Quick Overview: The Basic 101 points in a nutshell

[Declan]

The Objective Function: Maximize the value of the Firm

Basic Corporate Financial Decisions:
1. How do you allocate resources across competing uses?
2. How do you raise funds to finance these projects?
3. How much do you reinvest back into the business and how much do you return to your stockholders?

The Corporate Financial Toolbox

1. Accounting statements and ratios.
2. Present value.
3. Risk and return models
4. option pricing models.

……..

The Financing Decision:
• Debt v Equity
• Debt/equity mix
• Financing Needs: from retained earnings, from new equity, from new debt.
• Cost of capital

The Dividend Decision:
• How much do you return to shareholders?
• Cash flow from operations

The Allocation Decision:
• How do you want to allocate capital resources (capital budgeting).
• Risk: beta.

Extraneous Factors
• Luck
• Institutional factors: Equity Analysts, rating agencies.
• The economy: interest rates, inflation, exchange rates.

Investors Observe: Earnings and cash flows, dividends.
Form expectations: of growth in earnings and cash flows from firm: of dividend payouts.
Correct for risk: Factor in risk premium.
And then react by setting market price/value.

Corporate Finance:
• Internal consistency
• Integrated whole
• Matters to everyone.
• Is fun!
• Apply models and theories.


Objective Function

• Understand the need for a proper objective function.
• Discuss thoroughly.


The Classical Objective Function: Maximize value or wealth.

The need for an objective function: a well defined and widely accepted objective function serves as the starting point for developing logically coherent financial theories, which in turn leads to the establishment of decision rules for financial managers.

The Characteristics of the Right Objective Function:
• Clear and unambiguous
• Allows clear measurements to evaluate success or failure
• No confusing side effects
• Consistent with firm's long term health and value

Stakeholders: shareholders, creditors, managers, employees, customers, society.

Underlying assumptions
1. interests of stockholders and bondholders can be aligned.
2. bondholders have full protection for their interests.
3. no social cost.
4. financial markets are efficient.

Managers
Choose projects
Finance them
Pay dividends

Reducing Agency Problems
• Give managers warrants and performance options
• Increase shareholder power
• Takeover threat.
• Covenants to protect bondholders, protective puts to guard against lbos.
• Good citizen constraints to protect society.

Ethics: Not the value driver.

Issues: stockholder power, institutional investors, proxies, greenmail.
The Body Shop, Starbucks, Nike, Levis etc!!!

The above, taken from Damodaran, is on some of the jpegs we use. It is also repeated, in a not dissimilar way, in most other text books.
The firm, in any corporate governance framework, tried to maximise its value. They might do this over shorter or longer term horizons.
To do this, they must choose what projects with positive NPVs/IRRS, to invest in.
They must also decide how to repay their investors.
We have certain theories and tool boxes underlying Corporate Finance. These are explored in the course.
Extra Powerpoints are here:
http://www.sotonsom.com/6194/1.CF.ppt
http://www.sotonsom.com/6194/dam2.ppt