INTRODUCTION TO CORPORATE FINANCE
Today, corporate finance managers must make decision in a much more coordinated manner and generally has direct responsibilities for a control process. Because there are financial implications in virtually all segments of business, she/he must have sufficient knowledge of finance to work these implications into the area.
At the end of this chapter, you should be able to:
• Undenstand the nature of corporate finance .
• Understand financial management framework.
• Identify the basic corporate finance goals.
• objectives and functions of corporate finance.
The definitions also introduce the concept of wealth maximization as the focus of decision-making that differs to some extends with maximization of profits.
As a profit seeking entity, business organizations exist to produce goods and services efficiently; and satisfy customers’ demands at a profit. The organization is therefore must:
1. Acquire or invest in real assets for the purpose of productions,
2. Search for ways and means to pay or finance them, and
3. Manage its day-to-day activities in production and distributions of goods and services.
They will continue to do so to ensure the firm is properly managed and remains as a viable entity in the market place. This is what corporate finance is all about, that is the acquisition and allocation of firm’s resources to maintain and create wealth through present and potential activities. Thus, the study of corporate finance deals with trying to provide answers concerning:
1. What long-term investment (assets) should the firm make? Investment decisions or asset allocation.
2. Where will the firm get the funds or capital (debt and equity) to finance the investment? Financing decisions or acquisition of resources.
3. How will then firms manage the short-term assets and liabilities? Working capital management.
Figure 1-1 outlined essential functions of corporate finance that directly provides answers to capital budgeting question, the capital structure question, and the net working capital question.
Figure 1-1 Financial Management Framework
Investment decision Asset structure Business risk
Financial consideration and decisions Total risk Share price
Financing decision Financial structure Financial risk
Market or investors’ feedback
CORPORATE FINANCE GOALS
The development of the firm's primary financial goal is in line with the above financial management concept as presented in Figure 1-1; that is:
“To make and execute decisions that provide maximum benefits to the owners or shareholders by maximizing owners' wealth through share price maximization.”
The above statement seems to deviate main motive of business enterprise to gain maximum profits. This leads to the basic differentiation between wealth maximization and profit maximization approach. There are several arguments of why getting as much profit as possible will not ensure the firm's viability in the long-term. In contrast to wealth maximization, the profit maximization holds on to the following views in term of:
1. Time Horizons. It focuses on short-term benefits and tries to gain as much profit as possible regardless of the long-term effects.
2. Timing of Returns. It does not consider the timing of returns and thus time value of money.
3. Distributions of Income. It tends to ignore the owners wish to receive a portion of earnings in the form of dividends.