Introduction to Corporate - PowerPoint Presentation

1. Introduction to Corporate Finance – Chapter 1Module 1.1

2. Types of financial decision making:Some random headlines from the WSJ on June 20 and June 21, 2013 Microsoft Explored Deal for NokiaSprint Tops Dish Bid for ClearwireDelta Air Lines Makes Headway on Virgin Atlantic StakeArcher Daniels Midland Confirms Talks on Sale of Cocoa UnitExxon Requests Permit to Export Canadian LNG From Pacific CoastSony's New Board Considers Dan Loeb's IPO ProposalHow did (or will) managers for these firms address these decisions? 1

3. Financial decision makingBasic idea is simple: Compare the financial benefits versus the costsComplications: costs and benefits typically occur at different points in time, and future cash flows are typically uncertain.Regarding the Sprint headlineThe cost is now increased to $5/share for ClearwireThat is a cost that is known today (if bid is accepted)The benefits to Sprint, however, are probably much more uncertain and will be weighted more heavily in the futureHow did Sprint decide that $5/share was still worthwhile? 2

4. 1.1 What Is Corporate Finance? Corporate Finance addresses the following three questions:What long-term investments should the firm choose?This is “capital budgeting” – modules 1-3, 6How should the firm raise funds for the selected investments?This is “capital structure” – module 7How should short-term assets be managed and financed?We will not address this last question in FINC850

5. Balance Sheet Model of the FirmCurrent AssetsFixed Assets1 Tangible 2 IntangibleTotal Value of Assets:Shareholders’ EquityCurrent LiabilitiesLong-Term DebtTotal Firm Value to Investors:

6. The Capital Budgeting DecisionCurrent AssetsFixed Assets1 Tangible 2 IntangibleShareholders’ EquityCurrent LiabilitiesLong-Term DebtWhat long-term investments should the firm choose?

7. The Capital Structure DecisionHow should the firm raise funds for the selected investments?Current AssetsFixed Assets1 Tangible 2 IntangibleShareholders’ EquityCurrent LiabilitiesLong-Term Debt

8. The Financial ManagerThe Financial Manager’s primary goal is to increase the value of the firm by: Selecting value creating projects Making smart financing decisions

9. 1.2 The Corporate FirmThe 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.

10. Forms of Business OrganizationThe Sole ProprietorshipThe PartnershipGeneral PartnershipLimited PartnershipThe CorporationThe sequence above is typically followed as firms grow from their founding to a corporation, often with the help of venture capitalists along the way.

11. A Comparison CorporationPartnershipLiquidityShares can be easily exchangedSubject to substantial restrictionsVoting RightsUsually each share gets one voteGeneral Partner is in charge; limited partners may have some voting rightsTaxationDoublePartners pay taxes on distributionsReinvestment and dividend payoutBroad latitudeAll net cash flow is distributed to partnersLiabilityLimited liabilityGeneral partners may have unlimited liability; limited partners enjoy limited liabilityContinuity Perpetual lifeLimited life

12. Cash flowfrom firm (C)1.3 The Importance of Cash FlowTaxes (D)GovernmentRetained cash flows (F)Investsin assets(B)Dividends anddebt payments (E)Current assetsFixed assetsShort-term debtLong-term debtEquity sharesUltimately, the firm must be a cash generating activity.The cash flows from the firm must exceed the cash flows from the financial markets.FirmFirm issues securities (A)Financialmarkets

13. 1.4 The Goal of Financial ManagementWhat is the correct goal?Maximize profit?Minimize costs?Maximize market share?Maximize shareholder wealth?

14. Maximizing shareholder value vs. profit maximizationShareholder value is the present (discounted) value of :Current-period profits available to shareholders and Anticipated future profits in excess of capital investment, available to shareholdersMaximizing shareholder wealth often considers tradeoffs between current and future profits, and the risk of obtaining their profits.13

15. Shareholders vs. ‘Stakeholders’Does maximizing shareholder wealth imply taking extreme positions toward other claimants? Does such a firm:Hire employees in the ‘day labor’ market, with absolutely no implication of continued employment?Refuse to make charitable contributions?Try to get as much profit as possible in every customer transaction?Maximizing shareholder wealth requires a careful balancing of interests14

16. How to create shareholder value?Investment and production decisions must ultimately stay focused on satisfying consumer needs and wants“Almost 50 years ago, Sam Walton started Walmart with a single store in Rogers, Ark., dedicated to providing customers with a broad assortment of merchandise at great prices. Sam told Walmart associates: "Customers are the reason why we're in business. And when we exceed their expectations, we're at our best." From the day the doors opened in Rogers, on July 2, 1962, Walmart's culture has been built on a common purpose: saving people money so they can live better. ”Michael Duke, CEO, Walmart, 2012 Annual ReportIf managers do not focus on efficient employment of assets, what is likely to happen?Someone will buy them (“market for corporate control”)No one buys them, and they slowly go broke (bankruptcy)How do we know if managers do a good job?Stock prices reflect market assessment of managers decisions (assumes a reasonably efficient market)Audited financial reports (assumes honesty)15

17. CEO’s focus on shareholder value“We continue to deliver strong returns to shareholders and returned $11.3 billion to them through dividends and share repurchases during the year. We were disciplined and focused on improving our business, and we made good progress.”“Though we are never satisfied, I am pleased with our progress over the past year. Looking ahead, we have a clear understanding of what we need to do at Walmart to drive long–term shareholder value and deliver on our mission.”Walter Duke, CEO, Walmart, 2012 Annual Report.http://www.walmartstores.com/sites/annual-report/2012/CEOletter.aspx16

18. Primary objective of financial managerAssure all decisions improve and/or protect shareholder valueTo help us, we need to address at least the following:How are cash flows valued? Which cash flows should we value?On what grounds do we base investment decisions?How are financial securities valued?How do we measure and reduce risk?We focus on these questions in FINC850!17

19. 1.5 The Agency ProblemAgency relationshipPrincipal hires an agent to represent his/her interestStockholders (principals) hire managers (agents) to run the companyAgency problemConflict of interest between principal and agentAre we sure the CEO and managers will work in the best interests of the shareholders?

20. Managerial GoalsManagerial goals may be different from shareholder goalsExpensive perquisites (corporate jets!?)SurvivalIndependence‘Empire Building’Increased growth and size are not necessarily equivalent to increased shareholder wealth, but the CEO may like having more assets under his care

21. Managing ManagersManagerial compensationIncentives can be used to align management and stockholder interestsThe incentives need to be structured carefully to make sure that they achieve their intended goalCorporate controlThe threat of a takeover may result in better managementOther stakeholders – such as debt holders also monitor managers closely.

22. 1.6 Regulation (just FYI)The Securities Act of 1933 and the Securities Exchange Act of 1934 Issuance of Securities (1933)Creation of SEC and reporting requirements (1934)Sarbanes-Oxley (“Sarbox”)Increased reporting requirements and responsibility of corporate directorsTherefore, regulators watch managers as well.