lecture notes 1 - ECO359 Lecture 1 Introduction, The...

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1 ECO359 – Lecture 1 Introduction, The Investment Decision Ata Mazaheri
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2 Lecture Outline Two issues Corporate Finance - What is corporate finance? - What is corporate firm? - Financial institutions, financial markets, and the corporation. The Investment Decision - Fisher Separation
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3 What is Corporate Finance? Corporate Finance addresses the following three questions: 1. What long-term investments should the firm engage in? Capital budgeting. 2. How can the firm raise the money for the required investments? Capital structure. 3. How much short-term cash flow does a company need to pay its bills? Working capital management.
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4 The Balance-Sheet Model of the Firm Current Assets Fixed Assets 1. Tangible 2. Intangible Assets Shareholders’ Equity Current Liabilities Long-Term Debt Liabilities/Shareholder’s Equity
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5 The Capital Budgeting Decision What long- term investments should the firm engage in? Current Assets Fixed Assets 1. Tangible 2. Intangible Assets Shareholders’ Equity Current Liabilities Long-Term Debt Liabilities/Shareholder’s Equity
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6 The Capital Structure Decision How can the firm raise the money for the required investments? Current Assets Fixed Assets 1. Tangible 2. Intangible Assets Shareholders’ Equity Current Liabilities Long-Term Debt Liabilities/Shareholder’s Equity
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7 Capital Structure (Cont’d) The value of the firm can be thought of as a pie. The goal of the manager is to increase the size of the pie. The Capital Structure decision can be viewed as how best to slice up the pie. If how you slice the pie affects the size of the pie, then the capital structure decision matters. 70% Debt 30% Equity
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8 Capital structure (cont’d) • Firm value = value of debt + value of equity. (bonds) (stocks) • Bonds = loan agreements. • Stocks = share certificates. • Both bonds and stocks are contingent claims on the value of the firm: their value depends on the firm’s value: Bondholders’ claim = Min(X,F), Shareholders’ claim = Max(0, X-F), Where X = firm value, F = amount promised to bondholders
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9 Capital Structure (Cont’d) $F $F Payoff to debt holders Value of the firm (X) $F Payoff to shareholders Value of the firm (X) Bondholder’s claim: Min[$ F ,$ X ] Shareholder’s claim: Max[0,$ X – $ F ] Conflict of interests between shareholders and debt-holders.
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10 How much short- term cash flow does a company need to pay its bills? Net Working Capital Current Assets Fixed Assets 1. Tangible 2. Intangible Assets Shareholders’ Equity Current Liabilities Long-Term Debt Liabilities/Shareholder’s Equity Working Capital Management
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11 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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12 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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lecture notes 1 - ECO359 Lecture 1 Introduction, The...

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