Chapter 2 : Corporation and Corporate Finance
Topics covered in this snack-sized chapter:
A legal entity, distinct and separate from the individuals who create and operate it.
- It may acquire, own and dispose of property in its own name.
- It may also incur liabilities and enter into contracts.
It can sell shares of ownership.
- Stock – shares of ownership.
- It gives the ability to corporations to raise large amounts of capital.
Types of corporations are:
Public Corporations
- Shares of stock are traded in public markets such as the NASDAQ or NYSE.
- Regulated by the securities and exchange commission.
Private or Nonpublic Corporations
- Shares are not traded publicly.
- Usually owned by a small group of investors.
Limited Liability:
- A corporation’s creditors usually may not go beyond the assets of the corporation to satisfy their claims.
Board of Directors:
- Elected by the shareholders.
- Meets periodically to establish corporate policies.
- Selects the Chief Executive Officers.
Dividends:
- Distribution of income to shareholders.
Liable for Taxes:
- On the income of the corporation.
- Before the distribution of dividends to shareholders.
- May cause double taxation of income.
Paid in Capital:
- Paid in capital comes from the issuance of stock.
Retained Earnings:
- From the earnings of the business not distributed as dividends.
Corporate finance is any financial or monetary activity that deals with a company and its money.
Corporate finance is about making business decisions.
Everything that a business does fits under the rubric of corporate finance.
Corporate finance is primarily concerned with three areas:
- Working Capital Management.
The correct goal of the firm is to maximize shareholder’s wealth (i.e., shareholder's equity) or, equivalently, to maximize the firm’s stock price.
The manager’s duty is to make investments that are expected to increase shareholders’ wealth.
Most people have been taught that the goal of the firm is to maximize current profits.
This goal is inadequate for at least three reasons:
- It ignores the time value of money.
- It can lead to a pre-occupation with the short-term results which in turn can lead to sub-optimal long-term results.
The Investment Decision:
- Invest in projects that yield a return greater than the minimum acceptable rate.
The Financing Decision:
- Choose a financing mix that maximizes rate of return.
The Dividend Decision:
- Return the cash to stockholders.
The External Financing Function
Raising capital to support companies’ operations and investment programs externally.
Corporations can raise equity capital privately.
Or they may go public by conducting an initial public offering (IPO) of stock.
The Capital Budgeting Function
Selecting the best projects in which to invest the resources of the firm, based on each project’s perceived risk and expected return.
The Financial Management Function
Managing firms’ internal cash flows and its mix of debt and equity financing.
To maximize the value of the debt and equity claims on firms.
To ensure that companies can pay off their obligations when they come due.
It involves obtaining seasonal financing, managing inventories, paying suppliers, collecting from customers, and investing surplus cash.
The Corporate Governance Function
Developing ownership and corporate governance structures for companies.
That ensures that the managers behave ethically and make decisions that benefit shareholders.
Dimensions of corporate governance
- Country’s legal environment - in U.S., Sarbanes-Oxley Act of 2002.
The Risk Management Function
Managing firms’ exposures to both types of risk insurable and uninsurable.
- Insurable, such as loss caused by fire or flood.
In order to maintain optimum risk-return trade-offs and thereby maximize shareholder value.
Modern risk management focuses on adverse interest rate movements:
- Currency value fluctuations.