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8/9/2019 Corporate Finance Lecture 1
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FinancialManagement I
Brian Clark, PhD
Lecture 1
Spring 2015Lally School o Management
!en""elaer Polytechnic In"titute
clark#2$rpi%e&u Spring 2015 Financial Management I ' Clark 1
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o Intro&uction" (you all ha)e to "peak*+
• ell the cla"" a#out-
• .our #ackgroun& (inclu&ing out"i&e o aca&emia+• .our ma/or (un&ergra& an& current+
• hy you are taking the cour"e
• hat you ant to learn
o Form group" or ca"e orko Intro&uce the cour"e
Spring 2015 Financial Management I ' Clark 2
o&ay" Cla""
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o 3"eul openare e#"ite-
• http-44oc%mit%e&u4cour"e"4"loan'"chool'o'mana
gement415'1'6nancial'management'"ummer'20074lecture'note"
4
• Leellen, 8onathan% 15.414 Financial Management,
Summer 2003% (MI 9penCour"eare-Ma""achu"ett" In"titute o echnology+,http-44oc%mit%e&u4cour"e"4"loan'"chool'o'management415'1'6nancial'management'"ummer'2007 (:cce""e& 21 8an, 201+% Licen"e- Creati)e
Common" B.';C'S:Spring 2015 Financial Management I ' Clark 7
Intro&uction
http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003/lecture-notes/http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003/lecture-notes/http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003/lecture-notes/http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003/lecture-notes/http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003/lecture-notes/http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003/lecture-notes/http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003/lecture-notes/http://ocw.mit.edu/courses/sloan-school-of-management/15-414-financial-management-summer-2003/lecture-notes/
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o ype" o 6rm"-
• Sole Proprietor"hip
• Partner"hip
• Limite& Lia#ility Company
• Corporation
Spring 2015 Financial Management I ' Clark
Chapter 1
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o In)e"tment )er"u" 6nancing-
• In)e"tment- ho a 6rm "pen&" money
• Financing- ho a 6rm pay" or it" in)e"tment"an& &i"#ur"e" the earning"
o :re they relate&<
Spring 2015 Financial Management I ' Clark 5
Corporate Finance
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Spring 2015 Financial Management I ' Clark =
Ba"ic Balance Sheet
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o Corporate 6nance i" all a#out managing the #alance
"heet to ma>imi?e )alue
o But, e nee& to un&er"tan& e)erything that goe" intothe #alance "heet to un&er"tan& )alue-
• Financial market"
• Securitie" pricing
• Li@ui&ity
• Si?e o the #alance "heet
• !i"k )er"u" return
• Incenti)e" (remem#er corporation" are run #y human"*+
Spring 2015 Financial Management I ' Clark A
Intro&uction (cont%+
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o o &o e rai"e un&"<
• Bon& market"
• @uity market"• Bank"
o hy choo"e one )er"u" the other<
Spring 2015 Financial Management I ' Clark
Financial Market"
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o o to )alue "tock", #on&", #ank loan", etc%<
• .ou &ont nee& to #e a all St% tra&er, #ut you
"houl& kno the #a"ic"• ;ee& to e)aluate the mo"t a)ora#le price
(although the market )alue i" only one a"pecto the o)erall co"t+
Spring 2015 Financial Management I ' Clark E
Securitie" Pricing
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o hat i" the purpo"e o capital market"<
o Capital market" ena#le economie" to gro #y
"prea&ing capital aroun& in the mo"t ecient mean"po""i#le (i%e%, the mo"t pro&ucti)e mem#er" o"ociety "houl& get the mo"t capital+
Spring 2015 Financial Management I ' Clark 10
ime Galue o Money
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o Ca"h management-
• Capital "itting i&le create" an opportunity co"t-
• It oul& ha)e #een #etter oH in)e"te& el"ehere• oe)er, in)e"ting capital &ecrea"e" the
e>i#ility o your capital
o De#t )"% e@uity-
• @uity may co"t more up ront, #ut it i"generally le"" re"tricti)e (in large corporation"+
Spring 2015 Financial Management I ' Clark 11
Li@ui&ity
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o o large &o e ant to make the #alance "heet<
• Merger", ac@ui"ition", organic groth<
o hat are the #ene6t" an& co"t" o "i?e<
• J"-
• Decrea"e& co"t o un&ing
• :cce"" to a&&itional un&ing
• conomie" o "cale an& "cope
• '"-
•
Coor&ination co"t"• Lo"" o control
o Si?e in the #anking in&u"try-
• Bank o :merica
• ell" Fargo
Spring 2015 Financial Management I ' Clark 12
