Resume
Summary corporate finance
- Établissement
- Karel De Grote-Hogeschool (KdG)
coporate finance chapter 1-8
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Chapter 1: Goals and governance of corporationTo carry on business a corporation needs an endless variety of assets. Some assets are tangible (plant
and machinery, office buildings, and vehicles) others are intangible (brand names and patents)
Corporations finance these assets by borrowing, by reinvesting profits back into the firm and by
selling additional shares to the firms’ shareholders
2 questions for financial managers
- What investments should the corporation make
- How should it pay for these investments?
Investment decisions spend money, financial decisions raise money for investment.
Financial managers add value whenever the corporation can invest to earn a higher return than its
shareholder can earn for themselves.
1.1 investment and financing decisions
Example FedEx how that company came to be.
To make this company a success they had to make good investment decision. In the beginning these
decisions were constrained by lack of financing. As it grew the investment decisions became more
complex: which type of planes should it buy, should it expand coverage to EU and Asia, …
They also needed to make good financing decisions: how should it raise the money it needed for
investment. In the beginning these choices were limited to family money and bank loans. As the
company grew its range of choices expanded.
All successful companies must make good investment AND financing decisions.
The investment (capital budgeting) decision
Investment decision are also called capital budgeting or capital expenditure (CAPEX) decisions.
Some investments involve tangible assets – assets tat you can touch and kick
Others involve intangible assets – R&D, advertising, and the design of computer software.
Sometimes investments can have very-long-term consequences. (US nuclear power plants)
Others may pay off in only a few months (Walmart supply investment for holidays)
The cumulative amount of small investments can be just as large as the occasional jumbo investment
shown in table 1.1.
Not all investments succeed. (Hewlett – Packard HP wrote down the value of their investment)
The financing decision
The financial managers second main responsibility is to raise the money that the firm requires for its
investments and operations.
Financing decision: decision on the resources and amounts of financing.
When a company needs to raise money, it can
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, - invite investors to put p cash in exchange for share of future profits = the investors receive
shares of stock and become shareholders, part-owners of the corporation = equity investors
who contribute equity financing.
- Or it can promise to pay back the investors cash plus a fixed rate of interest. In this case the
investors are lenders that is debt investors who one day must be repaid.
The choice between debt and equity financing is often called the capital structure decision. Capital =
firms’ sources of long-term financing. A firm that is seeking to raise long-term financing is said to be
raising capital.
Difference between investment and financing decisions.
- When the firm invests it acquires real assets, which are then used to produce the firm’s
goods and services. Real assets: assets used to produce goods and services.
- The firm finances its investment in real assets by issuing financial assets to investors.
Financial assets: financial claims to the income generated by him firms’ real assets.
A share of stock is a financial asset, which has value as a claim on the firm’s reals assets and on the
income that those assets will produce
e.g. a bank loan is a financial asset also. It gives the bank the right to get its money back plus interest.
If the firm cannot generate enough money to pay the bank back, the bank can force the firm into
bankruptcy and stake a claim on its real assets.
Financial assets that can be purchased and traded by investors in public markets are called securities.
The firm can issue an almost endless variety of financial assets. Long/short term, debt investors or
bank loan, …
Value comes mainly from the investment side of the balance sheet.
Market value = market capitalization or market cap = number of share x how much the shares are
traded for.
Financing decisions may not add much value compared to good investment decisions, but they can
destroy value if they are stupid or ambushed by bad news.
1.1 self test p.7
Financial managers responsibility for two decisions
- the investment decision = purchase of real assets
- the financing decision = sale of financial assets.
1.2 what is a corporation
Corporation: a business organized as a separate legal entity owned by stockholders. For many
purposes, the corporation is considered a resident of the state/ it can enter contracts, borrow, or
lend money, and sue or be sued. It pays its own taxed.
A corporation’s owners are called shareholders or stockholder. The shareholders do not directly own
the business real assets. Instead they have indirect ownership of financial assets (shares of
corporation).
