Welcome to BUS 328

• Instructors: Phuoc Tran

• Office: 105.B03
• Monday to Friday by appointment
• Email: [email protected]

1
1
 Week 1

• Chapter 1: Introduction to Corporate Finance

• Chapter 2: Financial Statements, Taxes and
Cash Flow

2
2
Chapter 1: Introduction to
Corporate Finance

3
3
 Key Learning Objectives

1. Understand the basic types of financial management

decisions and the role of financial manager.

2. Understand the different forms of business

organization and their implications.

3. Understand the conflict of interest that can arise

between managers and owners.

4
4
 What is Corporate Finance?

Imagine that you were to start up an ice-cream

business, what would you do?

5
5
 What is Corporate Finance?
• Corporate finance attempts to find the answers to the
following questions:
1. What long-term assets/investments should the business take on?
CAPITAL BUDGETING - THE INVESTMENT DECISION

2. How can finance be obtained to pay for the required investments?

CAPITAL STRUCTURE - THE FINANCE DECISION

3. How should the firm manage its day-to-day financial activities?

WORKING CAPITAL MANAGEMENT

6
6
 Corporate Finance
Corporate finance attempts to find the answers to the
following questions:
1. What long-term assets/investments should the
business acquire?

→ Capital Budgeting

7
7
 Capital Budgeting
• Capital budgeting is the planning and managing
of a firm’s investment in long-term assets.
E.g. Property, plant and equipment (PPE)
• Involves evaluating the:
– size of future cash flows
– timing of future cash flows
– risk to future cash flows.

8
8
 Cash Flow Size
• Accounting income does not mean cash flow.
• For example, a sale is recorded at the time of sale, and
a cost is recorded when it is incurred, not when the
cash is exchanged.
• Revenue – Expenses = Net Income
➢Revenue Recognition Principle
➢Expenses => Matching Principle
❖ Regardless of cash received

9
9
 Cash Flow Timing
• A dollar today is worth more than a dollar at
some future date.

• There is a trade-off between the size of an

investment’s cash flow, and when the cash
flow is received.

10
10
 Cash Flow Timing
Which is the better project?
Future Cash Flows

Year Project A Project B

1 $0 $200 000

2 $100 000 $100 000

3 $200 000 $0

Total $300 000 $300 000

11
11
 Cash Flow Risk

• The role of the financial manager is to deal with the

uncertainty associated with investment decisions.

• Assessing the risk associated with the size and

timing of expected future cash flows is critical to
investment decisions.

12
12
 Cash Flow Risk
Which is the better project?

Future Cash Flows

Pessimistic Most likely Optimistic

Europe $150 000 $200 000 $250 000

India $50 000 $250 000 $350 000

13
13
 Corporate Finance
Corporate finance attempts to find the answers to the
following questions:

2. What sources of funds should be used to finance

these assets/ investments?

→ Capital Structure

14
14
 Capital Structure

• A firm’s capital structure is the specific mix of

debt and equity maintained by the firm.

• Decisions need to be made on both the financing

mix, and how and where to raise the money.

15
15
 Microsoft’s Capital Structure

Source: Morningstar.com
16
16
Sabeco’s Capital Structure

17
17
 Corporate Finance
Corporate finance attempts to find the answers to the
following questions:

3. How should the firm manage its day-to-day financial

activities?

→ Working Capital Management

18
18
 Working Capital Management
• Working Capital refers to a firm’s short-term assets
and liabilities
– How much cash and inventory should be kept on hand?

– Should credit terms be extended? If so, what are the

conditions?

– How is short-term financing acquired?

19
19
 Possible Goals Of Financial Management
▪ What should be the goal of financial management?
– Survival?
– Avoid financial distress and bankruptcy?
– Beat the competition?
– Maximize sales or market share?
– Maximize profit?
– Minimize costs?
– Maintain steady earnings growth?

20
20
 Problems with these Goals
Each of these goals presents problems.
• These goals are either associated with increasing
profitability or reducing risk.
• They are not consistent with the long-term
interests of shareholders.
• It is necessary to find a goal that can encompass
both profitability and risk.