Si?e o the Balance
Sheet
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o Smaller 6rm" ten& to outperorm larger 6rm"
in term" o "tock market return"
• But, they al"o ten& to #e more )olatile
o Mea"uring return i" "imple
o o &o e mea"ure ri"k<
•
o much ri"k are you illing to take on<• hat actor" inuence ho much ri"k you take
on<
Spring 2015 Financial Management I ' Clark 17
!i"k )er"u" !eturn
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o o can e align the goal" o the
"takehol&er" ith the goal" o management<
• he "tructure o the 6rm matter"• Pay "tructure
• Payout policy
• Capital "tructure
Spring 2015 Financial Management I ' Clark 1
Strategic Koal" an&
Incenti)e"
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o : e note" on the ca"e "tu&ie"-
• Plea"e proorea& your ork
• 9nly the inormation inclu&e& in the ca"e rite'up ill #e
con"i&ere& hen gra&ing• I you perorm any analy"i", it nee&" to #e inclu&e& a" a ta#le or
6gure
• :ll ta#le" an& 6gure" mu"t #e la#ele& "o I can rea& them
• !emem#er, the goal i" to con)ince your au&ience (me*+ that youun&er"tan& the material an& are making the correct &eci"ion"
o hen pre"enting, plea"e #e prepare& an& &o not rea& the"li&e"%
• ry to "peak to your au&ience to con)ince them o your mainpoint"' @ue"tion" lea& to &etaile& re"pon"e"
Spring 2015 Financial Management I ' Clark 15
Ca"e Stu&ie"
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o Mi&term-
• Chapter" 1'E
• ime )alue o money
• Capital #u&geting
• In)e"tment &eci"ion rule"
• Galuation o "tock" an& #on&"
o Final-
• Chapter" 1'1E
• Capital market" an& 6nancing (i%e%, ho to rai"e the un&" tomake in)e"tment"+
• Co"t o capital
• Capital "tructure
• Managerial incenti)e"
Spring 2015 Financial Management I ' Clark 1=
>am"
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o http-44%p#"%org4g#h4page"4rontline4melt
&on4)ie
4 o PBS Frontline In"i&e the Melt&onN
Spring 2015 Financial Management I ' Clark 1A
Gi&eo
http://www.pbs.org/wgbh/pages/frontline/meltdown/view/http://www.pbs.org/wgbh/pages/frontline/meltdown/view/http://www.pbs.org/wgbh/pages/frontline/meltdown/view/http://www.pbs.org/wgbh/pages/frontline/meltdown/view/http://www.pbs.org/wgbh/pages/frontline/meltdown/view/http://www.pbs.org/wgbh/pages/frontline/meltdown/view/
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o o i" the )i&eo rele)ant to corporate 6nance<
• Moral ha?ar&
• Financing &eci"ion"
• &e#t )"% e@uity• long )"% "hort term &e#t
• !i"k )er"u" return
• le)erage an& capital "tructure
• Inormation a"ymmetry
• inter#ank len&ing
• Market li@ui&ity• market" rely on tru"t
• Ko)ernment an& 6nance-
• Sar#ane"'9>ley :ct (re"pon"e to nron O orl&Com+
• Do&&'Frank :ct (re"pon"e to 6nancial cri"i" o 200+
Spring 2015 Financial Management I ' Clark 1
Di"cu""ion
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• !ea& chapter" 1'
• ;e>t eek e ill co)er-
• Financial &eci"ion making an& the la o oneprice
• :r#itrage
• ime )alue o money
Spring 2015 Financial Management I ' Clark 1E
or ;e>t eek
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-20
Figure 1.1 ypes o! ".#. $ir%s
Source: www.bizstats.com
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-21
1.1 The Four Types of Firms(cont'd)
• #ole Proprietorship
– &usiness is o'ned and run (y one person
– ypically has !e', i! any, e%ployees
– Advantages• Easy to create
– )isadvantages•
"nli%ited personal lia(ility• *i%ited li!e
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-22
1.1 The Four Types of Firms(cont'd)
• Partnership
– #i%ilar to a sole proprietorship, (ut 'ith %orethan one o'ner
– All partners are personally lia(le !or all o! the!ir%+s de(ts. A lender can reuire any partner torepay all o! the !ir%+s outstanding de(ts.
–
he partnership ends 'ith the death or'ithdra'al o! any single partner.
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-2
1.1 The Four Types of Firms(cont'd)
• Partnership
– *i%ited Partnership has t'o types o! o'ners.
• eneral Partners –
/ave the sa%e rights and lia(ility as partners in a regular partnership – ypically run the !ir% on a day-to-day (asis
• *i%ited Partners – /ave li%ited lia(ility and cannot lose %ore than their
initial invest%ent – /ave no %anage%ent authority and cannot legally (e
involved in the %anagerial decision %aing !or the(usiness
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-24
1.1 The Four Types of Firms(cont'd)
• *i%ited *ia(ility Co%pany 3**C
– All o'ners have li%ited lia(ility (ut they canalso run the (usiness.
– 5elatively ne' (usiness !or% in the ".#.
