basic concepts of corporate finance, investment decision, financing decision, theories of corporate finance and shareholders and management conflict

1. Corporate finance
By Muhammad Shafiq
forshaf@gmail.com
http://www.slideshare.net/forshaf

2. Sequence
• Finance
• Type of finance
• Corporate finance
• Investment decision
• Financing decision

3. Finance; defined
• Finance is a field that deals with the study of investments.
• It those activities which have to do with the provision and management of
funds for the satisfactory conduct of a business
• Acquisition and conservation of funds in meeting the financial needs and
overall objectives of business enterprise
• It includes the dynamics of assets and liabilities over time under conditions of
different degrees of uncertainty and risk.
• Finance can also be defined as the science of money management.
• A key point in finance is the time value of money, which states that
purchasing power of one unit of currency can vary over time.
• Finance aims to price assets based on their risk level and their expected rate
of return.

4. Hypothetical Organization Chart
Chairman of the Board and
Chief Executive Officer (CEO)
Board of Directors
President and Chief
Operating Officer (COO)
Treasurer Controller
Cash Manager
Capital Expenditures
Credit Manager
Financial Planning
Tax Manager
Financial Accounting
Cost Accounting
Data Processing
Vice President Finance

5. finance
• the management of large amounts of money, especially by governments or
large companies.
• provide funding for (a person or enterprise).
• Business finance is a term that encompasses a wide range of activities and
disciplines revolving around the management of money and other valuable
assets.
•
Financing is the act of providing funds for business activities, making
purchases or investing.
• Financial institutions and banks are in the business of financing as they
provide capital to businesses, consumers and investors to help them
achieve their goals.

6. Classification of finance
• Finance can be broken into three different sub-categories: public
finance, corporate finance and personal finance.

7. Personal finance
• Personal finance is the financial management which an individual or a
family unit performs to budget, save, and spend monetary resources
over time, taking into account various financial risks and future life
events.
• When planning personal finances, the individual would consider the
suitability to his or her needs of a range of banking products
(checking, savings accounts, credit cards and consumer loans) or
investment private equity, (stock market, bonds, mutual funds) and
insurance (life insurance, health insurance, disability insurance)
products or participation and monitoring of individual- or employer-
sponsored retirement plans, social security benefits, and income
tax management.

8. Public finance
• Public finance is the study of the role of the government in the
economy. It is the branch of economics which assesses the
government revenue and government expenditure of the public
authorities and the adjustment of one or the other to achieve
desirable effects and avoid undesirable ones.
• The purview of public finance is considered to be threefold:
governmental effects on (1) efficient allocation of resources,
(2)distribution of income, and (3) macroeconomic stabilization.

9. Corporate finance
• Corporate finance is the area of finance dealing with the sources of
funding and the capital structure of corporations and the actions that
managers take to increase the value of the firm to the shareholders,
as well as the tools and analysis used to allocate financial resources.
The primary goal of corporate finance is to maximize or
increase shareholder value. Although it is in principle different from
managerial finance which studies the financial management of all
firms, rather than corporations alone, the main concepts in the study
of corporate finance are applicable to the financial problems of all
kinds of firms.

10. Corporate Finance?
• Corporate finance attempts to find the answers to the following
questions:
• What investments should the business take on?
THE INVESTMENT DECISION
• How can finance be obtained to pay for the required
investments?
THE FINANCE DECISION
• Should dividends be paid? If so, how much?
THE DIVIDEND DECISION

11. Corporate finance defined
• Corporate finance is the area of finance dealing with the sources of funding and the capital
structure of corporations and the actions that managers take to increase the value of the firm to
the shareholders, as well as the tools and analysis used to allocate financial resources.
• • Finance is about the bottom line of business activities.
• • Every business is a process of acquiring and disposing assets:
• – Real assets (tangible and intangible).
• – Financial assets.
• • Two objectives of business:
• – Grow wealth.
• – Use wealth (assets) to best meet economic needs.
• • Financially, a business decision reduces to valuation of assets.
• • Valuation is the central issue of finance.

