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Corporate Finance, 2e by Smart, Megginson, Gitman. Chapter 1 The Scope Of Corporate Finance. Professor XXXXX Course Name / Number. What is Corporate Finance?. The activities involved in managing cash flows in a business environment . The Core Principles of Finance. The time value of money

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chapter 1 the scope of corporate finance

Chapter 1The Scope Of Corporate Finance

Professor XXXXX

Course Name / Number

© 2007 Thomson South-Western

what is corporate finance
What is Corporate Finance?
  • The activities involved in managing cash flows in a business environment
the core principles of finance
The Core Principles of Finance
  • The time value of money
    • The opportunity to earn a return on invested funds means that a dollar today is worth more than a dollar in the future.
  • Compensation for risk
    • Investors expect compensation for bearing risk.
the core principles of finance5
The Core Principles of Finance
  • Don’t put your eggs in one basket
    • Investors can achieve a more favorable trade-off between risk and return by diversifying their portfolios.
  • Markets are smart
    • Competition for information tends to make markets efficient.
  • No arbitrage
    • Arbitrage opportunities are extremely scarce.
the 5 basic corporate finance functions



Capital Budgeting

Financial Management

Corporate Governance

Risk Management

The 5 Basic Corporate Finance Functions
the financing function
The Financing Function
  • Businesses can raise money in 2 ways:
    • externally from investors or creditors
      • IPOs
      • Primary market transactions
      • Secondary market transactions
    • internally by retaining operating cash flows
      • Most common method
raising capital key facts
Raising Capital: Key Facts

Most financing from internal rather than external sources

Most external financing is debt

Primary vs. secondary market transactions or offerings

Financial intermediaries declining as a source of capital for large firms

Securities markets growing in importance

the capital budgeting function12
The Capital Budgeting Function
  • The capital budgeting process consists of three steps.

Step 1 - identifying potential investments

Step 2 - analyzing those investments to identify which will create shareholder value

Step 3 - implementing and monitoring the investments selected in step 2


The Financial Management Function

Managing daily cash inflows and outflows

Forecasting cash balances

Building a long-term financial plan

Choosing the right mix of debt and equity

the corporate governance function
The Corporate Governance Function
  • Hires and promotes qualified, honest people, and structures employees’ financial incentives to motivate them to maximize firm value
  • In practice the incentives of stockholders, managers, and other stakeholders often conflict.
  • Dimensions of corporate governance:
    • Board of directors
    • Securities and Exchange Commission
    • Sarbanes-Oxley Act of 2002
the risk management function
The Risk Management Function
  • Identifying, measuring, and managing all types of risk exposures
  • Some risks are insurable, and some risks can be reduced through diversification.
  • Financial instruments like forwards, futures, options, and swaps may also be used to hedge market risks such as interest-rate, price, and currency fluctuations.
business organizational forms in the united states
Business Organizational Formsin the United States
  • No Distinction Between Business & Owner
  • Easy To Set Up, Operate; Business Earnings Taxed As Personal Income
  • Limited Life, Limited Access to Capital, Unlimited Personal Liability

Sole Proprietorships


  • Two Or More Owners
  • Joint and Several Liability
  • Limited Life, Limited Access to Capital, Unlimited Personal Liability

Limited Partnerships

  • One Or More General Partners with Unlimited Personal Liability
  • Most Partners are Totally Passive with Limited Liability - Limited Partners; Share of Profits Taxed as Partnership Income
business organizational forms in the united states18
Business Organizational Formsin the United States
  • Separate Legal Entity With Many of the Economic Rights & Responsibilities of Individuals
  • Unlimited Life, Limited Liability, Separable Contracting, Unlimited Access to Capital
  • Owned by Shareholders, Who Elect the Board of Directors
  • In the U.S., Incorporation is Executed At State Level and Governed by State Law


Are there any disadvantages for corporations?

YES! Double taxation

business organizational forms in the united states20
Business Organizational Formsin the United States
  • Shareholders are taxed as partners while still retaining Limited Liability as Corporate Shareholders
  • Status is Subject to Several Eligibility Requirements

S Corporations

Limited- Liability Companies

  • Combines the Partnership’s Pass-Through Taxation with the S Corporation’s Limited Liability
forms of business organizations used by non u s companies
Forms of Business OrganizationsUsed by Non-U.S. Companies

Limited-Liability Companies

  • Britain: public limited companies (PLC)
  • Germany: Aktiengesellschaft (AG)
  • France: Société Générale
  • Spain, Mexico, and elsewhere in Latin America: Sociedad Anónima

State-Owned Enterprises

  • Historically, the telephone, television, utility, airline and railroad companies in many European countries
  • Privatization programs have reduced the role of the states around the world

How much has been raised through Privatization Programs?

what should a financial manager try to maximize
What Should a Financial Manager Try to Maximize?
  • Maximize Profit?
    • Earnings per share are backward-looking, dependent on accounting principles,
    • Do not fully consider cash flow timing
    • Ignores risk
  • Maximize Shareholder Wealth?
    • Maximize stock price, not profits
    • Shareholders, as residual claimants, have better incentives to maximize firm value.
agency costs
Agency Costs
  • Managers act as agents of the owners who hired them and gave them decision-making authority to manage the firm for the owners’ benefit.
  • In practice however, self-interests may cause managers to pursue objectives other than shareholder-wealth maximization.
  • This conflict of goals gives rise to managerial agency problems.
how agency costs can be controlled
How Agency Costs Can Be Controlled
  • Ways to overcome agency problems:
    • Takeovers
    • Monitoring and bonding
    • Compensation contracts
      • Executive compensation packages
importance of ethics
Importance of Ethics
  • Widespread publicity surrounding numerous ethical violations began with the Enron collapse in late 2001.
  • Society in general and the financial community in particular are developing and enforcing ethical standards.
  • Ethical behavior is necessary in order to maximize shareholder’s wealth.