Principle of corporate

fianc
Introduction
Lecturer Yusuf Hussein
Mohamed

180

0
Corporate

Finance as
a part of
Economic
s

1950

193
THE
0GREAT
DEPRESSI
ON
Failure in real market
transmits to capital
market
Attention shifts from
legal control to
bankruptcy,
reorganization and
regulation of capital
market

190
Rapid
0
industrialization

- new business,
expansions,
mergers- in the
USA and Europe
Shortage of
capital due to
the absence of
capital market
Distrust in
financial
statements
resulting in lack
of investors

Quantitative
method of
analyzing
financial
problems

Development
of various
financial
theories
Efficiency
and regulation
of financial
markets

19
Due to market
40 focus is
downfall,
shifted from expansion
and modernization to
survival of firms
Amendments in
companys regulations
Investors
and setting of
increased
accounting standards
confidence
in
Advanced through
financial
development of
statements
mathematical tools to
cash, accounts
receivables and fixed
assets management

Technological
advancement
Focus on value
maximization
Globalization of
business
Increased use
of information
and
communication
technology
Multinational
companies

21st
Century
THE
DIGITAL
ERA

What is Finance?
Finance can be defined as the art and
science of managing money.
Finance is concerned with the
process, institutions, markets, and
instruments involved in the transfer
of money among individuals,
businesses, and governments.
Copyright 2006
Pearson Addison-Wesley.
All rights reserved.

1-3

What is Corporate Finance?

The activities involved in managing cash
flows in a business environment
Every decision that a business makes has
financial implications, and any decision
which affects the finances of a business is a
corporate finance decision.
Defined broadly, everything that a business
does fits under corporate finance.

1-4

WHAT IS
CORPORATE
FINANCE?

Corporate Financeis the

area offinance dealing
with the sources of
funding and thecapital
structureof
corporations
and
the
actions that managers take
to increase thevalueof
the
firm
to
theshareholders, as well
as
the
tools

TRADITIO
NAL
APPROAC
H

Corporate Finance is the

management of financial
resources of a business
entity.

Corporate Finance is not only

concerned with financing
decision, but also with
investment and current
management decisions.

MODER
N

Three Questions Addressed by the

Study of Finance:
1. What long-term investments should
the firm undertake? (capital
budgeting decisions)
2. How should the firm fund these
investments? (capital structure
decisions)
3. How can the firm best manage its
cash flows as they arise in its dayto-day operations? (working capital
management decisions)

Stockholders
OWNERS

Board
Of
Directors

Chief Financial
Officer
CFO

Chief Executive
Officer
CEO

MANAGE
RS

Chief Marketing
Officer
CMO

Chief Production
Officer
CPO

Credit Manager

Treasurer

Inventory Manager
Director of Capital
Budgeting
Cash and Liquidity
Manager
Cost Accounting Manager

Controller

Financial Accounting
Manager
Tax Department Manager

Why Study Finance?

Knowledge of financial tools is critical
to making good decisions in both
professional world and personal lives.
Finance is an integral part of
corporate world
How will GMs strategic decision to invest
$740 million to produce the Chevy Volt
require the expertise of different
disciplines within the business school
such as marketing, management,
accounting, operations management,

Why Study Finance? (cont.)

Many personal decisions require
financial knowledge (for example:
buying a house, planning for
retirement, leasing a car)

Corporate Finance
is about..

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.
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The 5 Basic Corporate Finance

Functions
Financing
(Capital-Raising)
Capital Budgeting

Financial Management

Corporate Governance

Risk Management
1 - 13

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

1 - 14

The Goal of the Financial

Manager

The goal of the financial manager must be

consistent with the mission of the
corporation.
What is the generally accepted mission of
a corporation?

Possible goals of financial

management

Survive
Beat the competition
Maximize sales
Maximize net income
Maximize market share
Minimize costs
Maximize the value of (stock) shares

The Capital Budgeting

Function

Capital Budgeting
selecting the best
projects in which to
invest the firms
resources

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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
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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
1 - 19

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
1 - 20

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.
1 - 21

The Core Principles of

Finance
Dont 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.
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AGENCY PROBLEM
Agency problems arise when there is
conflict of interest between the stockholders
and the managers. Such problems are likely to
arise more when the managers have little or
no ownership in the firm.
Examples:
Not pursuing risky project for fear of losing
jobs, stealing, expensive perks.
All else equal, agency problems will reduce
the firm value.

RESOLVING
CONFLICTS
Managerial
Compensation
Direct
Intervention By
Shareholders
The Threat of
Firing