapter 1

University of Toledo || College of Business and Innovation

BUAD-6200: Corporate Finance

Lecture- (Chapter-01)
Introduction to Corporate Finance
Chapter Outline
1.1 What is Corporate Finance?
1.2 The Corporate Firm
1.3 The Importance of Cash Flows
1.4 The Goals of Financial Management
1.5 The Agency Problem and Control of the Corporation
1.6 Regulation
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University of Toledo || College of Business and Innovation

BUAD-6200 || Corporate Finance || Chapter 1

Key Concepts and Skills

Know the basic types of financial management decisions

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and the role of the Financial Manager

Know the financial implications of the various forms of
business organization
Know the goal of financial management
Understand the conflicts of interest that can arise between
owners and managers
Understand the various types of financial markets

Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business and Innovation

BUAD-6200 || Corporate Finance || Chapter 1

What is Corporate Finance?

Corporate Finance addresses the following

three questions:

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What long-term investments should the firm engage

in?
How can the firm raise the money for the required
investments?
How much short-term cash flow does a company need
to pay its bills?

Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

The Balance-Sheet Model of the Firm

Total Value of Assets

Total Firm Value to Investors

Current Assets

Current
Liabilities

Fixed Assets

Long-Term
Debt

1 Tangible
2 Intangible

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4

Corporate
Finance

Total Firm
Value

Shareholder
s Equity
Corporate
Firm

Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

The Balance-Sheet Model of the Firm

The Capital Budgeting Decision
Current Assets

Current
Liabilities

Fixed Assets

Long-Term
Debt

What long-term
investments
should the firm
engage in?

1 Tangible
2 Intangible

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5

Corporate
Finance

Total Firm
Value

Corporate
Firm

Shareholders
Equity
Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

The Balance-Sheet Model of the Firm

The Capital Structure Decision

Current
Liabilities

Current Assets

Fixed Assets
1 Tangible

How can the firm

raise the money
for the required
investments?

2 Intangible

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Corporate
Finance

Long-Term
Debt
Shareholders
Equity

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

The Balance-Sheet Model of the Firm

The Net Working Capital Investment Decision

Current
Liabilities
Net
Working
Capital

Current Assets
Fixed Assets
1 Tangible
2 Intangible
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Corporate
Finance

How much short-term

cash flow does a
company need to pay
its bills?

Total Firm
Value

Corporate
Firm

Long-Term
Debt
Shareholders
Equity
Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

Capital Structure
The value of the firm can be
thought of as a pie.

25%50% 30%
DebtDebtEquity

The goal of the manager is to

increase the size of the pie.

70% Debt

50%
75%
Equity
Equity

The Capital Structure decision can

be viewed as how best to slice up a
the pie.

If how you slice the pie affects the size of the pie, then the
capital structure decision matters.
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Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

Hypothetical Organization Chart

Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
President and Chief
Operating Officer (COO)
Vice President and
Chief Financial Officer (CFO)

Treasurer

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Controller

Cash Manager

Credit Manager

Tax Manager

Cost Accounting

Capital Expenditures

Financial Planning

Financial Accounting

Data Processing

Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

The Financial Manager

To create value, the financial manager should:
Try to make smart investment decisions.
Try to make smart financing decisions.

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Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

The Importance of Cash Flows

Firm

Firm issues securities (A)

Invests
in assets
(B)

Retained
cash flows (F)
Short-term debt
Cash flow
from firm (C)

Dividends and
debt payments (E)

Ultimately, the firm must be a

cash generating activity.
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Corporate
Finance

Total Firm
Value

Government
Corporate
Firm

Long-term debt
Equity shares

Taxes (D)

Current assets
Fixed assets

Financial
markets

The cash flows from the firm

must exceed the cash flows from
the financial markets.
Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

The Corporate Firm

The corporate form of business is the standard method

for solving the problems encountered in raising large

amounts of cash.
However, businesses can take other forms.

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Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

Forms of Business Organization

The Sole

Proprietorship
The Partnership
General
Partnership
Limited Partnership
The Corporation

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Corporate
Finance

Total Firm
Value

Advantages and

Disadvantages
Liquidity and

Marketability of
Ownership
Control
Liability
Continuity of Existence
Tax Considerations

Corporate
Firm

Financial
Market

University of Toledo || College of Business and Innovation

BUAD6200 || Corporate Finance || Chapter 1

A Comparison of Partnership and Corporations

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Corporation

Partnership

Liquidity

Shares can
easily be
exchanged

Subject to substantial
restrictions

Voting Rights

Usually each
share gets one
vote

General partner is in
charge; limited
partners may have
some voting rights

Taxation

Double

Partners pay taxes on

distribution

Reinvestment
and Dividend
Payout

Broad latitude

All net cash flow is

distributed to
partners

Liability

Limited liability

Corporate
Finance

Total Firm
Value

General partners may

have unlimited
liability. Limited
Corporate
partnersFinancial
enjoy limited
Firm
Market
liability

University of Toledo || College of Business

BUAD6200 || Corporate Finance || Chapter 1

The Goal of Financial Management

What is the correct goal?
Maximize profit?
Minimize costs?
Maximize market share?
Maximize shareholder wealth?
The traditional answer is that the managers of

the corporation are obliged to make efforts to

maximize shareholder wealth.

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Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business

BUAD6200 || Corporate Finance || Chapter 1

The Agency Problem

Agency relationship
Principal hires an agent to represent his/her interest
Stockholders (principals) hire managers (agents) to run
the company
Agency problem

Conflict of interest between principal and agent

Can you name one or two agency relationship

from your everyday life?

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Doctors, car mechanic, or ?

Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business

BUAD6200 || Corporate Finance || Chapter 1

Managerial Goals
Managerial goals may be different from

shareholder goals
Expensive perquisites
Survival
Independence

Increased growth and size are not necessarily

equivalent to increased shareholder wealth

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Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business

BUAD6200 || Corporate Finance || Chapter 1

Managing Managers
Managerial compensation
Incentives can be used to align management and
stockholder interests
The incentives need to be structured carefully to
make sure that they achieve their intended goal
Corporate control

The threat of a takeover may result in better

management

Other stakeholders

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Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business

BUAD6200 || Corporate Finance || Chapter 1

Separation of Ownership and Control

Board of Directors

Debt
Assets
Equity
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Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

Shareholders

Debtholders

Management

University of Toledo || College of Business

BUAD6200 || Corporate Finance || Chapter 1

Financial Markets
Primary Market
When a corporation issues securities, cash flows from
investors to the firm.
Usually an underwriter is involved
Secondary Markets
Involve the sale of used securities from one investor

to another.
Securities may be exchange traded or trade over-thecounter in a dealer market.

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Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business

BUAD6200 || Corporate Finance || Chapter 1

Financial Markets

Firms

Stocks and
Bonds

Investors

Money

Bob

securities

Sue

money
Primary Market
Secondary Market

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Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market

University of Toledo || College of Business

BUAD6200 || Corporate Finance || Chapter 1

Quick Quiz
What are the three basic questions Financial Managers

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must answer?
What are the three major forms of business
organization?
What is the goal of financial management?
What are agency problems, and why do they exist within
a corporation?
What is the difference between a primary market and a
secondary market?

Corporate
Finance

Total Firm
Value

Corporate
Firm

Financial
Market