Preah Kossomak Polytechnic Institute (PPI)

FUNDAMENTALS OF
CORPORATE FINANCE

Eighth Edition @2008

Stephen A. Ross
Randolph W. Westerfield
Bradford D. Jordan
Prepared and Taught by YIN SOKHNG, MFI
Website: www.morodorkkhmer.com
E-mail: info@morodorkkhmer.com
Tel: (855) 16889872 / 17989972
 Table of Contents

Chapter 1 Introduction to Corporate Finance

Chapter 2 Financial Statements, Taxes, and Cash Flow
Chapter 3 Working with Financial Statements
Chapter 4 Long-Term Financial Planning and Growth
Chapter 5 Introduction to Valuation: The Time Value of Money
Chapter 6 Discounted Cash Flow Valuation
Chapter 7 Interest Rates and Bond Valuation
Chapter 8 Stock Valuation
Chapter 9 Net Present Value and Other Investment Criteria

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 Chapter 1
Introduction to Corporate Finance

Chapter Outline
• 1.1 Corporate Finance and the Financial Manager
• 1.2 Corporate Firm/Forms of Business Organization
• 1.3 Corporate Securities as Contingent Claims on
Total Firm Value
• 1.4 The Goal of Financial Management
• 1.5 The Agency Problem and Control of the
Corporation
• 1.6 Financial Markets and the Corporation
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 1.1 What is Corporate Finance?
Corporate finance is the study of financial
decision-making in business organizations.

Corporate Finance is the activity of providing :

- money to corporations for investment, and
- the ways that corporations' use this money.
Corporate Finance branch of economics concerned
with how businesses raise and spend their money.

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Financial Management Decisions
• Capital
Budgeting
• Capital Structure
• Working Capital
Management

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Financial Management Decisions
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?

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 The Capital Budgeting Decision

1. What long-term investments should the firm engage

in?
 Type and proportions of assets the firm need tend to
be set by the nature of the business.
 Use the terms capital budgeting and capital
expenditure to making and managing expenditures on
long-lived assets.

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 The Capital Structure Decision

2. How can the firm raise the money for the required
investments?
The answer to this involves the capital structure,
which represents the proportions of :
 the firm’s financing from current debt,
 the firm’s financing from long-term debt, and
 the firm’s financing from equity

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 The Net Working Capital Investment
Decision
3. How much short-term cash flow does a company
need to pay its bills?
The answer to this involves :
 the firm’s net working capital,
 the subject of short-term finance,
 the firm’s short-term management cash flow, and
 the timing of cash inflows and cash outflows.

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Hypothetical Organization Chart

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 The Financial Manager
A member of the top manager team (CFO)
responsible for:
Providing the timely and relevant data to support
planning and control activities.
 Preparing financial statement for external users.
The treasurer is responsible for:
 handing cash flows,
 managing capital expenditures decisions, and
 making financial plans.

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 The Financial Manager
To create value from the firm’s capital budgeting,
financing, and net working capital activities, the
financial manager should:
1.Try to make smart investment decisions (try to buy
assets that generate more cash than cost).
2.Try to make smart financing decisions (sell bonds or
stocks and other financing instruments that raise more
cash than cost).

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The Firm and the Financial Markets
Firm issues securities (A) Financial
markets
Invests
Retained
in assets cash flows (F)
(B)
Short-term debt
Current assets Cash flow Dividends and Long-term debt
Fixed assets from firm (C) debt payments (E)
Equity shares

Taxes (D)

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 1.2 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.

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 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

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 A Comparison of Partnership
and Corporations
Corporation Partnership

Liquidity Shares can easily be Subject to substantial

exchanged. restrictions.

Voting Rights Usually each share gets General Partner is in charge;

limited partners may have some
one vote voting rights.

Taxation Double Partners pay taxes on

distributions.
Reinvestment and Broad latitude All net cash flow is
dividend payout distributed to partners.

Liability Limited liability General partners may have

unlimited liability. Limited
partners enjoy limited
liability.
Continuity Perpetual life Limited life

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1.3 Corporate Securities as Contingent
Claims on Total Firm Value

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 Bonds Compared to Stock
• Bondholders are • Stockholders are owners
• Stock is equity
creditors
• Dividends not fixed
• Bonds a liability charges
• Interest is fixed • Dividends not expense
• Dividends not tax
charge
deductible
• Interest is expense • Voting
• Interest tax
deductible
• No voting

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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 shareholder’s 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.

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 Debt and Equity as Contingent Claims
Payoff to Payoff to
debt holders shareholders
If the value of the firm is
If the value of the firm is less than $F, share holders
more than $F, debt holders get nothing.
get a maximum of $F.

$F

Value of the firm (X) Value of the firm (X)

Debt holders are promised $F. If the value of the firm is

more than $F, share holders
If the value of the firm is less than $F, they get the
get everything above $F.
whatever the firm if worth.
Algebraically, the bondholder’s claim is: Algebraically, the shareholder’s claim is:
Min[$F,$X] Max[0,$X – $F]

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 Combined Payoffs to Debt and Equity

Combined Payoffs to debt holders If the value of the firm is less

and shareholders than $F, the shareholder’s claim
is: Max[0,$X – $F] = $0 and the
debt holder’s claim is Min[$F,$X]
= $X.

Payoff to The sum of these is = $X

$F shareholders
If the value of the firm is more
Payoff to debt than $F, the shareholder’s claim
holders is: Max[0,$X – $F] = $X – $F and
Value of the firm (X) the debt holder’s claim is:
Min[$F,$X] = $F.
Debt holders are promised
$F. The sum of these is = $X
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 1.4 Goals of the Corporate Firm
• The traditional answer is that the managers of
the corporation are obliged to make efforts to
maximize shareholder wealth.

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 Managerial Goals
• Managerial goals may be different from
shareholder goals
– Survival
– Independence
– Minimize costs and Maximize profits.
• Increased growth and size are not necessarily
the same thing as increased shareholder
wealth.
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 1.5 The Agency Problem
• The agency relationship
• Will managers work in the shareholders’ best interests?
Agency costs
Direct agency Costs
Indirect agency Costs
• Control of the firm
• How do agency costs affect firm value (and shareholder
wealth)?

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 1.6 Financial Markets
• Financial markets are composed of the money
markets and capital markets.
• Money Markets
– For debt securities that will pay off in the short
term.
– Usually less than one year.
• Capital Markets
– For long-term debt (equity securities).
– With maturity at over one yare.
– For equity shares.
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 Financial Instruments
Money Market
Government securities:
- Treasury bills (T-bills)
- Short term Municipal
bonds
Non-government securities:
Debt securities:
-Certificate of Deposits (CDs)
-Commercial Paper (CP)
-Repurchase Agreements (Repo.)
-Banker’s acceptances (BAs)
Capital Markets
Government securities:
-Treasury notes (T-notes)
-Long-term Municipal Bonds
-Treasury bonds (T-bonds)
Non-government securities:
- Corporate bond/ Bond
payable
Stock/Equity shares:
-Preferred stock
- Common stock

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 Financial Markets
• The function of market in financial market are
divided two (transaction) 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 (OTC) in a dealer market.
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 Financial Markets

Stocks and
Bonds Investors
Firms
securities
Money SBUs SBUs

money

Primary Market

Secondary Market

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 The Public Issue
• The Basic Procedure
– Management gets the approval of the Board of
Directors.
– The firm prepares and files a registration
statement with the SEC.
– The SEC studies the registration statement during
the waiting period.
– The firm prepares and files an amended
registration statement with the SEC.

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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.

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