21
21
22
22
 The Firm’s Objective
• The goal of financial management is to maximize
shareholders’ wealth.

• Shareholders’ wealth can be measured as the

current value per share of existing shares.

• This goal overcomes the problems encountered

with the goals outlined above.

23
23
 A More General Goal
• What is the appropriate goal for financial
management when the firm has no traded shares?

‘Maximise the market value of the owners’ equity’

• Good financial decisions increase the market value

of the owners’ equity, while poor financial
decisions decrease it.

24
24
 Forms of Business Organization
Three main forms (in the U.S and Australia)
▪ Sole proprietorship
▪ Partnership
• General
• Limited
▪ Corporation

25
25
 Sole Proprietorship
• The business is owned by a single individual.
• The least regulated form of organization.
• Owner keeps all the profits, but assumes unlimited
liability for the business’s debts.
• Life of the business is limited to the owner’s life span.
• Amount of equity raised is limited to owner’s personal
wealth.

26
26
 Partnership
• The business is formed by two or more individuals.
• All partners share in profits and losses of the
business, and have unlimited liability for debts.
• Easy and inexpensive form of organization.
• Partnership dissolves if one partner sells out or dies.
• Amount of equity raised is limited to the combined
personal wealth of the partners.
• Income is taxed as personal income to partners.

27
27
 Corporation
• A business created as a distinct legal entity,
composed of one of more individuals or entities.
• Most complex and expensive form of organization.
• Shareholders and management are usually
separated.
• Ownership can be readily transferred.
• Both equity and debt finance are easier to raise.
• Life of a company is not limited.
• Owners (shareholders) have limited liability.

28
28
Forms of Business Organization

What are the advantages and

disadvantages of each form of business
organization?

29
29
 Agency Problem
▪ Agency relationship
➢Principal hires an agent to represent
his/her interest
➢Stockholders (principles) hire managers
(agents) to run the company
▪ The agency problem is the possibility of
conflict of interests between these two
parties.
• Agency costs refer to the direct and
indirect costs arising from this conflict of
interest.
30
30
31
31
Do Managers Act in Shareholders’ Interests?

The answer to this will depend on two factors:

• how closely management goals are aligned with

shareholder goals.

• the ease with which management can be replaced

if it does not act in shareholders’ best interests.

32
32
 Alignment of Goals
▪ Managerial compensation
➢Tie compensation to financial performance in
general and share value in particular
➢Better performers, more promotion opportunities
or greater demand in the labor market
▪ Corporate control
➢Proxy fight
➢Takeover threat
▪ Other stakeholders
33
33
 Forms of Business Organization in Viet Nam
(Additional lectures)
1.The Limited Liability Company (LLC)
An LLC may take the form of either an LLC with two or
more members ("Multiple Member LLC") or an LLC with
one member ("Single Member LLC").
An LLC has the status of a recognized legal entity and a
member of a LLC is responsible for the debts and
liabilities of the enterprise to the extent of the amount of
capital that the member has contributed or committed to
contribute to the enterprise. An LLC does not issue
shares.

34
34
• a. Multiple Member LLC is an enterprise that has more
than one but no more than fifty members, which may
be organizations, individuals, or a combination of both.

• b. Single Member LLC is owned by one organization or

individual member ("Company Owner") who is liable
for the debts and other liabilities of the company to
the extent of the amount of the charter capital of the
company. A single member LLC may increase its charter
capital by way of additional investment from the
Company Owner or by obtaining capital contributions
from other persons.

35
35
2.The Joint Stock Company (JSC)
• A JSC is an enterprise whose charter capital is
divided into shares held by three or more
organizations or individuals. Shareholders are
responsible for the debts and liabilities of the
enterprise to the extent of the amount of their
contributed capital. A JSC has the right to issue
securities in order to raise capital and it may list
on the Securities Exchange.
• The JSC must have common shares and may have
preferred shares and/or issue bonds

36
36
3. Partnership Company (PC)
• A PC is a form of enterprise set up by at least two
partners and has a status of a legal person - a PC
is akin to a limited liability partnership in other
jurisdictions.
• A PC must have two general partners and may
also have limited partners (literally, "capital
contributing members"). General partners are
liable for all obligations of the PC with their own
property, while limited partners are only liable to
the extent of their capital contribution.

