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FUNDAMENTALS OF CORPORATE FINANCE Fourth Canadian Edition Stephen A. Ross Randolph W. Westerfield Bradford D. Jordan Gordon S. Roberts CLICK MOUSE OR HIT SPACEBAR TO ADVANCE Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson,Ltd. The University of Lethbridge Faculty of Management Management 3040Y - Finance Terry D. Harbottle Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Outline of the Text Part I: Part II: Part III: Part IV: Part V: Part VI: Part VII: Part VIII: Part IX: Irwin/McGraw-Hill Overview of Corporate Finance Financial Statements and Long-Term Financial Planning Valuation of Future Cash Flows Capital Budgeting Risk and Return Cost of Capital and Long-Term Financial Policy Short-Term Financial Planning and Management Topics in Corporate Finance Derivative Securities and Corporate Finance copyright © 2002 McGraw-Hill Ryerson, Ltd. Table of Contents Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Chapter 11 Chapter 12 Chapter 13 Chapter 14 Irwin/McGraw-Hill Introduction to Corporate Finance Financial Statements, Taxes, and Cash Flow Working with Financial Statements Long-Term Financial Planning and Corporate Growth Introduction to Valuation: The Time Value of Money Discounted Cash Flow Valuation Interest Rates and Bond Valuation Stock Valuation Net Present Value and Other Investment Criteria Making Capital Investment Decisions Project Analysis and Evaluation Some Lessons from Capital Market History Return, Risk, and the Security Market Line Cost of Capital copyright © 2002 McGraw-Hill Ryerson, Ltd. Table of Contents (continued) Chapter 15 Raising Capital Chapter 16 Financial Leverage and Capital Structure Policy Chapter 17 Dividends and Dividend Policy Chapter 18 Short-Term Finance and Planning Chapter 19 Cash and Liquidity Management Chapter 20 Credit and Inventory Management Chapter 21 International Corporate Finance Chapter 22 Leasing Chapter 23 Mergers and Acquisitions Chapter 24 Risk Management: An Introduction to Financial Engineering Chapter 25 Options and Corporate Securities Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd. Chapter 1 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, Financial Insts, & the Corporation 1.6 Trends in Financial Markets & Financial Mgmt. 1.7 Outline of the Text 1.8 Summary and Conclusions Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc. 1999 Corporate Finance Long-term investments Capital Budgeting Long-term financing Capital Structure Short-term financing Working Capital Management Financial Risk management Irwin/McGraw-Hill Derivative securities copyright © 2002 McGraw-Hill Ryerson, Ltd. Capital Budgeting ‘The Process of planning and managing a firm’s long term investments’ evaluating the size, timing and risk of future cash flows are the key components of capital budgeting overall objective is to identify and invest in projects & assets that will generate a return greater than the firm’s cost of capital Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Capital Structure Addresses the question of how a firm should obtain and manage the long term financing needed to support its long term investments: it is the specific mixture of long term debt and equity capital the decision on how much debt vs. Equity impacts the risk level for the firm and the firm’s cost of capital Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Working Capital Management Working capital refers to a firms short term assets and short term liabilities includes accounts receivable, inventory and accounts payable how much cash to keep on hand, inventory to carry, credit terms to offer to customers are examples of working capital management decisions Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Financial Risk Management The process of identifying, quantifying and decisions to manage certain types of risk: currency risks interest rate risks commodity price risk Other risks such as strategic, operating and commercial risks need to be considered by the firm as a whole - ideally looking at risk on an enterprise wide basis (holistic risk management) Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. A Framework for Integrated Risk Management Strategic -technology & information - knowledge management -industry value chain transformation Organization wide Risk Crisis Management -environmental disasters -brand crisis/computer system failure Operating Risks -distribution networks -manufacturing Identification Impact Response Commercial Risks - new competitor(s) - customer service expectations - new pricing models - supply chain management Financial Risk -price - interest & fx. rate -commodity price Irwin/McGraw-Hill 1999 GBN Canada ©The McGraw-Hill Companies, Inc. A Simplified Organizational Chart (Figure 1.1) Board of Directors Chairman of the Board and Chief Executive Officer (CEO) President and Chief Operations Officer (COO) Vice President Marketing Controller Treasurer Irwin/McGraw-Hill 1999 Vice President Production Vice President Finance (CFO) Cash Manager Credit Manager Tax Manager Cost Accounting Manager Capital