Chapter 1 - Introduction to Corporate Finance

Question 1

What is Corporate Finance?

Answer 1

A study to deal with these questions:

1. What long-term investments should you make?
2. Where will you get the long-term financing to pay for your investment?
3. How will you manage your everyday financial activities, such as collecting from customers and paying suppliers?

Question 2

What is the difference between the finance and the accounting manager?

Answer 2

The accounting function takes all the financial information and data that arises as a result of ongoing business activities, and presents this in ways that allow management to assess the performance and risk of their firm (financial accounting) and make informed decisions on future corporate activity (management accounting).

Question 3

What are the three basic types of question a financial manager must be concerned with?

Answer 3

1. Capital Budgeting
2. Capital Structure
3. Working Capital Management

Question 4

What is capital budgeting?

Answer 4

The process of planning and managing a firm’s long-term investments

• Evaluating the size, timing and risk of future cash flows is the essence of capital budgeting.

Question 5

What is a capital/financial structure?

Answer 5

The mixture of long-term debt and equity maintained by a firm

• Long-term debt: Long-term borrowing by the firm (longer than one year) to finance its long-term investments
• Equity: The amount of money raised by the firm that comes from the owners’ (shareholders’) investment

Question 6

1. What is working capital?

2. What are some questions about working capital that must be answered?

Answer 6

1. A firm’s short-term assets and liabilities
2. • How much cash and inventory should we keep on hand?
     - Should we sell on credit?
     - How will we obtain any needed short-term financing? Purchase on credit or borrow in the short-term and pay cash?

Question 7

What are possible goals of financial management?

Answer 7

Controlling risk:

• Survive
• Avoid financial distress and bankruptcy
• Stability & safety

Profitability:

• Beat the competition
• Maximize sales or market share
• Minimize costs
• Maximize profits
• Maintain steady earnings growth
• -> The goal of financial management is to maximize the current value per share of the existing equity

Question 8

What are the shortcomings of the goal of profit maximization?

Answer 8

The goal doesn’t tell us what the appropriate trade-off is between current and future profits/

Question 9

What is a financial market?

Answer 9

A way of bringing buyers and sellers together

Question 10

What is the difference between primary and secondary markets?

Answer 10

• The term primary market refers to the original sale of securities by governments and corporations.
• The secondary markets are those in which these securities are bought and sold after the original sale.

Question 11

What is a dealer market? How do dealer and auction markets differ?

Answer 11

• Dealers buy and sell for themselves, at their own risk.
• Auction markets have have a physical location. The primary purpose of an auction market is to match those who wish to sell with those who wish to buy.

Question 12

What does OTC stand for?

Answer 12

Dealer markets in equities and long-term debt are called over-the-counter (OTC) markets.

Question 13

Some European stock exchanges:

Answer 13

• Euronext
• London Stock Exchange
• Deutsche Börse
• BME Spanish Exchanges
• Six Swiss Exchange
• NASDAQ OMX Nordic Exchange

Question 14

Liquid assets vs illiquid asset

Answer 14

Liquid asset: Cash

Illiquid asset: Real estate