Chapter 13 and 14 are self-study
Chapter 1: Introduction to Corporate Finance
Corporate Investment and Financing Decisions 1
Real assets= Assets used to produce goods and services.
Financial assets= Financial claims to the income generated by the firm’s real assets.
Investment decision Financing decision
Purchase of real assets Sale of financial assets
Warehouse, machine → tangible Auto financing: CFO (cashflow from operating
Software → intangible activities)
Selling shares/equity
Debt: bank loan
Bond
Investment decisions
Capital budgeting decision.
• Decision to invest in tangible or intangible assets.
• Also called the investment decision.
• Also called capital expenditure or CAPEX decisions.
CFO: cash flow from operating activities
CFI: cash flow from investing activities
CFF: cash flow from financing activities
Financing Decisions
Shareholders are equity investors.
• Contribute equity financing.
Capital structure decision.
• Choice between debt and equity financing.
• Capital refers to firm’s sources of long-term financing.
, Chapter 13 and 14 are self-study
Figure 1.1 Flow of Cash Between Financial Markets and the Firm’s Operations
1) Cash raised by selling financial assets to investors.
2) Cash invested in the firm’s operations and used to purchase real assets.
3) Cash generated by the firm’s operations.
4) (a) Cash reinvested (b) Cash returned to investors.
The Financial Goal of the Corporation 1
Stockholders want three things.
1. To maximize current wealth.
2. To transform wealth into most desirable time pattern of consumption.
3. To manage risk characteristics of chosen consumption plan.
, Chapter 13 and 14 are self-study
How can the financial manager help the shareholder?
→ Maximize Wealth (Fisher Separation Theorem)
Profit maximization.
Not a well-defined financial objective.
• Which year’s profits?
• Shareholders will not welcome higher short-term profits if long-term profits are damaged.
• Company may increase future profits by cutting year’s dividend, investing freed-up cash in firm.
• Not in shareholders’ best interest if company earns less than opportunity cost of capital.
Agency problem
Agency problem= Managers are agents for stockholders and are tempted to act in their own interests
rather than maximizing value.
Agency cost= Value lost from agency problems or from the cost of mitigating agency problems.
Do managers maximize shareholder wealth or manager wealth?
Corporate governance.
• The laws, regulations, institutions, and corporate practices that protect shareholders and other
investors.
Should Managers Maximize Shareholder Wealth?
Managers have many constituencies or stakeholders.
Stakeholder: Other parties affected by the company, such as customers, employees, suppliers, the
environment, communities, and taxpayers.
Should managers work for shareholders or stakeholders?
Investment Trade-Off
Hurdle rate/cost of capital.
• Minimum acceptable rate of return on investment.
Opportunity cost of capital.
• Investing in a project eliminates other opportunities to use invested cash.
, Chapter 13 and 14 are self-study
Key Questions in Finance
How do I calculate the rate of return?
Use the formula:
The book emphasizes focusing on both nominal and real returns, adjusting for inflation where necessary.
Is a higher rate of return on investment always better?
No. According to the book, a higher rate of return often comes with increased risk. It’s essential to
consider the risk-adjusted return using tools like the Sharpe Ratio.
What determines value in financial markets?
Value is determined by the present value of future cash flows, discounted at an appropriate cost of
capital. The book highlights the importance of factors like market efficiency, expectations, and investor
sentiment.
What are the cash flows?
Cash flows represent the inflows and outflows of cash from an asset or project. They include:
• Operating cash flows (from revenues and costs).
• Investing cash flows (capital expenditures).
• Financing cash flows (debt, equity, dividends).
How does the financial manager judge whether cash flow forecasts are realistic?
By:
• Comparing forecasts with historical data.
• Stress-testing assumptions against economic and market scenarios.
• Consulting industry benchmarks.
How do we measure risk?
The book defines risk as the variability of returns. Key measures include:
• Standard deviation (total risk).
• Beta (systematic risk relative to the market).
• Scenario analysis and sensitivity analysis.
