Introduction to Corporate

Finance
Week 01
EM961 – Financial Management
What is Financial Management?

Concerns the acquisition, financing,

and management of assets with some
overall goal in mind.

Focus: Corporate Financial

Management
 What are Assets?
An asset, in business terms, is a resource of value that you own or lease that helps
you run your business.
Assets, in accounting terms, are resources that you can sell or convert into cash or
use to produce value
Divided into categories:
• tangible assets - the physical, material and financial resources of your business
• intangible assets - resources without material substance, but with clear business
value
or
• current assets - those with a shorter life span and easily transferable into cash (≤
1 year)
• fixed assets - intended for long-term use and unlikely to convert quickly into
cash (non current assets)
 Asset Examples
Examples of tangible Examples of intangible assets:
assets: • intellectual property
• cash • trade secrets
• stock • licences
• buildings • franchises
• land • reputation
• office equipment • brand
• machinery • goodwill
• vehicles
 Asset Examples
Examples of current assets: Examples of fixed assets (non current
• cash/cash equivalents assets):

• receivables • property
• plant
• deposit accounts
• money orders • equipment

• cheques • tools and machinery

• furniture
• bank drafts
• marketable securities • investments (long-term)

• investments (short term)

• inventory
• stock
• prepaid expenses
What Is Corporate Finance?
• Corporate finance provides answers to some important questions:
• What long-term investments should the firm take on? (investment decision)
• lines of business you will be in and
• sorts of buildings, machinery, and equipment you will need
• Where will the firm get the long-term financing to pay for the investments? (finance
decision)
• you bring in other owners or
• you will borrow the money
• How will the firm manage its everyday financial activities? (asset management decision)
• collecting from customers and
• paying suppliers
• should dividends be paid? If so, how much? (dividend decision)
• Financial Managers try to answer some or all of these questions
The Financial Manager
• The top financial manager within a
firm is usually the Chief Financial
Officer (CFO)
• Treasurer – oversees cash
management, credit
management, capital
expenditures, and financial
planning
• Controller – oversees taxes,
cost accounting, financial
accounting and data
processing

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Financial Management Decisions
• Capital budgeting (The process of planning and managing a firm’s long-term investments) 
investment decision
• how, when, where and how much money will be spent on investment opportunities.
• A firm has many options to invest their funds but firm has to select the most appropriate assets for
investment which will bring maximum benefit for the firm
• Capital structure (The mixture of debt and equity maintained by a firm)  finance decision
• How much should the firm borrow to pay for its assets?
• What is the best mixture of debt and equity?
• The least expensive sources of funds? (loan, bonds, credit card, crowdfunding, venture capital, etc.)
• Working capital management (A firm’s short-term assets and liabilities)  asset
management and dividend decisions
• How do we manage the day-to-day finances of the firm?
• 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?
• whether to pay a dividend to shareholders or maintain the funds within the firm for internal growth
Balance Sheet (Neraca Keuangan) Model of the Firm
Total Value of Assets: Total Firm Value to Investors:
Current
Liabilities
Current Assets
Long-Term
Debt

Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity
The Capital Budgeting Decision
Current
Liabilities
Current Assets
Long-Term
Debt

Fixed Assets
What long-
1 Tangible term Shareholders’
2 Intangible
investments Equity
should the firm
choose?
The Investment Decision
• Capital budgeting is the planning and control of cash outflows in the
expectation of deriving future cash inflows from investments in non-
current assets.

• Involves evaluating the:

• size of future cash flows
• timing of future cash flows
• risk of future cash flows.

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Fundamentals of Corporate Finance 3e
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Ross, Thompson, Christensen, Westerfield and Jordan
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.

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Fundamentals of Corporate Finance 3e
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Ross, Thompson, Christensen, Westerfield and Jordan
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.

Which is the better project? Future Cash Flows

Year Project A Project B

1 $0 $20 000

2 $10 000 $10 000

3 $20 000 $0
Copyright  2004 McGraw-Hill Australia Pty Ltd
Total $30 000
PPTs t/a Fundamentals of Corporate Finance 3e $30 000
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Ross, Thompson, Christensen, Westerfield and Jordan
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.

