2.Introduction to Corporate Finance.pdf

1203106 CORPORATE FINANCE INTRODUCTION TO CORPORATE FINANCE โ WHAT IS CORPORATE FINANCE? You decide to start a firm to make a product. To do this, you hire managers to buy raw materials and assemble a workforce to produce and sell finished products. In fin...

1203106 CORPORATE FINANCE INTRODUCTION TO CORPORATE FINANCE โ WHAT IS CORPORATE FINANCE? You decide to start a firm to make a product. To do this, you hire managers to buy raw materials and assemble a workforce to produce and sell finished products. In finance terms, you invest in assets such as inventory, machinery, land, and labor. The amount of cash you invest in assets must be matched by an equal amount of cash raised by financing. WHAT IS CORPORATE FINANCE? (CON.) When you begin to sell the products, your firm will generate cash and profit. This is the basis of value creation. The firm's purpose is to create value for you, the owner. TYPES OF CORPORATE FIRMS Sole Proprietorship Partnership Corporation SOLE PROPRIETORSHIP A business owned by one person. Cheapest type of business to form. Pays no corporate income taxes. All profits of the business are taxed as individual income. Has unlimited liability for business debts and obligations. The life of the sole proprietorship is limited by the life of the owner. The equity available to the business is limited to the owner’s personal wealth.  PARTNERSHIP าง Two or more people get together and form a partnership. Partnerships categorizes into 2 types. General Partnership: All partners agree to provide some fraction of the work and cash, and to share the profits and losses. Each partner is liable for all of the debts of the partnership. ห้ หุ  PARTNERSHIP (CON.) Limited Partnership: าง น ว Limited partnerships permit the liability of some of the partners to be limited to the amount of cash each has contributed to the partnership. Limited partnerships usually require that (1) at least one partner be a general partner and (2) the limited partners do not participate in managing the business. ห้ หุ้ ส่ PARTNERSHIP (CON.) Written documents are required in complicated arrangements. It is difficult for a partnership to raise large amounts of cash. Equity contributions are usually limited to a partner’s ability and desire to contribute to the partnership. Income from a partnership is taxed as personal income to the partners. Management control resides with the general partners. CORPORATION Ownership in a corporation is represented by shares of stock. The corporation has an unlimited life. The shareholders’ liability is limited to the amount invested in the ownership shares. The corporation can raise cash more easily than sole proprietorship and partnerships. CORPORATION (CON.) The disadvantage is double taxation. First, when a corporation makes a profit, it has to pay corporate income tax. Then, when corporate income is paid out to investors as a dividend, shareholders have to pay personal income tax on the dividend income. FINANCIAL MANAGER In large corporations, finance activity is usually associated with a top officer, such as the Vice President or Chief Financial Officer (CFO). The treasurer and controller report to the CFO. GOAL OF FINANCIAL MANAGEMENT The financial manager acts in the shareholders' best interests by making decisions that increase the value of the stock. “The goal of financial management is to maximize the current value of the existing stock.” THE AGENCY PROBLEM AND Control of the Corporation The relationship between stockholders and management is called an agency relationship. Such a relationship exists whenever someone (the principal) hires another (the agent) to represent their interests. A conflict of interest between the principal and the agent is possible. Such a conflict is called an agency problem. THE AGENCY PROBLEM AND Control of the Corporation (Con.) Managerial compensation is a common method to incentivize managers to act in the interests of stockholders. It is usually tied to a firm's financial performance. For example, managers are frequently given the option to buy stock at a specific price. If the stock's value increases beyond the strike price, the option becomes more valuable. Q&A