1、Corporate FinanceLecture1 Fundamentals,Dr. Ouyang Hongbing Department of Finance School of Economics Huazhong University of Science and Technology Spring, 2014,What is Corporate Finance?,Corporate Finance addresses the following three questions: What long-term investments should the firm engage in?

2、How can the firm raise the money for the required investments? How much short-term cash flow does a company need to pay its bills?,The Balance-Sheet Model of the Firm,The Balance-Sheet Model of the Firm,Current Assets,Fixed Assets 1 Tangible 2 Intangible,Shareholders Equity,Current Liabilities,Long-

3、Term Debt,What long-term investments should the firm engage in?,The Capital Budgeting Decision,The Balance-Sheet Model of the Firm,How can the firm raise the money for the required investments?,The Capital Structure Decision,Current Assets,Fixed Assets 1 Tangible 2 Intangible,Shareholders Equity,Cur

4、rent Liabilities,Long-Term Debt,The Balance-Sheet Model of the Firm,How much short-term cash flow does a company need to pay its bills?,The Net Working Capital Investment Decision,Net Working Capital,Shareholders Equity,Current Liabilities,Long-Term Debt,Current Assets,Fixed Assets 1 Tangible 2 Inta

5、ngible,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.,The Capital Structure decision can be viewed as how best to slice up a the pie.,If how you slice the pie affects the size of the pie, then the capital structure deci

6、sion matters.,50% Debt,50% Equity,Hypothetical Organization Chart,The Financial Manager,To create value, the financial manager should: Try to make smart investment decisions. Try to make smart financing decisions.,Cash flowfrom firm (C),The Firm and the Financial Markets,Taxes (D),Firm issues securi

7、ties (A),Retained cash flows (F),Investsin assets(B),Dividends anddebt payments (E),Current assetsFixed assets,Short-term debt Long-term debt Equity shares,Ultimately, the firm must be a cash generating activity.,The cash flows from the firm must exceed the cash flows from the financial markets.,1.2

8、 Corporate Securities as Contingent Claims on Total Firm Value,The basic feature of a debt is that it is a promise by the borrowing firm to repay a fixed dollar amount of by a certain date. The shareholders claim on firm value is the residual amount that remains after the debtholders are paid. If th

9、e value of the firm is less than the amount promised to the debtholders, the shareholders get nothing.,Debt and Equity as Contingent Claims,$F,Debt holders are promised $F.,If the value of the firm is less than $F, they get the whatever the firm if worth.,If the value of the firm is more than $F, de

10、bt holders get a maximum of $F.,If the value of the firm is less than $F, share holders get nothing.,If the value of the firm is more than $F, share holders get everything above $F.,Algebraically, the bondholders claim is: Min$F,$X,Algebraically, the shareholders claim is: Max0,$X $F,Combined Payoff

11、s to Debt and Equity,$F,Debt holders are promised $F.,If the value of the firm is less than $F, the shareholders claim is: Max0,$X $F = $0 and the debt holders claim is Min$F,$X = $X. The sum of these is = $X,If the value of the firm is more than $F, the shareholders claim is: Max0,$X $F = $X $F and

12、 the debt holders claim is: Min$F,$X = $F. The sum of these is = $X,1.3 The Corporate Firm,The corporate form of business is the standard method for solving the problems encountered in raising large amounts of cash. However, businesses can take other forms.,Forms of Business Organization,The Sole Pr

13、oprietorship The Partnership General Partnership Limited Partnership The Corporation Advantages and Disadvantages Liquidity and Marketability of Ownership Control Liability Continuity of Existence Tax Considerations,A Comparison of Partnership and Corporations,1.4 Goals of the Corporate Firm,The tra

14、ditional answer is that the managers of the corporation are obliged to make efforts to maximize shareholder wealth.,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 shareho

15、lders 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.,Managerial Goals,Managerial goals may be different from shareholder goal

16、s Expensive perquisites Survival Independence Increased growth and size (corporate wealth) are not necessarily the same thing as increased shareholder wealth.,Separation of Ownership and Control,Board of Directors,Management,Assets,Debt,Equity,Shareholders,Debtholders,Do Shareholders Control Manager

17、ial Behavior?,Shareholders vote for the board of directors, who in turn hire the management team. Contracts can be carefully constructed to be incentive compatible. There is a market for managerial talentthis may provide market discipline to the managersthey can be replaced. If the managers fail to

18、maximize share price, they may be replaced in a hostile takeover.,1.5 Financial Markets,Money market vs. Capital market Primary market vs. Secondary market Auction market vs. Dealer market,Financial Markets,Primary Market When a corporation issues securities, cash flows from investors to the firm. U

19、sually an underwriter is involved Issuer may choose public offering or private placement Secondary Markets Involve the sale of “used” securities from one investor to another. Securities may be exchange traded or trade over-the-counter in a dealer market.,Financial Markets,Firms,Investors,Sue,Bob,Financial Markets,Dealer market No physical market. Dealers communicate with each other by computers or telephones Investors can negotiate with dealers Several dealers make market for one security Auction market Trading takes place at a single site on the floor of the exchange (a post). Spec