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Chapter 1

Principles of Corporate Finance Tenth Edition. Chapter 1. Goals and Governance of the Firm. Lectures Prof. Scott Brown. Topics Covered. Corporate Investment and Financing Decisions The Role of the Financial Manager and the Opportunity Cost of Capital Goals of the Corporation

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Chapter 1

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  1. Principles of Corporate Finance Tenth Edition Chapter 1 Goals and Governance of the Firm Lectures Prof. Scott Brown

  2. Topics Covered • Corporate Investment and Financing Decisions • The Role of the Financial Manager and the Opportunity Cost of Capital • Goals of the Corporation • Agency Problems and Corporate Governance

  3. Investment and Financing Decisions • Common Finance Terminology • Real assets • Financial assets / Securities • Capital markets and financial markets • Investment / capital budgeting • Financing

  4. Investment and Financing Decisions • Real Assets • Assets used to produce goods and services. • Financial Assets • Financial claims to the income generated by the firm’s real assets.

  5. Investment and Financing Decisions • Investment decision • purchase of real assets • Financing decision • sale of financial assets

  6. Investment and Financing Decisions • Capital Budgeting Decision • Decision to invest in tangible or intangible assets. • …also called the Investment Decision • …also called Capital Expenditures or (CAPEX)

  7. Investment and Financing Decisions • “Capital Budgeting” Tangible Assets Expand Stores @ $800 million Intangible Assets New Drug R&D @ $800 million

  8. Investment and Financing Decisions

  9. (2) (1) (4a) (4b) (3) (1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors Role of The Financial Manager Financial Firm's Financial manager operations markets

  10. Treasurer Controller Who is The Financial Manager? Chief Financial Officer

  11. The Investment Trade-off

  12. The Investment Trade-off • Hurdle rate • Cost of capital • Opportunity cost of capital

  13. Goals of The Corporation Each stockholder wants three things: • To be as rich as possible, that is, to maximize his or her current wealth. • To transform that wealth into the most desirable time pattern of consumption either by borrowing to spend now or investing to spend later. • To manage the risk characteristics of that consumption plan.

  14. Goals of The Corporation • Profit maximization is not a well-defined financial objective, for at least two reasons: 1. Maximize profits? Which year’s profits? A corporation may be able to increase current profits by cutting back on outlays for maintenance or staff training, but that may add value. Shareholders will not welcome higher short-term profits if long-term profits are damaged. 2. A company may be able to increase future profits by cutting this year’s dividend and investing the freed-up cash in the firm. That is not in the shareholders’ best interest if the company earns less than the opportunity cost of capital.

  15. Whose Company Is It? ** Survey of 378 managers from 5 countries

  16. Dividends vs. Jobs ** Survey of 399 managers from 5 countries. Which is more important...jobs or paying dividends?

  17. Goals of The Corporation • Shareholders desire wealth maximization • Do managers maximize shareholder wealth? • Mangers have many constituencies “stakeholders” • “Agency Problems” represent the conflict of interest between management and owners

  18. Difference in Information Stock prices and returns Issues of shares and other securities Dividends Financing Different Objectives Managers vs. stockholders Top mgmt vs. operating mgmt Stockholders vs. banks and lenders Agency Problem Ownership vs. Management

  19. Agency Problem • Agency costs are incurred when: • managers do not attempt to maximize firm value and • shareholders incur costs to monitor the managers and constrain their actions.

  20. Agency Problem • Agency Problems • Managers, acting as agents for stockholders, may act in their own interests rather than maximizing value. • Stakeholder • Anyone with a financial interest in the firm.

  21. Agency Problem • Tools to Ensure Management Pays Attention to the Value of the Firm • Manger’s actions are subject to the scrutiny of the board of directors. • Shirkers are likely to find they are ousted by more energetic managers. • Financial incentives such as stock options

  22. Agency Problem Agency Problem and Corporate Governance Solutions • Legal and Regulatory Requirements • Compensation plans • Board of Directors • Monitoring • Takeovers • Shareholder pressure

  23. Web Resources Click to access web sites Internet connection required www.corpgov.net www.thecorporatelibrary.com www.riskmetrics.com

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