FUNDAMENTALS OF CORPORATE FINANCE
Stephen A. Ross
Randolph W. Westerfield
Bradford D. Jordan
Introduction to Corporate Finance
Chapter Organization
1.1 Corporate Finance and the Financial
Manager
1.2 Forms of Business Organization
1.3 The Goal of Financial Management
1.4 The Agency Problem and Control of the
Corporation
1.5 Financial Markets and the Corporation
1.6 Summary and Conclusions
The Four Basic Areas of Finance
Corporate Finance
What, Where and how.
Investments
Financial Institutions
International Finance
Financial Management Decisions
Capital budgeting
The process of planning and managing a firms long
term investments
E.g. should a retailer as Walmart open a new outlet or
should Unilever develop a new product.
Capital Structure
The mixture of debt and equity maintained by a firm.
Working Capital Management.
A firms short term assets and liabilities.
Forms of Business Organization
Organizational Forms
Sole Proprietorship
Partnership
General Partnership / Limited Partnership
Corporation
Limited Liability Company
Economic Considerations
Why are corporations generally larger than other forms
of business?
Sole Proprietorship
Advantages Disadvantages
Inexpensively formed Unlimited personal
Few government liability.
regulations Transferring
Taxed once. ownership is difficult.
Difficult to obtain large
some of funds.
Partnership
General Partnership / Limited Partnership
Advantages Disadvantages
Inexpensively formed Unlimited liability.
Few government Limited life of the
regulations organization.
Taxed like an Transferring
individual. ownership of a general
partner is difficult.
Difficult to obtain large
some of funds.
Partnership
General Partnership: At least two owners and
no more than twenty.
Commonly the number of partners lies between
two and four.
The Limited Partnership: A partners invest
capital into the business but do not participate in
running and managing the business.
Such partners are limited partners.
There must be at least one partner that has
limited liability and at least one partner that has
unlimited liability.
The law allows this type of partnership to have
more than 20 owners.
Corporation
Corporation is a “legal” person and distinct from
its owners.
Corporations can sue and can be sued.
Corporations can own stocks in another
corporation.
In a corporation the stockholders and managers
are separate.
Forming a corporation involves preparing articles
of incorporation and set of By Laws.
Corporation (Created by a State)
Advantages Disadvantages
Unlimited life. Time consuming and
Easily transferable. difficult to set up.
Limited Liability. Double Taxation.
Can obtain large Earning of the
funds. corporation.
Dividends paid to
the stockholders.
The Goal of Financial Management
The Goal of Financial Management
What are firm decision-makers hired to do?
“General Motors is not in the business of making
automobiles. General Motors is in the business of
making money.”
Alfred P. Sloan
Possible goals
Three equivalent goals of financial management:
Maximize shareholder wealth
Maximize share price
Maximize firm value
Session 2
Agency Relationships
Delegates
Stockholder Managers
Principals Agents
Important Agency Relationships
Stockholders and managers
Stockholders and creditors.
Agency Problem
Def: “Potential conflict of interest between shareholders
and the managers / creditors”
It arises when managers own less than 100% of the
firms common stocks.
Potential of agency problem is greatest in large
organizations.
Managers since they hold less % of shares may peruse
different goals.
Agency costs
Direct agency costs
Methods to Motivate Managers.
Managerial Compensation (tie compensation
with performance).
Threat of firing
The threat of takeover
Shareholders’ Intervention (Many institutional
investors routinely monitor top corporations).
BUSINESS ETHICS:
Financial Markets and the Corporation
Since money can be raised easily from financial
markets thus:
What is the role of financial markets in
corporate finance?
Cash flows to and from the firm (Ref: Fig)
Primary vs. secondary markets
Primary Vs Secondary Markets
Primary market: “Original sale of securities by
corporations and governments”
Public Offerings (need to be registered with SEC).
Private placements (involving a specific buyer).
Secondary Market: “Market where securities are bought
and sold after the original sale”
Dealer Market
Auction Market.
Kinds of Secondary Markets
Dealer Market Auction Market.
• Buy and sell for • Buy and sell for others.
themselves. • It has a physical location.
• They own the commodity. • They do not own the
• Buying and selling is commodity.
done by dealer. • They match who wish to
sell with those who wish
to buy.
Questions …….!!!
Chapter 1 Quick Quiz
Quick Quiz
1. Who performs the financial management
function in the typical corporation?
2. What are the major advantages and
disadvantages of the corporate form of
organization?
3. Why is shareholder wealth maximization a
more appropriate goal than profit
maximization?
