FUNDAMENTALS

of Corporate
FINANCE

SECOND EDITION

Stephen A. Ross
Randolph W. Westerfield
Bradford D. Jordan
Joseph Lim
Ruth Tan

Copyright © 2016 by McGraw-Hill Education. All rights reserved.

 CHAPTER 1
I N T R O D U C T I O N T O C O R P O R AT E F I N A N C E

Copyright © 2016 by McGraw-Hill Education. All rights reserved.

 KEY CONCEPTS AND SKILLS
• Know the basic types of financial management
decisions and the role of the financial manager

• Know the financial implications of the different

forms of business organization

• Know the goal of financial management

• Understand the conflicts of interest that can arise

between owners and managers

• Understand the various types of financial markets

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 CHAPTER OUTLINE
• Corporate Finance and the Financial
Manager

• Forms of Business Organization

• The Goal of Financial Management

• The Agency Problem and Control of the

Corporation

• Financial Markets and the Corporation

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 CORPORATE FINANCE

• Some important questions that are answered

using finance:
 What long-term investments should the firm
take on?

 Where will we get the long-term financing to

pay for the investment?

 How will we manage the everyday financial

activities of the firm?
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 FINANCIAL MANAGER
• Financial managers try to answer some or all of
these questions

• The top financial manager within a firm is usually

the Chief Financial Officer (CFO)
 Treasurer – oversees cash management, credit
management, capital expenditures, and financial
planning

 Controller – oversees taxes, cost accounting, financial

accounting and data processing

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FINANCIAL MANAGEMENT
DECISIONS
• Capital budgeting
 What long-term investments or projects
should the business take on?

• Capital structure
 How should we pay for our assets?
 Should we use debt or equity?

• Working capital management

 How do we manage the day-to-day
finances of the firm?
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 FORMS OF BUSINESS
ORGANIZATION

• Three major forms:

 Sole Proprietorship

 Partnership
• General
• Limited

 Corporation
• Limited Liability Company
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SOLE PROPRIETORSHIP
• Advantages • Disadvantages
 Easiest to start  Limited to life
 Least regulated of owner
 Single owner  Equity capital
keeps all the profits limited to owner’s
 Taxed once as personal wealth
personal income  Unlimited liability
 Difficult to sell
ownership interest

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 PARTNERSHIP
• Advantages • Disadvantages
 Two or more  Unlimited liability
owners • General partnership
 More capital • Limited partnership
available  Partnership
 Relatively easy to dissolves when one
start partner dies or
 Income taxed wishes to sell
once as personal  Difficult to transfer
income ownership

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 CORPORATION
• Advantages • Disadvantages
 Limited liability  Double taxation
 Unlimited life (income taxed at
 Separation of the corporate rate
ownership and and then
management dividends taxed at
the personal rate)
 Transfer of
ownership is easy
 Easier to raise
capital

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INTERNATIONAL CORPORATIONS

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 A COMPARISON OF THE DIFFERENT
FORMS OF BUSINESS ORGANIZATION

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 GOAL OF FINANCIAL MANAGEMENT

• What should be the primary goal for the firm?

• Maximize profit?

• Minimize cost?

• Maximize market share?

• Maximize shareholder wealth?

WHICH INVESTMENT IS PREFERRED?
 GOAL OF FINANCE: MAXIMIZING PROFIT?

• Maximizing profit is not a suitable goal because:

1. Timing is important—the receipt of funds sooner rather than later is
preferred
2. Profits do not necessarily result in cash flows available to
stockholders
3. Profit maximization fails to account for risk
 GOAL OF FINANCE: MINIMIZING COST?

• Minimizing cost is not a suitable goal because:

• Minimizing costs may increase current profits but the future
well-being of the company may be affected, for example,
• Reducing maintenance costs may result in machines
breaking down earlier in the future
• Reducing R&D expenditures may cause the products to
be less competitive
• Reducing headcount may reduce the quality of service
 GOAL OF FINANCE: MAXIMIZING MARKET SHARE?

• Maximizing market share is not a suitable goal

because:
• In order to increase market the firm may large amounts in
advertising and promotion
• Having a large market share may not translate into higher
profits if the firm cannot increase revenue much more by
increasing prices
 GOAL OF FINANCE: MAXIMIZING SHAREHOLDER
WEALTH?

• This is the right goal of finance because:

• It avoids the problems of the other goals by taking risk, level
of cash flow, and timing into consideration.
• Maximize stock price, not profits
• Shareholders, as residual claimants, have better incentives
to maximize firm value.
 THE AGENCY PROBLEM
• Agency relationship
 Principal hires an agent to represent
his/her interests
 Stockholders (principals) hire managers (agents) to
run the company

• Agency problem
 Conflict of interest between
principal and agent

• Management goals and agency costs

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 MANAGING MANAGERS
• Managerial compensation
 Incentives can be used to align
management and stockholder interests
 The incentives need to be structured carefully
to make sure that they achieve their goal

• Corporate control
 The threat of a takeover may result in better
management

• Other stakeholders

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 WORK THE WEB EXAMPLE

• The Internet provides a wealth of information

about individual companies
• One excellent site is finance.yahoo.com
• Click on the web surfer to go to the site,
choose a company and see what information
you can find!

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 FINANCIAL MARKETS

• Primary market
• A market where the firm sells its securities to public for the
first time
• Secondary markets
• A market in which the securities issued by firms are traded
• Listed securities trade in an organized exchange, e.g. the
stock market (NYSE)
• Over-the-counter securities are bought from or sold to a
dealer

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END OF CHAPTER
CHAPTER 1

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