Chapter 1

Principles of
Corporate Finance
Tenth Edition

Goals and
Governance of the
Firm
Slides by
Matthew Will

McGraw-Hill/Irwin

Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

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

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Investment and Financing Decisions

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

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Investment and Financing Decisions

Real Assets
Assets used to produce goods and services.

Financial Assets
Financial claims to the income generated by the
firms real assets.

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Investment and Financing Decisions

Investment decision
purchase of real assets

Financing decision
sale of financial assets

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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)

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Investment and Financing Decisions

Capital Budgeting

Tangible Assets

Intangible Assets

Expand Stores

New Drug R&D

@ $800 million

@ $800 million

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Investment and Financing Decisions

Company (revenue in billions for
2007 or 2008)

Recent Investment Decision

Recent Financing Decision

Boeing ($61 billion)

Began production of its 787 Dreamliner

The cash flow from Boeings

aircraft, at a forecast cost of more than

operations allowed it to repay some of

$10 billion.

its debt and repurchase $2.8 billion of

stock.

Royal Dutch Shell ($458 billion)

Invests in a $1.5 billion deepwater oil

In 2008 returned $13.1 billion of cash

and gas field in the .

to its stockholders by buying back

their shares.

(26,289 billion)

GlaxoSmithKline (24 billion)

In 2008 opened new engineering and

Returned 443 billion to shareholders

safety testing facilities in .

in the form of dividends.

Spent 3.7 billion in 2008 on research

Financed R&D expenditures largely

and development of new drugs.

with reinvested cash flow generated

by sales of pharmaceutical products.

Wal-Mart ($379billion)

Union Pacific ($18 billion)

In 2008 announced plans to invest over a

In 2008 raised $2.5 billion by an issue

billion dollars in 90 new stores in .

of 5-year and 30-year bonds.

Acquired 315 new locomotives in 2007.

Largely financed its investment in

locomotives by long-term leases.

Wells Fargo ($52 billion)

LVMH (17 billion )

Lenovo ($16 billion)

Acquired Wachovia Bank in 2008 for

Financed the acquisition by an

$15.1 billion.

exchange of shares.

Acquired the Spanish winery, Bodega

Issued a 6-year bond in 2007, raising

Numanthia Termes.

300 million Swiss francs.

Expanded its chain of retail stores to

Borrowed $400 million for 5 years

cover over 2,000 cities.

from a group of banks

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Role of The Financial Manager

(2)

(1)

Financial
manager

Firm's
operations
(3)

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(4a)

(4b)

(1) Cash raised from investors

(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors

Financial
markets

Who is The Financial Manager?

Chief
ChiefFinancial
FinancialOfficer
Officer

Treasurer

Controller

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The Investment Trade-off

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The Investment Trade-off

Hurdle rate
Cost of capital
Opportunity cost of capital

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Goals of The Corporation

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

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Goals of The Corporation

Profit maximization is not a well-defined financial objective, for at
least two reasons:
1. Maximize profits? Which years 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 years
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.

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Whose Company Is It?

** Survey of 378 managers from 5 countries

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Dividends vs. Jobs

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** Survey of 399 managers from 5 countries. Which is more important...jobs

or paying dividends?

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

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Agency Problem

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Ownership vs. Management

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

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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.

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Agency Problem

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Tools to Ensure Management Pays Attention

to the Value of the Firm
Mangers 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

Agency Problem
Agency Problem and Corporate Governance
Solutions
1.Legal and Regulatory Requirements
2.Compensation plans
3.Board of Directors
4.Monitoring
5.Takeovers
6.Shareholder pressure

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

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