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CORPORATE

FINANCE
Wajeeh Elali, PhD
Ahlia University
2015 / 2016
Elali
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What is Finance?
Finance is the art and
science of handling
money
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What is Finance?
Finance is the art and
science of handling
money
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What is Corporate Finance?


Corporate Finance addresses the
following three questions:
1. What long-term investments should the firm

engage in?
2. How can the firm raise the money for the
required investments?
3. How much short-term cash flow does a
company need to pay its bills?
4

The Balance-Sheet Model of the Firm


Total Value of Assets:

Current Assets

Total Firm Value to Investors:


Current
Liabilities
Long-Term
Debt

Fixed Assets
1 Tangible
2 Intangible

Shareholders
Equity
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The Balance-Sheet Model of


the Firm
The Capital Budgeting Decision

Current
Liabilities

Current
Assets

Fixed Assets
1 Tangible
2 Intangible

Long-Term
Debt

What long-term
investments
should the firm
engage in?

Shareholders
Equity
6

The Balance-Sheet Model of


the Firm
The Capital Structure Decision

Current
Assets

How can the


firm raise the
money for the
Fixed Assets
required
1 Tangible investments?
2 Intangible

Current
Liabilities
Long-Term
Debt

Shareholders
Equity
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The Balance-Sheet Model of


the
Firm
The Net Working Capital Investment Decision
Current
Assets

Fixed Assets
1 Tangible
2 Intangible

Current
Liabilities
Net
Working
Capital

How much
short-term cash
flow does a
company need
to pay its bills?

Long-Term
Debt

Shareholders
Equity
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Capital Structure
The value of the firm can
be thought of as a pie.
The goal of the manager is
to increase the size of the
pie.

70%
25%50%30%
Debt
DebtDebt
Equity
75%
50%
Equity

The Capital Structure


decision can be viewed as
how best to slice up the
pie.
If how you slice the pie affects the size of the
pie, then the capital structure decision
matters.

Who is The Financial


Manager?

10

Hypothetical Organization Chart


Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
President and Chief
Operating Officer (COO)
Vice President Finance

Treasurer

Controller

Cash Manager

Credit Manager

Tax Manager

Cost Accounting

Capital Expenditures

Financial Planning

Financial Accounting

Data Processing
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The Financial Manager


To create value, the financial manager
should:
1. Try to make smart investment
decisions.
2. Try to make smart financing decisions.

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The Firm and the Financial


Markets
Firm
Invests
in assets
(B)

Financial
markets

Retained
cash flows (D)
Short-term debt
Cash flow
from firm (C)

Dividends and
debt payments (F)
Taxes (E)

Current assets
Fixed assets

Firm issues securities (A)

Ultimately, the firm


must be a cash
generating activity.

Government

Long-term debt
Equity shares

The cash flows from


the firm must
exceed the cash
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flows from the
financial markets.

Goals of the Corporate Firm


What are firm decision-makers hired to
do?
The traditional answer is that the
managers of the corporation are obliged
to make efforts to maximize shareholder
wealth.

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The Set-of-Contracts Perspective


The firm can be viewed as a set of contracts.
One of these contracts is between shareholders
and managers.
The managers will usually act in the shareholders
interests.
The shareholders can devise contracts that align the

incentives of the managers with the goals of the


shareholders.
The shareholders can monitor the managers behavior.

This contracting and monitoring is costly.


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Managerial Goals
Managerial goals may be different from
shareholder goals
Expensive perquisites
Survival
Independence

Increased growth and size are not


necessarily the same thing as increased
shareholder wealth.
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Separation of Ownership and


Control
Board of Directors

Shareholders

Assets

Debt

Debtholders

Management

Equity
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The Agency Problem


The agency relationship
Will managers work in the shareholders
best interests?
Agency costs

Direct agency Costs


Indirect agency Costs

Control of the firm


How do agency costs affect firm value
(and shareholder wealth)?

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Financial Institutions, Financial


Markets, And The Corporation
Financial Institutions
Indirect finance
Funds
suppliers

Deposits

Financial
intermediaries

Loans

Funds
demanders

Direct finance
Funds
suppliers

Financial
intermediaries

Funds
demanders

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Financial Markets
Money versus Capital Markets
Money Markets
For short-term debt instruments
Capital Markets
For long-term debt and equity

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Financial Markets
Primary versus Secondary Markets
Primary Market
When a corporation issues securities, cash flows from

investors to the firm.


Usually an underwriter is involved

Secondary Markets
Involve the sale of used securities from one

investor to another.
Securities may be exchange traded or trade over-thecounter in a dealer market.
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Financial Markets

Firms

Stocks and
Bonds
Money

Investors
Sam

securities

Sara

money
Primary Market
Secondary
Market

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