Introduction to Corporate Finance

1. Introduction to Corporate Finance Chapter One

2. FIN 6301Financial 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.

3. 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.

4. 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

5. Other Resources • Wall Street Journal • Barron’s • Financial Calculator

6. 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

7. Areas of Finance Investors The Firm Financial Markets Financial Intermediaries

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

9. 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

10. 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

11. What is Corporate Finance? Corporate Finance addresses the following three questions: • What long-term investments should the firm engage in? • How can the firm raise the money for the required investments? • How much short-term cash flow does a company need to pay its bills?

12. Microsoft to Dole OutIts 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.

13. 25% Debt 70% Debt 30% Equity 75% Equity Capital Structure The value of the firm can be thought of as a pie. 50% Debt The goal of the manager is to increase the size of the pie. 50% Equity The Capital Structure 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.

14. The Financial Manager To create value, the financial manager should: • Try to make smart investment decisions. • Try to make smart financing decisions.

15. 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.

16. Payoff to debt holders Payoff to shareholders $F $F Value of the firm (X) Value of the firm (X) Debt and Equity as Contingent Claims If the value of the firm is more than $F, debt holders get a maximum of $F. If the value of the firm is less than $F, share holders get nothing. $F If the value of the firm is more than $F, share holders get everything above $F. Debt holders are promised $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,$X] Algebraically, the shareholder’s claim is: Max[0,$X –$F]

17. Combined Payoffs to debt holders and shareholders Payoff to shareholders Payoff to debt holders $F Value of the firm (X) Combined Payoffs to Debt and Equity If the value of the firm is less than $F, the shareholder’s claim is: Max[0,$X –$F] = $0 and the debt holder’s claim is Min[$F,$X] = $X. The sum of these is = $X $F If the value of the firm is more than $F, the shareholder’s claim is: Max[0,$X –$F] = $X –$F and the debt holder’s claim is: Min[$F,$X] = $F. The sum of these is = $X Debt holders are promised $F.

18. 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.

19. 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

20. Goals of the Corporate Firm • The traditional answer is that the managers of the corporation are obliged to make efforts to maximize shareholder wealth.

21. 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.

22. 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.

23. 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.

24. 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.

25. 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.