Introduction to

Corporate Finance
COR P OR ATE F I N AN CE
DR . A MN I SUHAIL AH A BA R A HA N
JA N UA RY, 2 0 2 0.

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Introduction
Corporations finance investments; borrowing, retaining & reinvesting cash & selling additional
shares of stocks to shareholders.
Financial Manager- 1) What investments to make
2)how to pay for investments
-investment= spending money
-Financing=raising money

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CORPORATE INVESTMENT & FINANCING
DECISIONS
Corporation needs real assets
Investment = purchase of real assets
Financing= sale of financial assets
Management control risk of investments of corporations.
Financing decisions include ; raising money and meeting obligations.
Financial Manager work with other functions.

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FINANCING DECISIONS
Raise money from lenders or shareholders
If borrow- lenders contribute cash, firm pays back with fixed rate of interest.
If from shareholders- hold shares of stocks, get future profits and CF.
Shareholders: equity financing
Capital structure decision: choice between debt and equity financing

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Equity financing two ways:
1)Issue new shares of stocks
2)Take CF of existing assets and reinvest in new assets. ( may or may not reinvest all)
-Payout : decision to pay dividends or repurchase shares
-Financing or investment decision is important? Eg. Microsoft.
-Business is risky- firm needs to identify risk and managed properly.

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Corporate Structure
1. Sole Proprietorship
2. Partnership
3. Corporations

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What is a corporation?
- a legal entity, carry business, sell, buy, own, borrow, lend, sue or be sued.
-takeover is possible
-pay taxes
-directors elected by shareholders
-legally distinct from shareholders.
-shareholders have limited liability.

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- usually corporations held privately by small group of investors.
-as they grow, new shares issued to raise capital, shares traded in public market.
-other countries large corporations are in private hands
-many public companies controlled by a few investors.
-Large public corporations, hundreds of shareholders. How to manage and control?

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- Separation of ownership and control, between owners and management.
- change in management have no effects.
-corporations also live forever.
-downside of separation of control: managers and directors act on their own interests.
- another disadvantage: taxed separately, time and money managing corporation’s legal
machinery.

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The Role of Financial Manager

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Financial Goal of Corporation
-maximize market value.
-Example: Walmart 3000 shareholders. Impossible to manage.
-Authority delegated to financial manager
-But how to satisfy all shareholders?
-Differences in investors; wealth, age, taste, risk appetite, strategies.
-* maximize current market value of Shareholders’ investment in firm.
-Maximizing shareholders’ wealth: they have access to financial markets.
-shareholders :risk averse & risk tolerant.

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Fundamental result
Each shareholder want 3 things:
1)rich as possible, maximize current wealth
2) transform wealth into desirable pattern of consumption
3) manage risk characteristics of the consumption plan.

-Stockholders must have access to competitive financial markets for pattern of comsumption;
choose risk characteristics.
-Thus, how financial manager help stockholders?

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-Some say “ maximize profit”. Reasonable?
-Questions to ask: which year’s profits? Or increase future profits by cutting off dividends
reinvesting cash into the firm?

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Investment Trade-off
-Why some investments increase market value while others reduce?
-example: propose project. Cash sufficient. Invest or not?
-If do not invest, corporation give cash to shareholders.
-What do shareholders really want?
-investments: depend on rate of return of investment project & rate or return they can earn
from investing.
-reinvestment higher: yes
-reinvestment lower: take cash instead

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-minimum rate of return, the hurdle rate or cost of capital.
-opportunity cost of capital as this depends on investment opportunities available.
-corporation invests in new project, investors lose opportunity to invest.
-corporations increase value –projects earning more than opportunity cost of capital.
-investors risk averse and trade of risk against return.
-managers thus look at financial markets.

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Should managers look into interests of
shareholders?
-managers: agent of shareholders
-main goal of managers for shareholders
-conflict arises between doing well and doing good.
-profitable firms: satisfied customers, loyal employees.
-non-profitable firms: dissatisfied customers & disgruntled employees, result: low stock price.
-how to add value? ; long-term relationships and reputation.
-boundaries need to be adhered to.
-law as deterrent for managers.

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Agency Problems and Corporate
Governance
- shareholders can only control managers through BOD.
-agents can do many things.
-more concerned about their job safety, maximize bonuses.
-conflict-agency problem.
-agency costs: 1) they don’t maximize firm value
2) incur cost to monitor & constrain managers
-well-designed incentives needed, standards for accounting & disclosure, requirements of BOD
-scandals, role of corporate governance important.

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Class Discussion
Is the agency concept in corporate finance similar in Islamic finance?

Is the goal of corporations aligned with the requirements or guidelines in doing businesses in
the Islamic perspective?

Is doing good good even if it does not pay off?

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