Chapter 1: Introduction to Corporate Finance
Corporate Investment and Financing Decisions 1
Real assets= Assets used to produce goods and services.
Financial assets= Financial claims to the income generated by the firm’s real assets.
Investment decision Financing decision
Purchase of real assets Sale of financial assets
Warehouse, machine → tangible Auto financing: CFO (cashflow from operating
Software → intangible activities)
Selling shares/equity
Debt: bank loan
Bond
Investment decisions
Capital budgeting decision.
• Decision to invest in tangible or intangible assets.
• Also called the investment decision.
• Also called capital expenditure or CAPEX decisions.
CFO: cash flow from operating activities
CFI: cash flow from investing activities
CFF: cash flow from financing activities
Financing Decisions
Shareholders are equity investors.
• Contribute equity financing.
Capital structure decision.
• Choice between debt and equity financing.
• Capital refers to firm’s sources of long-term financing.
, Chapter 13 and 14 are self-study
Figure 1.1 Flow of Cash Between Financial Markets and the Firm’s Operations
1) Cash raised by selling financial assets to investors.
2) Cash invested in the firm’s operations and used to purchase real assets.
3) Cash generated by the firm’s operations.
4) (a) Cash reinvested (b) Cash returned to investors.
The Financial Goal of the Corporation 1
Stockholders want three things.
1. To maximize current wealth.
2. To transform wealth into most desirable time pattern of consumption.
3. To manage risk characteristics of chosen consumption plan.
, Chapter 13 and 14 are self-study
How can the financial manager help the shareholder?
→ Maximize Wealth (Fisher Separation Theorem)
Profit maximization.
Not a well-defined financial objective.
• Which year’s profits?
• Shareholders will not welcome higher short-term profits if long-term profits are damaged.
• Company may increase future profits by cutting year’s dividend, investing freed-up cash in firm.
• Not in shareholders’ best interest if company earns less than opportunity cost of capital.
Agency problem
Agency problem= Managers are agents for stockholders and are tempted to act in their own interests
rather than maximizing value.
Agency cost= Value lost from agency problems or from the cost of mitigating agency problems.
Do managers maximize shareholder wealth or manager wealth?
Corporate governance.
• The laws, regulations, institutions, and corporate practices that protect shareholders and other
investors.
Should Managers Maximize Shareholder Wealth?
Managers have many constituencies or stakeholders.
Stakeholder: Other parties affected by the company, such as customers, employees, suppliers, the
environment, communities, and taxpayers.
Should managers work for shareholders or stakeholders?
Investment Trade-Off
Hurdle rate/cost of capital.
• Minimum acceptable rate of return on investment.
Opportunity cost of capital.
• Investing in a project eliminates other opportunities to use invested cash.
, Chapter 13 and 14 are self-study
Key Questions in Finance
How do I calculate the rate of return?
Use the formula:
The book emphasizes focusing on both nominal and real returns, adjusting for inflation where necessary.
Is a higher rate of return on investment always better?
No. According to the book, a higher rate of return often comes with increased risk. It’s essential to
consider the risk-adjusted return using tools like the Sharpe Ratio.
What determines value in financial markets?
Value is determined by the present value of future cash flows, discounted at an appropriate cost of
capital. The book highlights the importance of factors like market efficiency, expectations, and investor
sentiment.
What are the cash flows?
Cash flows represent the inflows and outflows of cash from an asset or project. They include:
• Operating cash flows (from revenues and costs).
• Investing cash flows (capital expenditures).
• Financing cash flows (debt, equity, dividends).
How does the financial manager judge whether cash flow forecasts are realistic?
By:
• Comparing forecasts with historical data.
• Stress-testing assumptions against economic and market scenarios.
• Consulting industry benchmarks.
How do we measure risk?
The book defines risk as the variability of returns. Key measures include:
• Standard deviation (total risk).
• Beta (systematic risk relative to the market).
• Scenario analysis and sensitivity analysis.
