Welcome to
FIN 501
Financial Management
By
Md Sajib Hossain, CFA, ACCA
Assistant Professor
Department of Finance
University of Dhaka
Chapter 1: Introduction to
corporate finance
Corporate Finance
Ross, Westerfield &
Jaffe
Outline
1.1 What is corporate finance?
1.2 The goal of financial management
1.3 The agency problem and control of the
corporation
1.4 Ethics and corporate governance
1.5 Financial markets
Main tasks of corporate finance
• Capital budgeting: the process of planning
and managing a firm’s long-term
investments fixed assets.
• Example: deciding whether or not to open a new
restaurant.
• Capital structure: the mixture of debt and
equity maintained by the firm S-T and L-
T debt and equity.
• Working capital management: a firm’s
short-term assets and liabilities current
assets and current liabilities.
The Capital Budgeting Decision
Current
Liabilities
Current
Assets Long-Term
Debt
Fixed Assets What long-term
1 Tangible
investments
should the firm Shareholders
2 Intangible choose? ’ Equity
Forms of firms
Sole Proprietorship
Partnership (General vs Limited)
Corporation: a business created as a distinct legal
entity composed of one or more individuals or
entities, e.g., IBM.
– Separation of control (shareholders) and management (professionals).
– Ownership can be easily transferred.
– Limited liability.
– Double taxation.
– Rather expensive to form.
– Agency problems.
The Importance of Cash Flow
Identification of the Cash Flow
Risk of the Cash Flow
Timing of the Cash Flow
Who make the decisions?
Owners (typically in small businesses).
Professional managers.
Possible goals of financial
management
Survive
Beat the competition
Maximize sales
Maximize net income
Maximize market share
Minimize costs
The “appropriate” goal of financial
management
Maximize the (fundamental or economic) value of
(stock) shares is the right goal.
Why? Shareholders own shares. Managers, as
agents, ought to act in a way to benefit
shareholders; i.e., to enhance the value of the
shares.
A limitation of this goal is that value is not directly
observable.
The agency problem
Agency relationship:
– Principals (citizens) hire an agent (the president) to
represent their interest.
– Principles (stockholders) hire agents (managers) to run the
company.
Agency problem:
– Conflict of interest between principals and agents.
– This occurs in a corporate setting whenever the agents do
not hold 100% of the firm’s shares.
– The source of agency problems is the separation of
(owners’) control and management.
Agency costs
Direct costs: (1) unnecessary expenses,
such as a corporate jet, and (2) monitoring
costs.
Indirect costs. For example, a manager
may choose not to take on the optimal
investment. She/he may prefer a less risky
project so that she/he has a higher
probability keeping her/his tenure.
Managerial incentives
Managerial goals are frequently different
from shareholders’ goals.
– Expensive perks (expensive company cars, office
location, discretionary expenses).
– Survival (avoiding firm’s going out of business)
– Independence ( preference of retained earningng
to using external funds).
Growth and size (related to compensation)
may not relate to shareholders’ wealth.
Corporate governance
Compensation:
– Incentives ($$$, options, threat of dismissal, etc.) used to
align management and stockholder interests.
Corporate control:
– Proxy Fights
– Managers may take the threat of a takeover seriously and
run the business in the interest of shareholders.
Financial Markets
Money Markets
Capital Markets
– Primary Market
– Secondary Market
Dealers Market
Auction Market
Sarbanes-Oxley Act (2002)
10K must have an assessment of the firm’s
internal control structure and financial
reporting.
The officers must explicitly declare that 10K
does not contain any false statements or
material omissions.
The officers are responsible for all internal
controls.
End-of-chapter
