fundamentals of corporate finance fourth canadian edition stephen a. ross randolph w. westerfield...
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FUNDAMENTALS OFFUNDAMENTALS OFCORPORATE FINANCECORPORATE FINANCE
Fourth Canadian Edition
Stephen A. RossRandolph W. Westerfield
Bradford D. JordanGordon S. Roberts
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Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson,Ltd.
Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc. 1999
The University of Lethbridge - Faculty of Management
Management 3040Y - Finance
Terry D. Harbottle
Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd.
Part I: Overview of Corporate Finance
Part II: Financial Statements and Long-Term Financial Planning
Part III: Valuation of Future Cash Flows
Part IV: Capital Budgeting
Part V: Risk and Return
Part VI: Cost of Capital and Long-Term Financial Policy
Part VII: Short-Term Financial Planning and Management
Part VIII: Topics in Corporate Finance
Part IX: Derivative Securities and Corporate Finance
Outline of the Text
Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd.
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 Corporate 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
Chapter 10 Making Capital Investment Decisions
Chapter 11 Project Analysis and Evaluation
Chapter 12 Some Lessons from Capital Market History
Chapter 13 Return, Risk, and the Security Market Line
Chapter 14 Cost of Capital
Table of Contents
Chapter 15 Raising Capital
Chapter 16 Financial Leverage and Capital Structure Policy
Chapter 17 Dividends and Dividend Policy
Chapter 18 Short-Term Finance and Planning
Chapter 19 Cash and Liquidity Management
Chapter 20 Credit and Inventory Management
Chapter 21 International Corporate Finance
Chapter 22 Leasing
Chapter 23 Mergers and Acquisitions
Chapter 24 Risk Management: An Introduction to Financial Engineering
Chapter 25 Options and Corporate Securities
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Table of Contents (continued)
T1.1 Chapter Outline Chapter 1Introduction to Corporate Finance
Chapter Organization
1.1 Corporate Finance and the Financial Manager
1.2 Forms of Business Organization
1.3 The Goal of Financial Management
1.4 The Agency Problem and Control of the Corporation
1.5 Financial Markets, Financial Insts, & the Corporation
1.6 Trends in Financial Markets & Financial Mgmt.
1.7 Outline of the Text
1.8 Summary and Conclusions
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T1.2 The Four Basic Areas of Finance - Corporate Finance
Corporate Finance
Long-term investments Capital Budgeting
Long-term financing Capital Structure
Short-term financing Working Capital Management
Financial Risk management Derivative securities
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Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc. 1999
Capital Budgeting
‘The Process of planning and managing a firm’s long term investments’
evaluating the size, timing and risk of future cash flows are the key components of capital budgeting
overall objective is to identify and invest in projects & assets that will generate a return greater than the firm’s cost of capital
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Cqpital Structure
‘addresses the the question of how a firm should obtain and manage the long term financing needed to support its long term investments and’
it is the specific mixture of long term debt and equity capital
the decision on how much debt vs. Equity impacts the risk level for the firm and the firm’s
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Working Capital Management
Working capital refers to a firms short term assets and short term liabilities
includes accounts receivable, inventory and accounts payable
how much cash to keep on hand, inventory to carry, credit terms to offer to customers are examples of working capital management decisions
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Financial Risk Management
The process of identifying, quantifying and decisions to manage certain types of risk:
currency risks interest rate risks commodity price risk
Other risks such as strategic, operating and commerical risks need to be considered by the firm as a whole - ideally looking at risk on an enterprise wide basis (holistic risk management)
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T1.2 A Simplified Organizational Chart (Figure 1.1)
Chairman of the Board andChief Executive Officer (CEO)
Board of Directors
President and ChiefOperations Officer (COO)
Vice PresidentMarketing
Vice PresidentFinance (CFO)
Vice PresidentProduction
Treasurer Controller
Cash Manager Credit Manager Tax ManagerCost AccountingManager
CapitalExpenditures
FinancialPlanning
FinancialAccountingManager
Data ProcessingManager
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Forms of Organization
Sole Proprietorship
Partnership
General Partnership / Limited Partnership
CorporationLimited Liability Company
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Corporations
A corporation is a legal entity separate and distinct from its owners
has many of the same rights, duties and privileges of an actual person:
borrow money can own property can enter into contracts
shareholders and management are usually separate in most larger corporations
the sharedolders elect the board of directors the board then selects the senior managers who in theory are
charged with running the affairs in the interests of the shareholders
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Advantages/Dis-advantages of the Corporate Form
Advantages
ownership (shares) can be readily transferrred
life of the corporation is not limited
limited liability makes this form attractive to investors
all of the above make it easy to raise cash - sells new stock
Dis-advantages
double taxation of its profits
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The Goal of Financial Management
What are firm decision-makers hired to do?
