Today

„ Welcome!
„ Introduction and Syllabus
„ A overview
An i off the
th Course
C
„ Introduction to Corporate Finance

BAFI 355 – Spring 2011 0-1

 BAFI 355: Corporate Finance

An Overview

BAFI 355 – Spring 2011 0-2

 Introduction

„ Many issues in Finance, but in the end what we

want is to value some asset
CF1 CF2 CFn
Value = + + L +
(1 + r)1 (1 + r) 2 (1 + r) n
n CFt
=∑ t
.
t =1 (1 + r)

„ To estimate an asset’s value, one estimates the

cash flow for each period t (CFt), the life of the
asset (n)
(n), and the appropriate discount rate (r)

BAFI 355 – Spring 2011 0-3

 Time Value of Money

What do you prefer,

prefer to have $1
dollar today, or to receive „ $1 today!
$1 after one year?

BAFI 355 – Spring 2011 0-4

 Time Value of Money: Example

How much will my mortgage payments be?

Please enter your information below (For your

convenience we have filled in common values. Feel
360
MortgagePay
t P mentt t
100,000 = ∑
f
free to
t change
h amountst as they
th applyl to
t your
situation.)
t
100,000 t =1 (1 + 7% / 12)
Loan Amount

Term in Years 30

No of Payments 360

Interest Rate of the Loan 7%

BAFI 355 – Spring 2011 0-5

 Overview of Accounting and
Finance

Balance sheet Income statement

Assets Liabilities
Net sales 3,000.00
Operating costs 2,616.20
Debt EBITDA 383.80
Depreciation 100 00
100.00
Amortization 0.00
EBITDA 283.80
Less interest 88.00
Equity EBT 195.80
Taxes (40%) 78.30
Net income 117.50

The bottom line: accounting ≠ finance!

BAFI 355 – Spring 2011 0-6
 Bonds and Their Valuation

A simple IOU:
$100 due in 1 year
US Bonds
Red 0 1
Date Coupon Price Yield

7/07 3.88 99.7344 4.02

8/10 4.13 100.195 4.08
PV = ?
8/15 4.25 100.293 4.21 100 100
Source: Financial Times, 08/22/2005 PV =
(1 + r)1

BAFI 355 – Spring 2011 0-7

 Stocks and Their Valuation

„ Features
F t off common stock
t k
„ Determining common stock
values
Stock price = $504 „ Preferred stock

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 Risk and Rates of Return

You have 1 dollar,

dollar to be
invested in either Asset A „ It depends
or Asset B. They are
expected to give you the on risk!
same return of 10%.

Which one should you choose?

BAFI 355 – Spring 2011 0-9

 The Cost of Capital

„ A firms raises capital to invest in

Assets Liabilities
projects
Debt „ The cost of capital will determine
which projects to take
Equity „ Thus we need to measure the
costt off capital
it l

BAFI 355 – Spring 2011 0-10

 The Basics of Capital Budgeting

Should we
build this „ A firm
firm’ss
plant? investment
decision
„ The methods:
payback, NPV,
CF1 CFn IRR
ProjectValue = + L +
(1 + r)1 (1 + r) n

BAFI 355 – Spring 2011 0-11

 Making Capital Investment
Decisions

Going forward with

capital budgeting
budgeting…
„ Identifying project
CF1 CFn
ProjectValue = + L + cash flows
(1 + r)1 (1 + r) n
„ Detailing project
risk
Still
thinking…

BAFI 355 – Spring 2011 0-12

 Overview of Capital Structure and
Dividend Policy

Assets Liabilities
Firm d
Fi decides
id on:
„ The capital structure
Debt
„ Debt or equity
„ How to pay back investors
Equity
„ Dividends stock repurchases
Dividends,

BAFI 355 – Spring 2011 0-13

BAFI 355 – Spring 2011 0-14
 Introduction
d to
Corporate Finance

BAFI 355 – Spring 2011 1-1

 Objectives
„ Understand Corporate Finance
„ What are the financial management
decisions?
„ What is a Corporation?
„ The goals of a Corporation

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 Corporate Finance Decisions
„ Capital budgeting
„ What long-term
Wh l i
investments or projects
j should
h ld the
h
business take on?
„ Capital structure
„ How should we pay for our assets? Should we use debt
or equity? How should we give money back to
investors?
„ Working capital management
„ How do we manage the day
day-to-day
to day finances of the
firm?