Expenditures Financial Planning Financial Accounting Manager Data Processing Manager ©The McGraw-Hill Companies, Inc. Forms of Organization Sole Proprietorship Partnership General Partnership / Limited Partnership Corporation Limited Liability Company Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Corporations A corporation is a legal entity separate and distinct from its owners has many of the same rights, duties and privileges of an actual person: borrow money can own property can enter into contracts shareholders and management are usually separate in most larger corporations the shareholders elect the board of directors the board then selects the senior managers who in theory are charged with running the affairs in the interests of the shareholders Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Advantages/Dis-advantages of the Corporate Form Advantages ownership (shares) can be readily transferred life of the corporation is not limited limited liability makes this form attractive to investors all of the above make it easy to raise cash - sell new stock Dis-advantages double taxation of its profits Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. 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 Maximize profits Maximize shareholder wealth/value Maximize share price Maximize firm value Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Corporate Finance Is about ‘the relationship between the business decisions and the value of the stock in the business’ ….or shareholder value If the return on business investments is greater than the firm’s cost of capital – shareholder value is being enhanced Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. The Agency Problem and Control of the Firm Agency Relationships and Management Goals potential for conflict - is their too much emphasis on corporate survival, job security and (more recently) with management wealth creation? Do managers Act in the Shareholders’ interests? They are influenced by: • how they are compensated - does their compensation encourage them to make decisions that will enhance shareholder value • how easily are they replaced if they do not pursue shareholder goals - control here is with the board of directors Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Agency costs Agency Costs - defined as the costs associated with the conflict of interests : Direct agency costs Indirect agency costs Impact of Agency Costs on Shareholder Wealth or Value direct - expenditures benefiting Management e.g. the unneeded corporate jet or direct - monitoring costs e.g. outside auditors indirect - lost opportunity where Management is not acting in the best interests of its shareholders e.g. costly acquisitions driven more by desire for power and prestige Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Conflict of Interest Will Managers work in the Shareholder’s best interest? Mechanisms to ensure Managers are acting in shareholders’ interest: • managerial compensation • active and knowledgeable board of directors • Active institutional investors Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Financial Markets Financial Institutions, Markets and the Corporation Financial Institutions Act as intermediaries between investors and firms raising funds - banks, trust companies, investment dealers, insurance companies, etc. direct finance indirect finance Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Financial Markets - brings buyers and sellers of debt and equity securities together How do financial markets differ? Type of securities traded/how trading is conducted and who the buyers and sellers are Money markets and capital markets money market - short term debt securities capital market - long term debt and equity Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. T1.7 Financial Markets Continued Primary vs. secondary markets Primary Market- where the original sale of issue of a security by a government or corporation occurs • public offering - underwritten by an investment dealer and registered with provincial securities commissions • private placement - debt and equity sold directly to a buyer - typically life insurance companies and , pension funds Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. T1.7 Financial Markets Continued Secondary Market - trading of securities subsequent to the initial sale - enables the transfer of ownership • auction market - TSE • dealer market - ‘over the counter (OTC) ‘ How do financial markets benefit society? Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. Financial Markets and Society what is the benefit to society? Channel savings into investment produce and transmit information on returns and risk provide a media and a payments system enable the shifting of the timing of consumption over a life cycle enable the management of risk enable the diversification of portfolios Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc. T1.9 Financial Markets and the Corporation - Cash Flows Between the Firm and the Financial Markets (Figure 1.2) Irwin/McGraw-Hill 1999 ©The McGraw-Hill Companies, Inc.
