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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
1-2
Investment and Financing Decisions
 Common Finance Terminology
– Real assets
– Financial assets / Securities
– Capital markets and financial
markets
– Investment / capital budgeting
– Financing
1-3
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.
1-4
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)
1-6
Investment and Financing Decisions
– “Capital Budgeting”
Tangible Assets
Intangible Assets
Expand Stores
New Drug R&D
@ $800 million
@ $800 million
1-7
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 Boeing’s
aircraft, at a forecast cost of more than
operations allowed it to repay some
$10 billion.
of 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
and gas field in the .
cash 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
In 2008 raised $2.5 billion by an
a billion dollars in 90 new stores in .
issue 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)
1-9
(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 Financial Officer
Treasurer
Controller
1-10
The Investment Trade-off
1-11
The Investment Trade-off
Hurdle rate
Cost of capital
Opportunity cost of capital
1-12
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 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.
1-14
1-15
Whose Company Is It?
** Survey of 378 managers from 5 countries
3
Japan
97
17
Germany
22
France
United States
71
76
24
0
All Stakeholders
78
29
United Kingdom
The Shareholders
83
20
40
60
80
% of responses
100
120
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Dividends vs. Jobs
** Survey of 399 managers from 5 countries. Which is more important...jobs
or paying dividends?
3
Japan
97
40
Germany
41
France
United States
89
89
11
0
Job Security
59
11
United Kingdom
Dividends
60
20
40
60
80
% of responses
100
120
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
– 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
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
1-22
Web Resources
Click to access web sites
Internet connection required
www.corpgov.net
www.thecorporatelibrary.com
www.riskmetrics.com
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