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Introduction to Corporate Finance

Aswath Damodaran

Stern School of Business

Aswath Damodaran

What is corporate finance?

Every decision that a business makes has financial implications, and any decision which affects the finances of a business is a corporate finance decision. Defined broadly, everything that a business does fits under the rubric of corporate finance.

Aswath Damodaran

The Three Major Decisions in Corporate Finance

The Allocation decision


Where do you invest the scarce resources of your business? What makes for a good investment?

The Financing decision


Where do you raise the funds for these investments? Generically, what mix of owners money (equity) or borrowed money(debt) do you use?

The Dividend Decision


How much of a firms funds should be reinvested in the business and how much should be returned to the owners?

Aswath Damodaran

The Traditional Accounting Balance Sheet

The Balance Sheet


Assets
Long Lived Real Ass ets
Short-lived As sets

Liabilities
Current Liabilties
Debt

Fixed Ass ets


Current Assets

Short-term liabilities of the firm


Debt obligations of firm

Investments in securities & as sets of other firms

Financ ial Investments

Other Liabilities
Equity

Other long-term obligations


Equity investment in firm

Ass ets w hich are not phys ic al, Intangible As sets like patents & trademarks

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The Financial View of the Firm

Assets
Existing Investments Ass ets in Place Generate cas hflow s today Includes long lived (fixed) and short-lived(working capital) ass ets Debt

Liabilities
Fixed Claim on cas h flows Little or No role in management Fixed Maturity Tax Deductible

Expected Value that will be created by future investments

Grow th As sets

Equity

Res idual Claim on cas h flow s Significant Role in management Perpetual Lives

Aswath Damodaran

First Principles of Corporate Finance


Invest in projects that yield a return greater than the minimum acceptable hurdle rate.
The hurdle rate should be higher for riskier projects and reflect the financing mix used - owners funds (equity) or borrowed money (debt) Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects.

Choose a financing mix that minimizes the hurdle rate and matches the assets being financed. If there are not enough investments that earn the hurdle rate, return the cash to stockholders.
The form of returns - dividends and stock buybacks - will depend upon the stockholders characteristics.

Objective: Maximize the Value of the Firm


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