37
37
4. Business Cooperation Contract (BCC)
• A BCC is a contractual relationship akin to a
partnership which does not create a new legal
entity but which is licensed to engage in
business activities in respect of a specific
project in Vietnam.
• This is changing as LLCs and JSCs are being
allowed into these fields.

38
38
5. Public - Private Partnership (PPP)
• Investment under the form of PPP is defined as a
form of investment conducted on the basis of a
contract ("PPP Project Contract") between an
authorized State agency and the investor and/or
project enterprise in order to implement, manage
and operate an infrastructure project or provide
public services.
• Apart from the forms of business provided under
the Investment Law 2014 and Enterprise Law
2014, other means of establishing a commercial
presence in Vietnam may include Representative
Offices, Branch Offices, contracted projects and
franchising arrangements.
39
39
 Homework

• Chapter 1: Questions 1, 2, 3, 6, 14 pages 17-18

• Chapter 2: Questions 6, 7, 8, 9, 10, 11, 12, 14,
15, 17, 21 pages 43-45
Question 2, 5, 8 page 42 (Concept
review and critical thinking)

40
40
Chapter 2: Financial Statements,
Taxes and Cash Flow

41
41
 Key Learning Objectives
1. Understand the structure of the balance sheet and
the difference between book value and market value
2. Understand the income statement and the difference
between accounting income and cash flow
3. Distinguish between average and marginal tax rates
4. Determine a firm’s cash flow from its financial
statements

42
42
 The Balance Sheet
• The balance sheet is a snapshot of the firm’s
assets and liabilities at a given point in time.
• Assets are listed in order of liquidity
– Ease of conversion to cash
– Without significant loss of value
• Balance Sheet Identity
Total Assets = Total Liabilities + Stockholders’ Equity

43
43
T-account form Balance Sheet

44
44
U.S Corporation Simplified Balance Sheet

45
45
 Net Working Capital and Liquidity
▪ Net Working Capital (NWC)
➢ NWC = Current Assets (CA) – Current Liabilities (CL)
➢ Positive when the cash received over the next 12 months
exceeds the cash paid out
➢ Usually positive in a healthy firm
▪ Liquidity
➢ Ability to convert to cash quickly without a significant loss in
value
➢ More liquid firms are less likely to experience financial distress
➢ But liquid assets earn a lower return
➢ Trade-off between advantages of liquidity and forgone potential
profits
46
46
 Debt VS Equity
▪ Financial leverage or ‘gearing’ is the use of debt in a
firm’s capital structure.

▪ Financial leverage can greatly magnify both gain and

loss

▪ Usually presented by
– Debt/Equity ratio (total Debt/total Equity), or
– Long-term Debt/Capitalization ratio (Capitalization = Long-
term Debt + Owners’ Equity)
47
47
Book Versus Market
Value Value

48 2-48
48
 Market Vs. Book Value
▪ The balance sheet provides the book value of the assets,

liabilities and equity.

▪ Market value is the price at which the assets, liabilities or

equity can actually be bought or sold.

▪ Market value and book value are often very different. Why?

▪ Which is more important to the decision-making process?

49
49
Example 2.2 Klingon Corporation
KLINGON CORPORATION
Balance Sheets
Market Value versus Book Value
Book Market Book Market
Assets Liabilities and
Shareholders’ Equity
NWC $ 400 $ 600 LTD $ 500 $ 500
NFA 700 1,000 SE 600 1,100
1,100 1,600 1,100 1,600
50
50
 The Income Statement
▪ The income statement measures performance over some
period of time.

▪ Income statement equation: Revenues – Expenses = Income

▪ Accrual accounting: revenue is recognized when it accrues

(often at the time of sale), not necessarily when the cash
comes in

▪ Matching principle: match revenue with costs/expenses

associated with producing them
51
51
US Corporation Simplified Income
Statement - Table 2.2

EBIT

Bottom
line

52
52
 Noncash Items
▪ Noncash items: expenses charged against revenues
that do not directly affect cash flow, i.e. depreciation,
amortization.
▪ Matching principle and noncash items make figures
shown on income statement not a good representation
of actual cash inflows and outflows.