Future Cash Flows

Pessimistic Expected Optimistic

Which is the better project?
Project 1 $100 000 $300 000 $500 000

Project 2 $200 000

Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Fundamentals of Corporate Finance 3e
$400 000 $600 000
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Ross, Thompson, Christensen, Westerfield and Jordan
The Capital Structure Decision
Current
Liabilities
Current Assets
Long-Term
How should the Debt
firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible
Shareholders’
2 Intangible Equity
Capital Structure 25%
Debt

75%
The value of the firm can be
Equity
thought of as a pie.
The goal of the manager is 50%
to increase the size of the Debt
pie.
50%
The Capital Structure Equity
decision can be viewed as 70% 30%
how best to slice the pie. Debt Equity

If how you slice the pie affects the size of the pie,
then the capital structure decision matters.
Short-Term Asset Management
Current
Liabilities
Current Assets
Net
Working Long-Term
Capital Debt

How should
Fixed Assets
short-term assets
1 Tangible be managed and
Shareholders’
financed?
2 Intangible Equity
Interrelationship of the decisions
made by a Financial Manager
 What are Liabilities (Kewajiban)?
Something for which someone is responsible, especially a debt or financial
obligation.
Examples of liabilities are:
• Bank debt.
• Mortgage debt.
• Money owed to suppliers (accounts payable)
• Wages owed.
• Taxes owed.
Liabilities are also grouped into two categories: current liabilities and long-term
liabilities. Current liabilities are those that are due in the next year, while long-
term liabilities will not be due until at least a year later.
 What is Equity (Ekuitas)?
Equity represents the value that would be returned to a company's shareholders if
all of the assets were liquidated and all of the company's debts were paid off.

Equity is the ownership of any asset after any liabilities associated with the asset
are cleared. For example, if you own a car worth $25,000, but you owe $10,000 on
that vehicle, the car represents $15,000 equity.
Forms of Business Organization
• Three major forms
• Sole Proprietorship (kepemilikan tunggal), misal: praktek dokter, store,
consultant, artist, freelance, etc.
• Partnership (kemitraan), misal law firms, physician groups, real estate
investment firms, accounting groups, etc.
• General
• Limited
• Corporation (perseroan)
• Limited Liability Company (to operate and be taxed like a partnership but retain limited
liability for owners, or hybrid of partnership and corporation)
• Limited Liability Partnerships (An LLP has a separate legal entity under the law. A
partnership firm has no separate legal status apart from its partners)
Sole Proprietorship

Advantages Disadvantages
• Easiest to start • Limited to life of owner
• Least regulated • Equity capital limited to owner’s
• Single owner keeps all the profits personal wealth
• Taxed once as personal income • Unlimited liability
• Difficult to transfer – must sell
entire business to new owner
Partnership
Advantages Disadvantages
• Two or more owners • Unlimited liability
• More capital available • General partnership
• Limited partnership (In a limited
• Relatively easy to start and partnership, operations are handled by
inexpensive form of organisation general partners, whereas limited
partners do not take part in the day-to-
• Income taxed once as personal day running of the business)
income • Partnership dissolves when one
• All partners share in profits and general partner dies or wishes to sell
losses of the business • Amount of equity raised is limited to
the combined personal wealth of the
partners
Corporation (Company)

