Chapter 1: The Scope Of Corporate Finance

1. Chapter 1:The Scope Of Corporate Finance Corporate Finance, 3e Graham, Smart, and Megginson PowerPoint Presentation by Jeff Whitworth, University of Houston-Clear Lake

2. What is Corporate Finance? • The activities involved in managing cash flows in a business environment 1 - 2

3. Financing (Raising Capital) Financial Management Capital Budgeting Risk Management Corporate Governance The 5 Basic Corporate Finance Functions 1 - 3

4. The Core Principles of Finance • The time value of money • The opportunity to earn a return on invested funds means that a dollar today is worth more than a dollar in the future. • Compensation for risk • Investors expect compensation for bearing risk.

5. The Core Principles of Finance • Don’t put all your eggs in one basket. • Investors can achieve a more favorable tradeoff between risk and return by diversifying their portfolios. • Markets are smart. • Competition for information tends to make markets efficient. • No arbitrage • Risk-free money-making opportunities are extremely scarce.

6. Primary Forms of Business Organization • No distinction between business and owner • Easy to set up and operate • Business earnings taxed as personal income • Limited life, Limited access to capital, Unlimited personal liability Sole Proprietorships Partnerships • Similar to sole proprietorship, but has two or more owners • Joint and several liability • Share of profits taxed as partnership income Limited Partnerships • One or more general partners with unlimited personal liability • Most owners are limited partners, who are passive investors with limited liability

7. Primary Forms of Business Organization • Separate legal entity with many of the economic rights and responsibilities of individuals • Unlimited life, Limited liability, Separable contracting, Improved access to capital • Owned by shareholders, who elect the Board of Directors • Board appoints a President or CEO to manage day-to-day operations Corporations Are there any disadvantages for corporations? YES! Double taxation

8. What Should a Financial Manager Try to Maximize? • Maximize Profit? • Earnings per share are backward-looking, dependent on accounting principles • Does not fully consider cash flow timing • Ignores risk • Maximize Shareholder Wealth? • Maximize stock price, not profits • Shareholders, as residual claimants, have better incentives to maximize firm value.

9. Agency Costs • Managers act as agents of the owners who hired them and gave them decision-making authority to manage the firm for the owners’ benefit. • In practice however, self-interest may cause managers to pursue objectives other than shareholder wealth maximization. • This conflict of goals gives rise to managerial agency problems.

10. How Agency Costs Can Be Controlled • Ways to limit agency problems: • Activism by institutional investors • Takeover threat • Monitoring and bonding • Compensation contracts

11. Importance of Ethics • Widespread publicity surrounding numerous ethical violations began with the Enron collapse in late 2001. • Society in general and the financial community in particular are developing and enforcing ethical standards. • Ethical behavior is necessary in order to maximize shareholder’s wealth.