Corporate Finance Lecture 1

What is corporate finance?

Corporate finance studies how firms make financial decisions to maximise firm value, focusing on investment decisions, financing decisions and liquidity management.

What are three major areas of Corporate Finance?

1. Investment decisions (capital budgeting) - choosing long-term projects

2. Financing decisions (capital structure) - deciding how to raise funds

3. Liquidity management (working capital) - managing day-to-day cash flows

What is a capital budgeting decision?

A decision about which long-term investments or projects a firm should undertake.

What is a capital structure decision?

A decision about how a firm finances its self using debt and equity.

What is working capital management?

Managing short-term assets and liabilities te ensure the firm can meet its day-to-day obligations.

What is the overriding goal of financial management?

Maximising firm value

Why is profit maximisation not the main goal?

Profit ignores risk, timing of cash flows and sustainability, whereas firm value reflects long-term shareholder wealth.

What is the triple bottom line?

A broader goal considering People, Planet and Profit, balancing economic, social and environmental objectives.

What is a sole proprietorship?

A business owned by a single individual who receives all profits and bears unlimited personal liability.

Advantages of a sole proprietorship

• Easy to start

• Full control by owner

• Taxed at personal tax rate

Disadvantages of sole proprietorship

• Unlimited personal liability

• Limited life (ends when owner dies)

• Limited access to capital

What is a partnership?

A business owned by two or more people governed by a partnership agreement.

Advantages of a partnership

• Easy to start

• Personal tax treatment

• Access to more funds than sole trader

Disadvantages of a partnership

• Joint unlimited liability

• Ends if partner leaves or dies

• Difficult to raise large amounts of capital

• Written documents are required in complicated arrangements; general and limited partnerships

What are the two types of partnerships

• General partnerships

• Limited partnerships

What are general partnerships?

• All partners provide some fraction of the work and cash and share profit and losses of the firm

• Each partner is liable

• Partnership agreement specifies the nature of the agreement and may be oral or written

What are limited partnerships?

Where the liability of some partnerships are limited to the amount of cash each has contributed to the partnership.

What do limited partnerships require?

• At least one partner be a general partner

• the limited partners to not participate in managing the business

What is a corporation?

A separate legal entity distinct from its owners.

What does limited liability mean?

Shareholders’ losses are limited to the amount they invested.

Difference between private and public corporations

• Private: shares not traded publicly, owners often directors

• Public (PLC): shares traded on stock exchanges

Advantages of a corporation

• Limited liability

• Unlimited life

• Easy transfer of ownership

• Easier to raise capital

• Separation of ownership from management

Disadvantages of corporations

• Double taxation

• More regulation

• Separation of ownership and control

What does the article of incorporation include for a corporation?

• Name of corporation

• Intended life of corporation

• Business purpose

• Number shares authorised to issue

• Nature of rights granted to shareholders

• Number of members of the initial board of directors

What is double taxation?

Corporate profits are taxed at the firm level and dividends are taxed again at the shareholders level.

Who is considered a financial manager?

Anyone responsible for significant investment or financing decisions.

Role of treasurer

Cash management, raising capital, banking relationships

Role of controller

Financial reporting, accounting and tax management

Role of CFO

Financial strategy, corporate planning and financial policy

What is a firm’s capital structure?

The mix of debt and equity used to finance the firm.

Firm Value formula

Firm value = Value of Debt + Value of Equity

What is the objective of choosing capital structure?

To find the optimal debt-to-equity ratio that maximises firm value.

What is an agency relationship?

A relationship where shareholders (principals) hire managers (agents) to run the firm.

What causes agency problems?

Conflict of interest between principals and agents.

What is Type 1 agency problem?

Conflict between shareholders and management.

What is Type 2 agency problems?

Conflict between majority and minority shareholders or debtholders.

Examples of Type 1 agency problems

• Managers preferring form growth over shareholder value

• Managers choosing low risk projects with lower NPV

Examples of Type 2 agency problems

• Large shareholder acting in self-interest

• Excessive dividends harming debtholders

What are agency costs?

Costs incurred to monitor managers and align their interests with shareholders.

How can agency problems be reduced?

• Monitoring

• Incentive-based compensation

• Threat of takeover or dismissal

• Transparent disclosure

• Good corporate governance

What is corporate governance?

A system of rules and practices ensuring firms are well managed and accountable.

Who oversees corporate governance?

The board of directors

Who is the Board accountable to?

Shareholders and Stakeholders

Difference between unitary and two-tier boards

• Unitary: Board reports directly to shareholders

• Two-tier: Supervisory board oversees management board

Role of non-executive directors

Provide independent oversight and are not directly involved in daily management

Purpose of financial markets

Match firms needing funds with investors supplying capital

Three ways firms raise finance

• Bank loans

• Debt securities (bonds)

• Equity (shares)

Primary vs Secondary markets

• Primary: New securities issued

• Secondary: Existing securities traded

Money markets vs capital markets

• Money markets: Short-term (< 1 year)

• Capital markets: Long-term financing

What is peer-to-peer lending?

Online platforms connecting borrowers directly with individual investors

Advantages of FinTech lending

• Lower costs

• No intermediaries

• Easier access for SME’s (Small and medium sized enterprises)

Disadvantages of Fintech lending

• Higher risk for investors

• Higher interest rates

• Smaller loans

Avantages of Public corporations

• Access to large capital

• Higher credibility

Disadvantages of Public corporations

• Strict regulation

• Loss of control

Advantages of Private corporations

• More control

• Greater pri