Advantages Disadvantages
• Owners (shareholders) have • Most complex and expensive form
limited liability of organisation
• Unlimited life • May involve double taxation in
• Separation of ownership and some countries (income taxed at
management the corporate rate and then
• Transfer of ownership is easy dividends taxed at the personal
rate)
• Easier to raise capital
Summary of 3 Business Forms
Goal of Financial Management
• What should be the possible goal of a corporation?
• Maximize profits?
• Minimize costs?
• Maximize sales or market share?
• Maximize the current value of the company’s stock?
• Survival?
• Avoid financial distress and bankruptcy?
• Beat the competition?
• Maintain steady earnings growth?
Maximizing Shareholders’ Wealth
• The Real Goal of the Firm is maximizing shareholder’s wealth
• Maximizing the share price is equivalent to maximizing shareholders’ wealth
• Why is this a valid goal?
• Decisions are made in shareholders‘ best interest
• Considers cash flows not profits
• Timing or duration of expected returns
• Takes account of risk of profits
• No traded stocks. The goal is maximize the market value of the existing owners’
equity
• So, we could have defined corporate finance as the study of the relationship
between business decisions and the value of the stock in the business
The Agency Problem
• Agency relationship
• Stockholders (principals) hire managers (agents) to run the company
• The agency relationship exists when a principal hires an agent to represent
his/her interests
• Agency problem
• Conflict of interest between principal and agent
• Agent may not work in the best interest of the principal
Management Goals
• Management goals may be different from shareholder s’ goals
• Management may be more interested in:
• Consuming expensive perks: asuransi terbaik, tunjangan besar
• It’s own survival: memberikan sumber daya yang cukup menghindari tidak jalannya
perusahaan
• It’s independence: mengambil keputusan tanpa mengikutkan pihak luar
• Management may focus on increased growth and size rather
than increasing shareholders’ wealth
Agency Costs
• Costs due to the conflict of interest between shareholders and
management
• Direct
• Corporate expenditure that benefits management but costs shareholders,
• e.g. country club membership
• Costs to monitor management actions,
• e.g. auditor costs
• Indirect
• Lost opportunity due to management forgoing profitable but risky projects for fear of
losing job if project fails
Managers Act in The Stockholders’ Interests?
The conflict of interests is limited due to:
• Managerial compensation: perjanjian dan pengaturan kompensasi
• Incentives can be used to align management and stockholder interests:
management stock option
• The incentives need to be structured carefully to make sure that they achieve
their goal: pembagian saham berdasarkan kinerja
• Corporate control
• The threat of a takeover may result in better management
• Other Stakeholders (pemangku kepentingan): someone other than a
stockholder or creditor who potentially has a claim on the cash flows of the firm
(Employees, customers, suppliers, and even the government)
Work the Web Example
• The Internet provides a wealth of information about individual
companies
• One excellent site is finance.yahoo.com
• Click on the web surfer to go to the site, choose a company and see
what information you can find!

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Financial Market
• Primary market
• A market where the firm sells its securities to public for the first time
• Secondary markets
• A market in which the securities issued by firms are traded
• Listed securities trade in an organized exchange, e.g. the stock market (NYSE)
• Over-the-counter securities are bought from or sold to a dealer:
• Over-the-counter (OTC) securities are securities that are not listed on a major
exchange in the United States and are instead traded via a broker-dealer
network, usually because many are smaller companies and do not meet the
requirements to be listed on a formal exchange

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Cash Flows between the Firm and the Financial Markets
Structure of Financial Markets

F in an cial M arkets

M on ey M ark et C ap ital M arket

P rim a ry M arket S ec on d ary M arke t P rim a ry M arket S ec on d ary M ark et

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Fundamentals of Corporate Finance 3e
Ross, Thompson, Christensen, Westerfield and Jordan 1-35
Slides prepared by Sue Wright
Financial Markets
• Financial markets bring together the buyers and
sellers of debt and equity securities.
• Money markets involve the trading of short-term
debt securities.
• Capital markets involve the trading of long-term debt
securities.
• Primary markets involve the original sale of
securities.
• Secondary markets involve the continual buying and
selling of issued securities.
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Fundamentals of Corporate Finance 3e
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Ross, Thompson, Christensen, Westerfield and Jordan
Pasar Modal Dunia Quick Quiz
• AS, NYSE
• AS, NASDAQ
• Jepang, Tokyo Stock Exchange
• Tiongkok, Shanghai Stock Exchange
• Hongkong, Hong Kong Stock Exchange
• Eurozone, Belanda, Euronext
• UK, London Stock Exchange
• Tiongkok, Shenzen Stock Exchange
• Canada, Toronto Stock Exchange
• India, Bombay Stock Exchange
Quick Quiz
• What are the three types of financial management decisions and what
questions are they designed to answer?
• What are the three major forms of business organization?
• What is the goal of financial management?
• What are agency problems and why do they exist within a
corporation?
• What is the difference between a primary market and a secondary
market?

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Ethics Issues
• Is it ethical for tobacco companies to sell a product that is known to be
addictive and a danger to the health of the user? Is it relevant that the
product is legal?
• Should boards of directors consider only price when faced with a buyout
offer?
• Is it ethical to concentrate only on shareholder wealth, or should
stakeholders as a whole be considered?
• Should firms be penalized for attempting to improve returns by stifling
competition (e.g., Microsoft)?

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Introduction to
Corporate Finance
(EM961 – Financial Management)
Cynthia Sari Dewi