Session 1 - Introduction of Corporate Finance

Introduction and Overview of
Corporate Finance
• Forms of business organization
• Objective of the firm: Maximize wealth
• Determinants of fundamental value
• Financial securities, markets and institutions
• Agency problem and corporate governance
Why is corporate finance important to

all managers?
• What is corporate finance?
• Corporate finance provides the skills managers
need to:
– Identify and select the corporate strategies and
individual projects that add value to their firm.
– Forecast the funding requirements of their
company, and devise strategies for acquiring those
funds.
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Business Organization from Start-up
to a Major Corporation
• Sole proprietorship
• Partnership
• Corporation
Starting as a Proprietorship
• Advantages:
– Ease of formation
– Subject to few regulations
– No corporate income taxes
• Disadvantages:
– Limited life
– Unlimited liability
– Difficult to raise capital to support growth
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Starting as or Growing into a
Partnership
• A partnership has roughly the same
advantages and disadvantages as a sole
proprietorship.
Becoming a Corporation
• A corporation is a legal entity separate from

its owners and managers.
• File papers of incorporation with state.
– Charter
– Bylaws
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Advantages and Disadvantages of a
Corporation
• Advantages:
– Unlimited life
– Easy transfer of ownership
– Limited liability
– Ease of raising capital
• Disadvantages:
– Double taxation
– Cost of set-up and report filing
Becoming a Public Corporation and

Growing Afterwards
• Initial Public Offering (IPO) of Stock
– Raises cash
– Allows founders and pre-IPO investors to
“harvest” some of their wealth
• Subsequent issues of debt and equity
Alibaba’s IPO at NYSE in Facebook’s 2012 IPO: raised
2014, at the closing time on about $6.4 billion by selling 180
the day of the IPO, million new shares, the owners
US$25Billion received almost $9.2 billion by
selling their own shares
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Goal of the Firm
• Profit maximization – Not really
• Shareholders wealth maximization – Yes!
What should be management’s

primary objective?
• The primary objective should be shareholder
wealth maximization, which translates to
maximizing the fundamental stock price.
– Should firms behave ethically? YES!
– Do firms have any responsibilities to society at
large? YES! Shareholders are also members of
society.
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What else do businesses, customers,
investors and regulators care nowadays?
• There are issues go beyond profit-
maximization
• Corporate Social Responsibility (CSR) and
Environmental, Social and Governance (ESG)
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What three aspects of cash flows

affect an investment’s value?
• Amount of expected cash flows (bigger is
better)
• Timing of the cash flow stream (sooner is
better)
• Risk of the cash flows (less risk is better)
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Free Cash Flows (FCF)
• Free cash flows are the cash flows that are

available (or free) for distribution to all
investors (stockholders and creditors).
• FCF = sales revenues - operating costs -
operating taxes - required investments in
operating capital.
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What is the weighted average cost of

capital (WACC)?
• WACC is the average rate of return required by
all of the company’s investors.
• WACC is affected by:
– Capital structure (the firm’s relative use of debt
and equity as sources of financing)
– Interest rates
– Risk of the firm
– Investors’ overall attitude toward risk
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What determines a firm’s
fundamental, or intrinsic value?
Intrinsic value is the sum of all the future
expected free cash flows when converted into
today’s dollars:
FCF1 FCF2 FCF
Value = + + +
(1 + WACC) 1
(1 + WACC) 2
(1 + WACC)
See “big picture” diagram on next slide.
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Determinants of Intrinsic Value: The

Big Picture
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What are some types of markets?

• A market is a method of exchanging one asset
(usually cash) for another asset.
• Physical assets vs. financial assets
• Spot versus future markets
• Money versus capital markets
• Primary versus secondary markets
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Primary vs. Secondary Security Sales
• Primary
– New issue (IPO or seasoned)
– Key factor: issuer receives the proceeds from the
sale.
• Secondary
– Existing owner sells to another party.
– Issuing firm doesn’t receive proceeds and is not
directly involved.
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Agency Problems and Corporate

Governance
• Agency problem: managers may act in their
own interests and not on behalf of owners
(stockholders)
• Corporate governance is the set of rules that
control a company’s behavior towards its
directors, managers, employees, shareholders,
creditors, customers, competitors, and
community.
• Corporate governance can help control agency
problems.
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Agency Conflicts
• Conflicts between stockholders (owners) and
managers
➢ Managers are naturally inclined to act in their own
best interests (which are not always the same as the
interest of stockholders)
• Conflicts between stockholders and creditors
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Agency Problem Solutions

Shareholders and Managers
• Board of directors
➢ Manager’s actions are subject to the scrutiny of the board of
directors
• Charter provisions affecting takeovers
➢ Shirkers are likely to find they are ousted by more energetic
managers
• Compensation plans
➢ Financial incentives such as stock options
• Block ownership
➢ Monitor manager and take active role, leading to better
corporate governance
Shareholders and Creditors
• Restrictive covenants in debt agreements
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More Questions
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More Questions
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More Questions
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Session 1 - Introduction of Corporate Finance

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Introduction and Overview of

Why is corporate finance important to

• A corporation is a legal entity separate from

Becoming a Public Corporation and

What should be management’s

What three aspects of cash flows

• Free cash flows are the cash flows that are

What is the weighted average cost of

See “big picture” diagram on next slide.

Determinants of Intrinsic Value: The

What are some types of markets?

Agency Problems and Corporate

Agency Problem Solutions

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