Class notes
Corporate Finance MGMT 413 Class Lecture Notes
- Course
- Mgmt 413 (MGMT413)
- Institution
- Purdue University
Notes from corporate finance class
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Types of Business OrganizationsSole Proprietorship Partnership Corporation
Who owns the The manager Partners Shareholders
business?
Are managers and No No Usually
owners separate
What is the owner’s Unlimited Unlimited Limited
liability? (exceptions)
Are owners and the No No No
business taxed
separately?
Sole proprietorship & partnership Corporation
Advantages ● Easy to establish ● Limited
● Least regulated liability
● Owner keeps all profits ● Professional
● Fewer agency issues management
& perpetual
lives
● Easy to raise
external
financing
Disadvantages ● Unlimited liability ● Double
● Difficult to raise external finance taxation
● Limited life of business ● Agency issues
between
managers and
shareholders
● Complicated
regulations
Killer acquisition: acquire a company that appears to be competition
- By acquiring, they can control that company and do whatever they want
Financial Decisions of a Firm
- Investment decisions: what projects should the company undertake?
- Should the firm buy machine A or machine B?
- Financing and Payout Decisions: how to raise money to fund a firm’s investments in real assets?
- Should the firm pay a dividend? If so, how much?
, - Both investing and financing decisions impact a firm’s value
- Investing choice impacts value through cost of capital
Goal of a Financial Manager
- Maximize shareholders’ wealth AKA maximize current share price!
- Do this by:
- Choose projects with positive and greatest NPV
- Choose capital structure to minimize cost of capital, which will maximize value of the firm
- Return excess cash to shareholders (at the “right” time with the “right” amount)
Cost of Capital
- Cost of capital AKA financing cost is the cost that a firm must pay its investors for their funding
- It’s the opportunity cost of funds for the suppliers of capital
- Required rate of return: a potential supplier will not voluntarily invest in a company unless its return
meets to exceeds what the supplier could earn elsewhere in an investment of comparable risk
- Cost of capital to firms = return on investment to investors
- It is calculated as a weighted average cost of capital – commonly called WACC
WACC
- WACC is calculated as the weighted average of costs of different sources of capital such as debt,
common equity and preferred shares:
- Uses of WACC:
- The rate at which future cash flows are discounted in valuation of firms or valuation
of projects → discount rate
- It is also referred to as the hurdle rate: a project must yield a return >= WACC to be acceptable
- T is the corporate income tax rate
- Wd, we, wp are the proportions of debt, preferred shares and common equity respectively in firm’s total capital. With
D, E, P and V represent debt, common equity, preferred shares and total firm value, then
- Wd = D/V
- We = E/V
- Wp =P/V
- V = D+E + P
- Rd, Re, Rp are the costs (or returns) of debt, preferred shares and common equity
respectively
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