2
,A corporation is legally distinct form the shareholders. Therefore, the shareholders have limited
liability and cannot be held personally responsible for the corporation’s debt. They can lose their
entire investment but no more.
Example business organisation.
Corporation can be closely held = the shares are not publicly traded.
Public corporations= their shares are traded in public markets such as NY stock exchange.
Public shareholders cannot possibly manage or control the corporation directly. They elect a board of
directors who in turn appoint the top managers and monitor their performance.
- This separation of ownership and control gives corporation permanence.
Downside of separation of corporate ownership: managers and directors can act in their own interest
rather than in the stockholders’ interest.
Disadvantages to being corporation
- Costs: time and money of managing the corporation’s legal machinery
- Tax drawback (US) they are separate legal entity so taxed separately. They pay tax on their
profits and shareholders are also taxed when they receive dividends.
Other forms of business organisations
You can have
- Small company (mom and pop companies
- Partnerships: tax advantage but can be held accountable for all the business debts =
unlimited liability.
- Limited partnerships: combine the tax advantage of partnership with the limited liability of a
corporation. Partners here are referred to as general or limited.
→ General partners: manage the business and have unlimited personal liability for its debts
→ Limited partner: are liable only for the money they invest and do not participate in
management.
- Limited liability partnerships: in which all partners have limited liability
- Profession corporation: the business has limited liability, but the professionals can still be
sued personally.
1.3 who is the financial manager
Chief financial officer (CFO): supervises all financial functions and sets overall financial strategy). The
CFO is deeply involved in financial policy and financial planning and is in constant contact with the
CEO and other top management. He is the most important financial voice of the corporation and
explains earnings results and forecasts to investors and the media. Figure 1.1 p 10!!!
Below CFO are a treasurer and a controller.
- Treasurer: responsible for financing, cash management and relationships with banks and
other financial institutions. He looks after the firm’s cash, new capital, and maintains
relationships with banks and other investors that hold the firm’s securities.
- Controller: responsible for budgeting, accounting, and taxes. He prepares the financial
statements, manages the firm’s internal budgets and accounting, and looks after its tax
affaires.
3
, Treasurer main functions is to obtain and manage the firm’s capital and the controller ensures that
the money is used efficiently.
Financial manager in this book: anyone responsible for an investment or financial decision.
What is the essential role of the financial manager = figure 1.2 p11?
- The figure traces how money flows from investors to the corporation and back again to
investor. The flow starts when cash is raised from investors (arrow 1). The cash could come
from banks or from securities sold to investors in financial markets. The cash is then used to
pay for the real assets needed for the corporation’s business (arrow 2). Later as the business
operates the assets generate cash inflows (arrow 3). That cash is either reinvested (arrow 4
a) or returned to the investors who furnished the money in the first place (arrow 4b).
- The choice between arrows 4 a and b is constrained by the promises made when cash was
raised at arrow.
The financial managers stand between the firm and outside investors. On the one hand he is involved
in the firm’s operations. One the other hand he deals with financial institutions and other investors
and with financial markets such as NY stock exchange.
1.4 goals of corporation
Shareholders want managers to maximize market value
Authority must be delegated in large firms. There is no way that in large corporations 100 000
shareholders can be actively involved in management.
How can shareholders effectively delegate decision making when they all have different tastes,
wealth, and tolerance for risk? Delegation can work only if the shareholders have a common goal.
Natural financial objective on which almost all shareholders can agree = maximize the current market
value of shareholders investment in the firm.
The simple, unqualified goal makes sense when the shareholders have access to well-functioning
financial markets and institutions. Access gives them the flexibility to manage their own savings and
consumption plans, leaving the corporation financial managers with only one task, increase market
value.
Shareholders will most certainly include
- Risk-avers shareholders
- Risk-tolerant shareholders.
Profit maximization is not a well-defined corporate objective. 2 reasons
- 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 will not add value unless the outlays were
wasteful in the first place. Shareholders will not welcome higher short-term profits f long-
term profits are damaged.
- 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 only a very low rate of return on the extra investment.
Maximizing or at least maintaining value is necessary for the long run survival of the corporation.
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