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Principles of corporate Finance Lecture notes
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Principles of corporate financeLecture 1
Financial decision making is all about the future
Accounting:
- Records the past
- Works with real amounts
- More dedicated to reporting with a book value approach
Finance:
- Estimates future cash flows
- Works with forecast
- More dedicated to decision making with a
market value approach
Do not forget to think of margins of error
Chapter 1 Goals and Governance of the Corporation
- Investment activities take place with respect to
the debit sheet (left hand side) of the balance sheet whereas:
- Finance activities focus on the right hand side of the balance sheet (credit side)
where the funding activities take place
The financial markets are more competitive that the product markets:
Financing activities therefore do not deliver, in general, large financial benefits
Remember: finance is all about the Cash Flows (available to the firm)
Investment or capital budget decision or CAPEX (capital expenditure
This is the decision to invest in tangible- (e.g. machines) or intangible assets (e.g. R&D
expenditures)
Financing decision:
This is the decision to choose the funding for the firm, project, take-over etc. (e.g. long/short
term Bank loan, issuing shares through an IPO or issuing Bonds: dept/equity financing)
Where do funds (equity) come from
1. Primary market
o E.g. IPO (initial public offering) where securities are sold directly to the
investors and the funds go to issuing firm
o E.g. SEO (seasoned offering) is a 2nd share issue where the funds from the sale
of the securities flow from the investor to the issuing firm
2. Secondary market
o Investors trade (buy and sell) securities with each other. Funds of the sale go
to the seller of the securities not to the firm!
(via stock exchanges e.g. AEX, CAC40, FTSE etc.)
Where do the dept funds come from?
The dept or loans from a company are mostly from financial institutions like Banks,
institutional investor etc.
Related terms:
- Real assets: assets used to produce goods and services
, - Financial assets: financial claims to the income generated by the firm’s real assets
Corporation
Is a business organized as a separate legal entity owned by stock/shareholders
Types of corporations
- Public company
- Private company
Types of business organizations
- Sole proprietorships
- Partnerships
- Corporations
- Limited liability options or partnerships: the owners of a corporation are not
personally liable for its obligations
Financial management structure
- CFO: Chief financial officer. Supervises all financial functions and sets overall strategy
Reports to CEO: chief executive officer
- Treasurer: cash management, raises capital, maintains contact with investors
- Controller: financial statements, internal budgets & accounting, tax affairs
Cash flows of a corporation
Goals of the corporations
- Shareholders desire wealth maximization
- Profit maximization
o Which year’s profits?
- Opportunity costs of capital
o The minimum acceptable rate or return on capital investment is set by the
investment opportunities available to shareholders in financial markets
Corporate governance & agency problems/costs
- Corporate governance related to the way HOW an organization/company/business
entity is or should be run
, - Agency problems arise when the points of attention or focal points between
managers of a company differ from the interests of the owners of the company (i.e.
the shareholders)
With respect to corporate governance (see: the Netherlands: code tebaksblat)
- Transparency of the company
- Equal treatment of shareholders (both minority and majority shareholders)
- Reportinf of relevant decisions with respect to the running of the company
- Monitoring of the management of the company and taking corrective actions
With respect to agency prooblems/costs
- Understanding the differences in priorities between the owners of a company (i.e.
the shareholders) and the managers of the company (maximizing equity/personal
wealth)
Ownership vs. management
- Difference in information
o Stock prices vs. returns
o Dilution of ownership
o Dividend policy
o Financing decisions
- Different objectives
o Managers vs. stockholders
o Top managers vs. lower managers
o Stockholders vs. blanks and lenders
How to avoid agency problems/costs
- Internal control and decision making procedures
- Executive compensation aligned with financial performance
- Corporate governance
The laws, regulations, institutions, and corporate practices that protect
shareholders and other investors (see previous slides)
Chapter 2 financial markets and institutions
- Business have to go to financial markets and institutions for the financing the need in
order to be able to grow
- Financial decisions
o Source funds (capital)
o Capital structure
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