Introduction to

Corporate Finance

Chapter One
FIN 6301
Financial Management
 Instructor:
 Mary Chaffin
 SOM 2.208
 972-883-2646
 chaf@utdallas.edu
 Office Hours:
 Monday 4:00-6:30 p.m.
 Wednesday 2:00-3:30 p.m.
Corporate Finance

 Ross, Westerfield and Jaffee, 7th Edition

 www.utdallas.edu/~chaf
 Copies of the transparencies.
 Solutions to end of chapter problems.
 Old exams.
 www.mhhe.com/rwj
 Appendix D: Using a Financial Calculator.
 Review material and practice quizzes.
Grading

 Exam I 30% or 15%

 Exam II 30% or 15%
 Final Exam 40%
 Assignments 15%
 Formula sheet allowed on exams - not
quizzes.
 Notice of Policy on Cheating
Other Resources

 Wall Street Journal

 Barron’s
 Financial Calculator
The Four Basic Areas of
Finance
 Corporate Finance
 Broadest field
 Specific to operations of a business
 Investments
 Interrelation on a smaller scale then money and capital
markets
 Money and Capital Markets
 Workings of the financial system
 Broad flow of money
 International Finance
Areas of Finance

Financial Markets

The Firm Investors

Financial
Intermediaries
Financial Calculators

 HP 10B ($30)
 HP 17B II ($80)
 HP 12C ($70)
 HP 19B II ($100+)
 TI BA II + ($30)
Financial Calculators

 HP 10B
 TI BA II+
 Tips on using calculator:
 Set p/y=1 (This comes set at 12 on a new
calculator)
 Clear registers before each use
 Set decimals to 4 places
Solution Methods

 Numerical – using regular calculator without

financial functions.
 Interest Tables - end of text.
 Financial Calculator – using five specific keys
which correspond to the five most commonly
used DCF variables:

N i PV PMT FV
What is Corporate Finance?
Corporate Finance addresses the following
three questions:

1. What long-term investments should the firm

engage in?
2. How can the firm raise the money for the
required investments?
3. How much short-term cash flow does a
company need to pay its bills?
Microsoft to Dole Out
Its Cash Hoard
 In an extraordinary move to shower its cash hoard
upon shareholders, Microsoft Corp. said it will make
a one-time dividend payment this year of $32 billion
and buy back up to $30 billion of the company's
stock over the next four years. The company also
said it will double the dividend it pays out annually to
$3.5 billion, or 32 cents a share.
 The plans, which Microsoft valued at up to $75
billion over four years, are believed to represent the
largest corporate cash disbursement in history. They
mark a turning point for high technology's most
successful company.
Capital Structure

The value of the firm can be

thought of as a pie.

The goal of the manager is 70%50%30%

25%
to increase the size of the DebtDebt
Equity
pie.
75%
50%
The Capital Structure Equity
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.
The Financial Manager

To create value, the financial manager

should:
1. Try to make smart investment decisions.

2. Try to make smart financing decisions.

Corporate Securities as
Contingent Claims on Total Firm
Value
 The basic feature of a debt is that it is a

promise by the borrowing firm to repay a

fixed dollar amount of by a certain date.
 The shareholder’s claim on firm value is the
residual amount that remains after the
debtholders are paid.
 If the value of the firm is less than the
amount promised to the debtholders, the
shareholders get nothing.
Debt and Equity as
Contingent
Payoff to
debt holders
Claims Payoff to
shareholders
If the value of the firm If the value of the
is more than $F, debt firm is less than $F,
holders get a share holders get
maximum of $F. nothing.
$F

$F $F
Value of the firm (X) Value of the firm (X)

Debt holders are promised If the value of the firm

$F.
If the value of the firm is less than $F,
they get the whatever the firm if worth.
Algebraically, the bondholder’s
claim is: Min[$F,$X]
is more than $F, share
holders get everything
above $F.
Algebraically, the shareholder’s
claim is: Max[0,$X – $F]
Combined Payoffs to Debt and Equity
If the value of the firm is less than
Combined Payoffs to debt holders
and shareholders $F, the shareholder’s claim is:
Max[0,$X – $F] = $0 and the debt
holder’s claim is Min[$F,$X] = $X.
The sum of these is = $X
Payoff to shareholders
$F
If the value of the firm is more than
Payoff to debt holders $F, the shareholder’s claim is:
Max[0,$X – $F] = $X – $F and the
$F debt holder’s claim is:
Value of the firm (X)
Min[$F,$X] = $F.
Debt holders are promised
$F. The sum of these is = $X
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.
Forms of Business
Organization
 The Sole Proprietorship
 The Partnership
 General Partnership
 Limited Partnership
 The Corporation
 Advantages and Disadvantages
 Liquidity and Marketability of Ownership
 Control
 Liability
 Continuity of Existence
 Tax Considerations
Goals of the Corporate Firm

 The traditional answer is that the managers

of the corporation are obliged to make efforts
to maximize shareholder wealth.
 The Set-of-Contracts
Perspective
 The firm can be viewed as a set of contracts.
 One of these contracts is between shareholders and
managers.
 The managers will usually act in the shareholders’
interests.
 The shareholders can devise contracts that align the
incentives of the managers with the goals of the
shareholders.
 The shareholders can monitor the managers behavior.
 This contracting and monitoring is costly.
Managerial Goals

 Managerial goals may be different from

shareholder goals
 Expensive perquisites
 Survival
 Independence
 Increased growth and size are not
necessarily the same thing as increased
shareholder wealth.
Do Shareholders Control
Managerial Behavior?
 Shareholders vote for the board of directors,
who in turn hire the management team.
 Contracts can be carefully constructed to be
incentive compatible.
 There is a market for managerial talent—
this may provide market discipline to the
managers—they can be replaced.
 If the managers fail to maximize share price,
they may be replaced in a hostile takeover.
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-
the-counter in a dealer market.
Exchange Trading of Listed
Stocks
 Auction markets are different from dealer
markets in two ways:
 Trading in a given auction exchange takes place
at a single site on the floor of the exchange.
 Transaction prices of shares are communicated
almost immediately to the public.