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-26
1.1 The Four Types of Firms(cont'd)
• Corporation
– A legal entity separate !ro% its o'ners
• /as %any o! the legal po'ers individuals have such as
the a(ility to enter into contracts, o'n assets, and(orro' %oney
• he corporation is solely responsi(le !or its o'no(ligations. Its o'ners are not lia(le !or any o(ligationthe corporation enters into.
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-27
1.1 The Four Types of Firms(cont'd)
• Corporation
– $or%ation
• Corporations %ust (e legally !or%ed. he corporation
!iles a charter 'ith the state it 'ishes to incorporatein. he state then charters the corporation, !or%allygiving its consent to the incorporation.
• )ue to its attractive legal environ%ent !orcorporations, )ela'are is a popular choice !or
incorporation.
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-28
1.1 The Four Types of Firms(cont'd)
• Corporation
– 9'nership• 5epresented (y shares o! stoc
• 9'ner o! stoc is called – #hareholder – #tochoder – Euity /older
• #u% o! all o'nership value is called euity.
• here is no li%it to the nu%(er o! shareholders, andthus the a%ount o! !unds a co%pany can raise (yselling stoc.
• 9'ner is entitled to dividend pay%ents.
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-2:
1.1 The Four Types of Firms(cont'd)
• Corporation
– a; I%plications• )ou(le a;ation
– # Corporations• $ir%+s pro!its are not su(
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-2=
Figure 1.2 9rgani>ational Chart o!a ypical Corporation
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-0
Figure 1.2 9rgani>ational Chart o!a ypical Corporation
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-1
1.2 Ownership versus Controlof Corporations (cont'd)
• $inancial ?anager
– 5esponsi(le !or@
• Invest%ent )ecisions
• $inancing )ecisions
• Cash ?anage%ent
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-2
1.2 Ownership versus Controlof Corporations (cont'd)
• oal o! the $ir%
– #hareholders 'ill agree that they are (etter o!!i! %anage%ent %aes decisions that %a;i%i>es
the value o! their shares.
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-
1.2 Ownership versus Controlof Corporations (cont'd)
• he $ir% and #ociety
– 9!ten, a corporation+s decisions that increasethe value o! the !ir%+s euity (ene!it society as
a 'hole. – As long as no(ody else is %ade 'orse o!! (y a
corporation+s decisions, increasing the value o!the !ir%+s euity is good !or society.
– It (eco%es a pro(le% 'hen increasing thevalue o! the !ir%+s euity co%es at the e;penseo! others.
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-4
1.2 Ownership versus Controlof Corporations (cont'd)
• Ethics and Incentives 'ithin Corporations
– Agency Pro(le%s
• ?anagers %ay act in their o'n interest rather than in
the (est interest o! the shareholders.• 9ne potential solution is to tie %anage%ent+s
co%pensation to !ir% per!or%ance.
• /o' should per!or%ance (e %easured
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-6
1.2 Ownership versus Controlof Corporations (cont'd)
• CE9 Per!or%ance
– I! a CE9 is per!or%ing poorly, shareholders cane;press their dissatis!action (y selling their
shares. his selling pressure 'ill drive the stocprice do'n.
– /ostile aeover• *o' stoc prices %ay entice a Corporate 5aider to (uy
enough stoc so they have enough control to replacecurrent %anage%ent. he stoc price 'ill rise a!terthe ne' %anage%ent tea% !i;es the co%pany.
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-7
1.2 Ownership versus Controlof Corporations (cont'd)
• Corporate &anruptcy
– 5eorgani>ation
– *iuidation
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-8
1. The !toc" #ar"et
• he stoc %aret provides liuidityto shareholders.
– *iuidity
•he a(ility to easily sell an asset !or close to the priceyou can currently (uy it !or
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-:
1. The !toc" #ar"et (cont'd)
• Pu(lic Co%pany
– #toc is traded (y the pu(lic on a stoce;change.
• Private Co%pany
– #toc %ay (e traded privately.
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-=
1. The !toc" #ar"et (cont'd)
• Pri%ary ?arets
– Bhen a corporation itsel! issues ne' shares o!stoc and sells the% to investors, they do so on
the pri%ary %aret.
• #econdary ?arets
– A!ter the initial transaction in the pri%ary
%aret, the shares continue to trade in asecondary %aret (et'een investors.
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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-40
1. The !toc" #ar"et (cont'd)
• *argest #toc ?arets
– e' Dor #toc E;change 3D#E• ?aret ?aers#pecialists
– Each stoc has only one %aret %aer
– A#)AF• )oes not %eet in a physical location
• ?ay have %any %aret %aers !or a single stoc
–
&id Price versus As Price• &id-As #pread – ransaction cost
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Figure 1. Borld'ide #toc ?arets5aned (y 'o Co%%on ?easures
#ource@ '''.'orld-e;changes.org