53
53
 Taxes
▪ Marginal vs. average tax rates
– Marginal: the percentage paid on the next dollar
earned
– Average: the tax bill / taxable income

▪ Marginal tax rate is relevant for financial analysis

▪ Corporate Tax Rates – Table 2.3 page 30 (the U.S)

54
54
55
55
 Example: Marginal VS Average
Tax Rate
▪ Suppose your firm earns an taxable income of
$3 million
– What is the firm’s tax liability?
– What is the average tax rate?
– What is the marginal tax rate?
▪ If you are considering a project that will
increase the firm’s taxable income by $1
million, what tax rate should you use in your
analysis?
56
56
 Example: Marginal VS Average
Tax Rate
▪ Tax liability:
.15(50,000) + .25(75,000 – 50,000) + .34(100,000 –
75,000) + .39(335,000 – 100,000) + .34(3,000,000 –
335,000) = $ 1,016,100
– Average tax rate = 1,016,100/3,000,000= 33.87%
– Marginal tax rate comes from the tables, it is 34%.
▪ Should use the marginal rate with an expected
additional 340,000 in taxes and a change in the
average rate to 1,356,100 / 4,000,000 = .339 or
33.9%
57
57
58
58
Corporate Tax Rates (CIT) in Vietnam

• The standard CIT rate is 25%.

• Oil and gas enterprise are subject to CIT rates
ranging from 32% to 50% depending on the
location.

59
59
 The Concept of Cash Flow
▪ Cash flow is one of the most important pieces of
information that a financial manager can derive from
financial statements.

▪ The statement of cash flows does not provide us with the

same information that we are looking at here.

▪ We will look at how cash is generated from utilizing assets

and how it is paid to those that finance the purchase of the
assets.
60
60
Cash Flow from Assets

61
61
 Example: US Corporation – Cash Flow I
▪ OCF (I/S) =EBIT + Depreciation –Taxes=694+65–212=$547

▪ NCS (B/S & I/S) = Ending Net Fixed Assets – Beginning Net
Fixed Assets + Depreciation = 1709 – 1644 + 65 = $130

▪ Ending NWC = 1403 – 389 = 1014; Beginning NWC = 1112 –

428 = $684

▪ Changes in NWC (B/S) = Ending NWC – Beginning NWC = 1014

– 684 = $330

▪ Cash Flow from Assets = 547 – 130 – 330 = $87

62
62
Example: US Corporation – Cash Flow II
▪ Net Borrowing (B/S) = Ending LT Debt – Beginning LT
Debt = 454 – 408 = $46

▪ Cash Flow to Creditors = Interest paid (I/S) – Net new

borrowing = 70 – 46 = $24

▪ New equity raised = Ending Common stock & paid-in

surplus – Beginning Common Stock & paid-in Surplus
= 640 – 600 = $40
63
63
Example: US Corporation – Cash Flow II

▪ Cash Flow to Stockholders = Dividends paid (I/S) –

New equity raised = $103 – 40 = $63

▪ Cash flow from Assets = Cash flow to Creditors + Cash

flow to Stockholders = 24 + 63 = $87

▪ The cash flow identity holds

64
64
End of Chapter

65
65
 Sole Proprietorship
• Advantages • Disadvantages
▪ Easiest to start ▪ Limited to life of
owner
▪ Least regulated
▪ Equity capital limited
▪ Single owner keeps to owner’s personal
all the profits wealth
▪ Taxed once as ▪ Unlimited liability
personal income ▪ Difficult to sell
ownership interest
66
66
 Partnership
• Advantages • Disadvantages
▪ More capital available ▪ Unlimited liability
▪ Relatively easy to ▪ Limited life of
start business
▪ Income taxed once as ▪ Difficult to transfer
personal income
ownership

67
67
 Corporation
• Advantages • Disadvantages
▪ Limited liability ▪ Separation of
▪ Unlimited life ownership and
▪ Separation of ownership management
and management ▪ Double taxation
▪ Transfer of ownership is
easy
▪ Easier to raise capital

68
68