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 Finance Areas
„ Money and capital markets
„ Investments
„ Financial management (or corporate
finance)

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 Alternative Forms of Business
Organization
„ Sole proprietorship
„ Partnership
„ Corporation

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 Sole proprietorships &
Partnerships
„ No distinction between ownership and control
„ Ad
Advantages
t
„ Ease of formation
„ Subject to few regulations
„ No corporate income taxes
„ Disadvantages
g
„ Limited life
„ Unlimited liability
„ Diffi lt to
Difficult t raise
i capital
it l

BAFI 355 – Spring 2011 1-6

 Corporation
„ A legal entity, separate and distinct from its owners
and managers
g
„ Advantages
„ Unlimited life
„ Easyy transfer of ownership
p
„ Limited liability
„ Ease of raising capital
„ Disadvantages
g
„ Double taxation
„ Cost of set-up and report filing
„ Separation of ownership and management
„ 80% of all business in US conducted by corporations

BAFI 355 – Spring 2011 1-7

 Corporate Finance
„ Thus, our course is about financial management
decisions in the context
conte t of a Corporation
Co po ation

Assets Liabilities

Debt
Financing decisions
Investment decisions
Dividend policy
Equity decisions

BAFI 355 – Spring 2011 1-8

 What are the Goals of a
Corporation?
“General Motors is not in the business of making automobiles.
General Motors is in the business of making money
money.”
Alfred P. Sloan

„ Whom are you serving?

Employees

Government
Corporation Owners

Clients
Community

BAFI 355 – Spring 2011 1-9

 The Goal of a Corporation

„ Primary
P i financial
fi i l goall is
i
Government
Employees
shareholder wealth
Corporation Owners
maximization
Clients
Community „ In practice, this translates into
maximizing stock price

„ But, what to say of:

„ Business ethics
„ Social responsability
„ Social Welfare

BAFI 355 – Spring 2011 1-10

 Maximizing Shareholder Wealth
„ Business ethics
„ Ethics
Ethi isi required
i d everywhere!
h !
„ Social responsability
„ A choice of the firm
firm. Increasingly aligned with
shareholders’ objectives
„ Social welfare
„ In well-functioning markets, maximizing stock

price maximizes social welfare

BAFI 355 – Spring 2011 1-11

 The Agency Problem
„ Agency relationship
„ Principal hires an agent to represent his/her
interest
„ Stockholders (principals) hire managers (agents)
t run th
to the company
„ Agency problem
„ Conflict of interest between principal and agent

„ Management goals and agency costs

BAFI 355 – Spring 2011 1-12

 Maximizing Stock Price?
So what affects stock price?
So,
„ Projected cash flows
to shareholders
„ Timing of the cash
flow stream
„ Riskiness of the cash
flows

BAFI 355 – Spring 2011 1-13

 Basic Valuation Model
CF1 CF2 CFn
Value = 1
+ 2
+L+
(1 + r) (1 + r) (1 + r) n
n CFt
=∑ t
.
(1 + r))
t =1 (

„ To estimate an asset’s value, one estimates the

cash flow for each period t (CFt),
) the life of the
asset (n), and the appropriate discount rate (r)
„ Throughout the course, we discuss how to
estimate
ti t ththe iinputs
t and
dhhow financial
fi i l managementt
is used to improve them and thus maximize a
firm’s value.

BAFI 355 – Spring 2011 1-14

 Our next step
CF1 CF2 CFn
Value = 1
+ 2
+L+
(1 + r)) (1 + r)) (1 + r)) n
n CFt
=∑ t
.
1 (1 + r)
t =1

„ Understand the concept of time value of money –

the denominator in the expression above

BAFI 355 – Spring 2011 1-15