“General Motors is not in the business of making automobiles. General Motors is in the business of making money.”
Alfred P. Sloan
Possible goals
Maximize profits
Maximize shareholder wealth/value
Maximize share price
Maximize firm value
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The Agency Problem and Control of the Firm
Agency Relationships and Management Goals potential for conflict - is their too much emphasis on
corporate survival, job security and (more recently) with mangement wealth creation?
Do managers Act in the Shareholders’ interests? They are influenced by:
• how they are compensated - does their compensation encourage them to make decisions that will enhance shareholder value
• how easily are they replaced if they do not pursue shareholder goals - control here is with the board of directors
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T1.6 The Agency Problem Continued
Agency costs
Agency Costs - defined as the costs associated with the
conflict of interests :
Direct agency costs
Indirect agency costs
Impact of Agency Costs on Shareholder Wealth or Value direct - expenditures benefiting Management e.g. the
unneeded corporate jet or direct - monitoring costs e.g. outside auditors indirect - lost opportunity where Management is not acting in
the best interests of its shareholders e.g. costly acquisitions driven more by desire for power and prestige
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Conflict of Interest
Will Managers work in the Shareholder’s best interest?
Mechanisms to ensure Managers are acting in shareholders’ interest:
• managerial compensation
• active and knowledgable iboard of directors
• Active institutional investors
• Takeover activity
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T1.7 Financial Markets
Financial Institutions, Markets and the Corporation
Financial Institutions
Act as intermediaries between investors and firms raising funds - banks, trust companies, investment dealers, insurance companies, etc. direct finance
indirect finance
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T1.7 Financial Markets Continued
Financial Markets - brings buyers and sellers of debt and equity securities together
How do financial markets differ? Type of securities traded/how trading is conducted and
who the buyers and sellers are
Money markets and capital markets money market - short term debt securities
capital market - long term debt and equity
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T1.7 Financial Markets Continued
Primary vs. secondary markets
Primary Market- where the original sale of issue of a
security by a government or corporation occurs
• public offering - underwritten by an investment
dealer and registered with provincial securities
commissions
• private placement - debt and equity sold directly to
a buyer - typically life insurance companies and ,
pension funds
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T1.7 Financial Markets Continued
Secondary Market - trading of securities subsequent to
the initial sale - enables the transfer of ownership
• auction market - TSE
• dealer market - ‘over the counter (OTC) ‘
How do financial markets benefit society?
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Financial Markets and Society
what is the benefit to society? Channel savings into investment produce and transmit information on returns and
risk provide a media and a payments system enable the shifting of the timing of consumption
over a life cycle enable the management of risk enable the diversification of portfolios
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T1.9 Financial Markets and the Corporation - Cash Flows Between the Firm and the Financial Markets (Figure 1.2)
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T1.9 Chapter 1 Quick Quiz
Quick Quiz
1. Who performs the financial management function in the typical corporation?
2. What are the major advantages and disadvantages of the corporate form of organization?
3. Why is shareholder wealth maximization a more appropriate goal than profit maximization?