Introduction to Corporate

Finance
Chapter One
FIN 6301
Financial Management
Instructor:
Mary Chaffin
SOM 2.208
972-883-2646
chaf@utdallas.edu
Office Hours:
Monday 4:00-6:30 p.m.
Wednesday 2:00-3:30 p.m.

Corporate Finance

Ross, Westerfield and Jaffee, 7
th
Edition
www.utdallas.edu/~chaf
Copies of the transparencies.
Solutions to end of chapter problems.
Old exams.
www.mhhe.com/rwj
Appendix D: Using a Financial Calculator.
Review material and practice quizzes.


Grading
Exam I 30% or 15%
Exam II 30% or 15%
Final Exam 40%
Assignments 15%
Formula sheet allowed on exams - not
quizzes.
Notice of Policy on Cheating
Other Resources
Wall Street Journal
Barrons
Financial Calculator
The Four Basic Areas of Finance
Corporate Finance
Broadest field
Specific to operations of a business
Investments
Interrelation on a smaller scale then money and capital
markets
Money and Capital Markets
Workings of the financial system
Broad flow of money
International Finance
Areas of Finance
The Firm
Financial Markets
Financial
Intermediaries
Investors
Financial Calculators
HP 10B ($30)
HP 17B II ($80)
HP 12C ($70)
HP 19B II ($100+)
TI BA II + ($30)


Financial Calculators
HP 10B
TI BA II+
Tips on using calculator:
Set p/y=1 (This comes set at 12 on a new
calculator)
Clear registers before each use
Set decimals to 4 places

Solution Methods
Numerical using regular calculator without
financial functions.
Interest Tables - end of text.
Financial Calculator using five specific keys
which correspond to the five most commonly
used DCF variables:

N i PV FV PMT
What is Corporate Finance?
Corporate Finance addresses the following
three questions:

1. What long-term investments should the firm
engage in?
2. How can the firm raise the money for the
required investments?
3. How much short-term cash flow does a
company need to pay its bills?
Microsoft to Dole Out
Its Cash Hoard
In an extraordinary move to shower its cash hoard
upon shareholders, Microsoft Corp. said it will make
a one-time dividend payment this year of $32 billion
and buy back up to $30 billion of the company's
stock over the next four years. The company also
said it will double the dividend it pays out annually to
$3.5 billion, or 32 cents a share.
The plans, which Microsoft valued at up to $75
billion over four years, are believed to represent the
largest corporate cash disbursement in history. They
mark a turning point for high technology's most
successful company.
Capital Structure
The value of the firm can be
thought of as a pie.
The goal of the manager is
to increase the size of the
pie.
The Capital Structure
decision can be viewed as
how best to slice up a the
pie.
If how you slice the pie affects the size of the pie,
then the capital structure decision matters.
50%
Debt
50%
Equity
25%
Debt
75%
Equity
70%
Debt
30%
Equity
The Financial Manager
To create value, the financial manager
should:
1. Try to make smart investment decisions.
2. Try to make smart financing decisions.

Corporate Securities as Contingent Claims
on Total Firm Value
The basic feature of a debt is that it is a
promise by the borrowing firm to repay a
fixed dollar amount of by a certain date.
The shareholders claim on firm value is the
residual amount that remains after the
debtholders are paid.
If the value of the firm is less than the
amount promised to the debtholders, the
shareholders get nothing.
Debt and Equity as Contingent Claims
$F
$F
Payoff to
debt holders
Value of the firm (X)
Debt holders are promised $F.
If the value of the firm is less than $F, they
get the whatever the firm if worth.
If the value of the firm
is more than $F, debt
holders get a
maximum of $F.
$F
Payoff to
shareholders
Value of the firm (X)
If the value of the
firm is less than $F,
share holders get
nothing.
If the value of the firm
is more than $F, share
holders get everything
above $F.
Algebraically, the bondholders
claim is: Min[$F,$X]
Algebraically, the shareholders
claim is: Max[0,$X $F]
Combined Payoffs to Debt and Equity
$F
$F
Combined Payoffs to debt holders
and shareholders
Value of the firm (X)
Debt holders are promised $F.
Payoff to debt holders
Payoff to shareholders
If the value of the firm is less than
$F, the shareholders claim is:
Max[0,$X $F] = $0 and the debt
holders claim is Min[$F,$X] = $X.
The sum of these is = $X
If the value of the firm is more than
$F, the shareholders claim is:
Max[0,$X $F] = $X $F and the
debt holders claim is:
Min[$F,$X] = $F.
The sum of these is = $X
The Corporate Firm
The 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.
Forms of Business Organization
The Sole Proprietorship
The Partnership
General Partnership
Limited Partnership
The Corporation
Advantages and Disadvantages
Liquidity and Marketability of Ownership
Control
Liability
Continuity of Existence
Tax Considerations
Goals of the Corporate Firm
The traditional answer is that the managers
of the corporation are obliged to make efforts
to maximize shareholder wealth.
The Set-of-Contracts Perspective
The firm can be viewed as a set of contracts.
One of these contracts is between shareholders and
managers.
The managers will usually act in the shareholders
interests.
The shareholders can devise contracts that align the
incentives of the managers with the goals of the
shareholders.
The shareholders can monitor the managers behavior.
This contracting and monitoring is costly.
Managerial Goals
Managerial goals may be different from
shareholder goals
Expensive perquisites
Survival
Independence
Increased growth and size are not
necessarily the same thing as increased
shareholder wealth.
Do Shareholders Control Managerial
Behavior?
Shareholders vote for the board of directors,
who in turn hire the management team.
Contracts can be carefully constructed to be
incentive compatible.
There is a market for managerial talent
this may provide market discipline to the
managersthey can be replaced.
If the managers fail to maximize share price,
they may be replaced in a hostile takeover.
Financial Markets
Primary Market
When a corporation issues securities, cash flows
from investors to the firm.
Usually an underwriter is involved
Secondary Markets
Involve the sale of used securities from one
investor to another.
Securities may be exchange traded or trade over-
the-counter in a dealer market.
Exchange Trading of Listed Stocks
Auction markets are different from dealer
markets in two ways:
Trading in a given auction exchange takes place
at a single site on the floor of the exchange.
Transaction prices of shares are communicated
almost immediately to the public.