Corporate Finance: Firms, Valuation, and Time Value of Money

Distinction between decision makers and firm type (CFO/finance manager vs owner).
Focus of the course: mostly corporations, with discussion of issuing bonds and stock and trading on financial markets.
Small businesses (sole proprietorships and partnerships) still face similar financial questions (what projects to fund, how to fund them, what to do with cash) but with different frictions and tools.
Key firm types:
- Sole proprietorships and partnerships: default form for small businesses; pass-through taxation; no separate legal entity; personal liability can flow through to owners.
- Corporations (C corporations) and S corporations: separate legal entity; liability protection; ability to own property; potential for infinite lifespan; ownership via shares; separation of ownership and control.
Why not every firm incorporates? Benefits scale with firm size; costs include regulatory compliance, legal/accounting expenses, and potential tax penalties depending on structure.
Main takeaway: even though decision contexts differ, the financial intuition and analysis are shared across firm types; we’ll predominantly use corporate contexts (C corps) for stock, bonds, and market trading.

Pass-through taxation (default for sole proprietorships and partnerships): earnings taxed at owners' personal rates; no separate corporate tax entity.
Liability and legal separation:
- Sole proprietorships/partnerships lack a separate legal entity; personal assets can be liable for business debts or liabilities.
- Corporations provide liability protection; personal assets are shielded from business liabilities.
S corporations vs C corporations (tax treatment):
- S corp: pass-through taxation like a partnership; earnings flow through to owners' personal taxes.
- C corp: earnings can be retained by the firm or distributed as dividends; subject to corporate tax; earnings may be taxed again when distributed to owners (double taxation potential) but allow reinvestment and growth.
Practical example: sole proprietorships can obtain an EIN and operate with pass-through tax treatment; the business is not a separate tax entity.

Liability shield: corporations separate personal and business liabilities, enabling ongoing operations even if owners are harmed or the company faces liabilities.
Succession and continuity: corporations persist beyond the founders; stock can be inherited or transferred; the entity itself remains a legal entity.
Ownership vs control: owners (shareholders) elect a board of directors to oversee major governance; the board hires/fires the CEO; day-to-day decisions are made by the CEO and executives.
Ownership structure can be dispersed (many shareholders) or concentrated (few owners initially, e.g., founders/VCs).
The separation enables broad investment by individuals who do not work for the company and a distributed ownership base.

Shareholders: equity holders and owners who elect the board; voting rights vary (one share = one vote is common but not universal).
Board of Directors: oversight body that appoints/removes the CEO; chair is typically elected by the board.
CEO and executives: responsible for day-to-day operations and strategy; report to the board.
Separation of ownership and control creates governance layers (owners -> board -> CEO -> operations).
Incentives and alignment:
- Share-based compensation aligns managers’ interests with shareholders’ wealth maximization, but the alignment weakens with distance from the top (slippage in incentives down the ladder).
- Other incentives: performance bonuses, stock options, and other compensation structures.
Charismatic founders and control: some tech firms issue multi-class shares with different voting rights (e.g., class B shares with higher voting power) to keep control with founders while raising capital.

One share, one vote is common, but not universal; some firms use share classes with unequal voting rights.
Example: Meta (Facebook) creator control through class B shares with elevated voting rights despite minority economic ownership; founders/early investors can retain control while opening up capital to others.
VC rounds often use preferred equity with liquidation preferences and anti-dilution provisions; VCs may have strong cash-flow rights but limited control unless negotiated.
Debt (bank loans, bonds): debt holders have cash-flow rights but typically no voting rights; debt sits between pure equity and pure debt in terms of control and claims.
General picture: intangible separation of cash-flow rights (ownership) and control rights (voting and governance) across different securities and capital structures.

Benefits of incorporation: liability protection, continuity, ease of transferring ownership, ability to raise capital more easily, separation of ownership and control, potential for broader investment.
Costs of incorporation: regulatory/compliance costs, professional fees, and tax considerations that may be higher for smaller firms.
Practical rule of thumb: corporations tend to be advantageous as firms scale beyond a certain size due to fixed costs and greater capital needs.

The CFO sits between financial markets and the firm’s real assets; uses information from financial markets to make decisions about real assets and operations.
Goal: maximize the value of the firm’s real assets by maximizing shareholder wealth.
Central question: how do we measure value and decide which projects to pursue?

Real value comes from producing goods/services efficiently; financial markets and mechanisms are used to fund and allocate capital to enable real asset investment.
Value is driven by future cash flows and their present value; more cash flows generally mean higher value, all else equal.
Time value of money: a dollar today is worth more than a dollar tomorrow because it can be invested to earn a return.
Illustrative comparison:
- If one project yields $1,500 over five years all in year 1 vs all in year 5, the earlier cash flow is preferred due to time value of money.
- If future cash flows are front-loaded, they’re generally more valuable in present terms than back-loaded cash flows, given a positive discount rate.
Discount rate r represents the opportunity cost of capital or required return; it reflects availability of alternative investments and risk; higher r discounts future cash flows more heavily.
Different rates matter for different contexts (borrowing vs lending, risk, horizon).

Future value: FV = PV imes (1 + r)^t
Present value: PV = rac{FV}{(1 + r)^t}
Present value of a single future cash flow with nonzero lag: PV = rac{FV}{(1 + r)^t}
Present value of a stream of cash flows: $$PV = ext{PV}ig(CF1, CF2,
ext{…}, CFT; rig) = rac{CF1}{(1 + r)^1} + rac{CF2}{(1 + r)^2} + \n rac{CF3}{(1 + r)^3} + \