Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The...

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Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin

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Page 1: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

Introduction to Corporate FinanceEric J. McLaughlin, Ph.D.

Chapter 1

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Page 2: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Chapter Outline

• Corporate Finance and the Financial Manager

• Forms of Business Organization

• The Goal of Financial Management

• The Agency Problem and Control of the Corporation

• Financial Markets and the Corporation

Chapter Outline

http://www.mhhe.com/rwj
Page 3: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Chapter Outline

• Corporate Finance and the Financial Manager

• Forms of Business Organization

• The Goal of Financial Management

• The Agency Problem and Control of the Corporation

• Financial Markets and the Corporation

Chapter Outline

Page 4: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Corporate FinanceSome important questions that are answered using finance:

1. What long-term investments should the firm take on?

2. Where will we get the long-term financing to pay for the investment?

3. How will we manage the everyday financial activities of the firm?

Page 5: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Financial ManagersChief Financial Officer (CFO):The top financial manager within a firm

Treasurer: Oversees cash management, credit management, capital expenditures, and financial planning

Controller: Oversees taxes, cost accounting, financial accounting and data processing

Page 6: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Financial Management

Decisions

• Capital budgeting

• What long-term investments or projects should the business take on?

• Capital structure

• How should we pay for our assets?• Should we use debt or equity?

• Working capital management

• How do we manage the day-to-day finances of the firm?

http://www.nolo.com/encyclopedia/articles/sb/which_form.html
Page 7: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Chapter Outline• Corporate Finance and the Financial

Manager

• Forms of Business Organization

• The Goal of Financial Management

• The Agency Problem and Control of the Corporation

• Financial Markets and the Corporation

Page 8: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Forms of Business Organization in the U.S.

• Single OwnerSole

Proprietorship

• General• Limited

Partnership

• C-Corporation• S-Corporation• Limited Liability Company (LLC)

Corporation

Page 9: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Forms of Business Organization in the U.S.

• Single OwnerSole

Proprietorship

• General• Limited

Partnership

• C-Corporation• S-Corporation• Limited Liability Company (LLC)

Corporation

Page 10: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Sole Proprietorship

Advantages:

• Easiest to start

• Least regulated

• Single owner keeps all the profits

• Taxed once as personal income

Page 11: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Sole ProprietorshipDisadvantages:

• Limited to life of owner

• Equity capital limited to owner’s personal wealth

• Unlimited liability

• Difficult to sell ownership interest

http://www.nolo.com/encyclopedia/articles/sb/which_form.html
Page 12: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Forms of Business Organization in the U.S.

• Single OwnerSole

Proprietorship

• General• Limited

Partnership

• C-Corporation• S-Corporation• Limited Liability Company (LLC)

Corporation

Page 13: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Partnership

Advantages:

• Two or more owners

• More capital available

• Relatively easy to start

• Income taxed once as personal income

Page 14: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Disadvantages:

• Unlimited liability General partnership Limited partnership

• Partnership dissolves when one partner dies or wishes to sell

• Difficult to transfer ownership

Partnership

http://www.nolo.com/encyclopedia/articles/sb/which_form.html
Page 15: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Forms of Business Organization in the U.S.

• Single OwnerSole

Proprietorship

• General• Limited

Partnership

• C-Corporation• S-Corporation• Limited Liability Company (LLC)

Corporation

Page 16: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Corporation

Advantages:

• Limited liability

• Unlimited life

• Separation of ownership and management

• Transfer of ownership is easy

• Easier to raise capital

Page 17: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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CorporationDisadvantages:

• Separation of ownership and management

• Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)

http://www.nolo.com/encyclopedia/articles/sb/which_form.html
Page 18: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Chapter Outline

• Corporate Finance and the Financial Manager

• Forms of Business Organization

• The Goal of Financial Management

• The Agency Problem and Control of the Corporation

• Financial Markets and the Corporation

Page 19: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Goal of Financial

Management

What should be the goal of a corporation?

Maximize profits?Minimize costs?Maximize market share?Maximize the current value of the company’s stock?

Does this mean we should do anything and everything to maximize owner wealth?

Page 20: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Chapter Outline

• Corporate Finance and the Financial Manager

• Forms of Business Organization

• The Goal of Financial Management

• The Agency Problem and Control of the Corporation

• Financial Markets and the Corporation

Page 21: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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The Agency ProblemAgency relationship

• Principal hires an agent to represent his/her interests

• Stockholders (principals) hire managers (agents) to run the company

Agency problem

Conflict of interest between principal and agent

Management goals and agency costs

Page 22: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Managing ManagersManagerial 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 goal

Corporate control

The threat of a takeover may result in better management

Other stakeholders

Page 23: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Work the Web Example

The Internet provides a wealth of information about individual companies

One excellent site is finance.yahoo.com

Click on the web surfer to go to the site, choose a company and see what information you can find!

http://www.finance.yahoo.com/
http://finance.yahoo.com/
Page 24: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

1-24

Chapter Outline

• Corporate Finance and the Financial Manager

• Forms of Business Organization

• The Goal of Financial Management

• The Agency Problem and Control of the Corporation

• Financial Markets and the Corporation

Page 25: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Financial Markets

Cash flows to the firmPrimary vs. secondary

marketsDealer vs. auction marketsListed vs. over-the-counter

securitiesNYSENASDAQ

http://www.nyse.com/
http://www.nasdaq.com/
Page 26: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Ethics Issues

Is it ethical for tobacco companies to sell a product that is known to be addictive and a danger to the health of the user? Is it relevant that the product is legal?

Should boards of directors consider only price when faced with a buyout offer?

Is it ethical to concentrate only on shareholder wealth, or should stakeholders as a whole be considered?

Should firms be penalized for attempting to improve returns by stifling competition (e.g., Microsoft)?

Page 27: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Terminology

• CFO (Chief Financial Officer)• Sole Proprietorship• Partnership• C-, S-, and LLC Corporations• “Agency” Problem

Page 28: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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Key Concepts and Skills

• Role of the financial manager

• Corporation classifications

• Goal of financial management

• Potential conflicts between financial managers and shareholders

Page 29: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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1. The CFO’s role in a corporation.

2. Why does the corporation classification matter?

3. Corporate manager’s possible conflicting goal with theowners of the company.

What are the most important topics of this chapter?

Page 30: Introduction to Corporate Finance Eric J. McLaughlin, Ph.D. Chapter 1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

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