12. Investment Decision
• Carry on business------------real assets
• One way_________selling claims called Financial Assets or Securities
• Another way---------- Loans from financial institution (bank)
• Third way-----------bond Issue

13. Investment decision
• Investment in real asset such as;
• Capital budgeting decision
• R&D or Advertising decision
• E-g US neculair project for 40 years then extended to 20 more Year (timing of
CFI is important for Financial Manager)
• CFI is certain: Example of Walmart spends $40 billions in store for season
• CFI is not certain: example of Iridium Communication Satellite sys, Investment 5 B sold
out for 25 million dollar

14. Financial Management Decisions
• Not alone
• Taking into consideration so many e-g
• Engineers
• Production manager
• Manufacturing department
• Marketing and so on
• Smaller decisions are take in routine but large decision require
precision and expertise

15. Financing Decision
• Relating to raising money
• Decision between debt or equity choice is capital structure decision
• Money can be raised from lenders or shareholders
• Lenders in return receive -----------fixed Payment plus interest
• Shareholders receive in return------------- profit from income
• Shareholders are equity investors

16. Capital Structure
The value of the firm can be
thought of as a pie.
The goal of the manager is
to increase the size of the
pie.
The Capital Structure
decision can be viewed as
how best to slice up the pie.
If how you slice the pie affects the size of the pie,
then the capital structure decision matters.
50%
Debt
50%
Equity
25%
Debt
75%
Equity
70%
Debt
30%
Equity

17. Financing Decision…
corporation raise equity financing by two ways
• Issue new share of stock
• Cash flow generated by its existing assets and reinvested in new
assets
• FM considers financing decision less important than investing but can
destroy firm when taken in stupid way
• E-g SamZell bought Tribune (News paper) in 2007, recession reduced the
revenue and decision become fatal. In 2008 filed for bankruptcy
• Business in inherently risky as debt advantages and disadvantages

18. Corporation
• A corporation is a legal entity that is separate and distinct from its
owners.
• Corporations enjoy most of the rights and responsibilities that an
individual possesses;
• that is, a corporation has the right to enter into contracts, loan and borrow money, sue
and be sued, hire employees, own assets and pay taxes but can not vote

19. Corporation in Pakistan: formation
•Four stages:
•Promotion stage
•Incorporation stage
•Raising of share capital
•Trading of business commencement certificate

20. Characteristics of corporation
• Limited liability
• E-g Lehman brothers bankruptcy
• Transferability of share
• Separation of ownership from management
• Board of Director through election
• Perpetual life
• E-g Hudson Company established in 1670; still exist in US
Disadvantage of cost+ time+ Money

21. Role of financial manager
“maximize the current market value of
shareholders investment in firm”
• Shareholders roster in company
• Risk averse investor
• Risk tolerant investor
• E-g Info sys has 416000 share holders, having every color and distict from
each other but one objective maximize the current market value of
shareholders investment in firm.

22. A Comparison of Partnership and Corporations
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 with dividend tax
credit
Partnership income is
taxable.
Reinvestment Broad latitude All net cash flow is
distributed to partners.
Liability Limited liability General partners may have
unlimited liability. Limited
partners enjoy limited
liability.
Continuity Perpetual life Limited life

23. Direct finance
LoansFinancial
intermediaries
Deposits
•Financial Institutions
Indirect finance
1.5 Financial Institutions, Financial
Markets, and the Corporation
Funds
suppliers
Funds
demanders
Financial
intermediaries
Funds
suppliers
Funds
demanders

24. Financial Markets
Money versus Capital Markets
•Money Markets
–For short-term debt instruments
•Capital Markets
–For long-term debt and equity

25. Role of financial manager:
“maximize the current market value of shareholders investment in firm”
• The investment trade-off by market hurdle rate or cost of capital.
• E-g Pantheon big Bazar Investment decision to invest or to pay dividend to
shareholders

26. Financial Markets
Firms
Investors
Secondary
Market
money
securities
SueBob
Stocks and
Bonds
Money
Primary Market

27. 1.6 Trends in Financial Markets and
Management
•Integration and globalization
•Increased volatility
•Financial Engineering reduces costs related to
–Risk
–Taxes
–Fnancing costs
•Improved computer technology allows
Economies of scale and scope
•Regulatory dialectic

28. 1.7 Outline of the Text
.IOverview
.IIValue and Capital Budgeting
.IIIRisk
.IVCapital Structure and Dividend Policy
.VLong-Term Financing
.VIOptions, Futures, and Corporate Finance
.VIIFinancial Planning and Short-Term Finance
.VIIISpecial Topics

29. Cash flow
from firm (C)
The Firm and the Financial Markets
Taxes(E)
Firm
Government
Firm issues securities (A)
Retained
cash flows (D)
Invests
in assets
(B)
Dividends and
debt payments (F)
Current assets
Fixed assets
Financial
markets
Short-term debt
Long-term debt
Equity shares
Ultimately, the firm
must be a cash
generating activity.
The cash flows from
the firm must exceed
the cash flows from
the financial markets.

30. Agency problem and corporate governance
• Conflict between shareholders and manager cause agency problem
• E-g CEO of Tyco spent $2 Million on his wife birthday, charging half to
company
• Corporations have to work effectively and ethically to avoid scandals