Session 1: Corporate Finance: What is it?

Summary

In this introductory session on Corporate Finance, the instructor lays out the core principles that drive business decisions: investment, financing, and dividend principles. Corporate finance is framed as a forward-looking discipline aimed at maximizing business value through strategic investments, efficient financing, and optimal dividend policies. The course emphasizes practical application over theory, using real-world companies to explore the intricacies of corporate finance across industries and markets. The instructor highlights the importance of common sense, focus, and understanding business life cycles, with a clear goal to help students navigate corporate financial decisions with confidence and clarity.

Takeaways

• 😀 Corporate Finance is more than just equations and models; it's based on first principles that guide business decisions.
• 😀 The main objectives of the Corporate Finance course are to equip students with tools, provide a big-picture understanding, and demonstrate the fun and satisfaction in applying finance principles.
• 😀 The financial balance sheet focuses on two key components: assets in place and growth assets, as opposed to an accounting balance sheet, which is backward-looking.
• 😀 In finance, businesses are funded through two primary sources: debt and equity. Debt holders have a first claim on cash flows, while equity holders take the residual.
• 😀 The three basic principles of Corporate Finance are: 1) Investment Principle - invest to exceed the minimum acceptable return; 2) Financing Principle - choose the debt/equity mix that maximizes value; 3) Dividend Principle - return cash to shareholders when no good investments are available.
• 😀 The investment principle stresses the importance of earning a return above a minimum threshold, with this rate depending on the risk of the investment.
• 😀 The financing principle emphasizes finding an optimal mix of debt and equity to minimize the company's hurdle rate and maximize its value.
• 😀 The dividend principle suggests that if there are no attractive investments, businesses should return cash to shareholders through dividends or stock buybacks.
• 😀 Corporate Finance is based on common sense; decisions should align with maximizing business value, such as raising money at the lowest cost and avoiding risky investments.
• 😀 Businesses go through life cycles: high-growth companies prioritize investment decisions, use more equity, and reinvest profits, while mature companies focus on paying dividends and can take on more debt.
• 😀 The principles of Corporate Finance are universal, applying to all types of businesses (public/private, small/large, developed/emerging markets), not just corporations. The class will explore real-world examples across industries and markets to illustrate these concepts.

Q & A

What is the instructor's primary definition of corporate finance?

The instructor defines corporate finance as any decision that involves the use of money. It's not just about equations or models, but about the first principles that govern business decisions.

What are the three main objectives of the course?

The three main objectives are: 1) To teach the tools, techniques, and models of modern corporate finance, 2) To provide a big-picture understanding of how these tools fit together, and 3) To demonstrate the fun and satisfaction of solving corporate finance problems.

How does the instructor differentiate between accounting and finance perspectives?

Accounting is backward-looking and focuses on recording past events. Finance, on the other hand, is forward-looking, focusing on future value, projections, and decision-making to optimize a company’s value.

What is the concept of the financial balance sheet?

The financial balance sheet consists of two types of assets: 'Assets in Place' (investments already made) and 'Growth Assets' (future expectations). On the liability side, businesses are funded by either debt or equity.

What are the three basic principles of corporate finance?

The three principles are: 1) The Investment Principle, which advocates investing in projects that exceed a minimum return hurdle rate; 2) The Financing Principle, which emphasizes finding the optimal debt/equity mix; and 3) The Dividend Principle, which advises returning money to shareholders when good investments aren't available.

What is the importance of the 'hurdle rate' in corporate finance?

The hurdle rate is the minimum acceptable return on an investment, adjusted for risk. It is crucial because it guides decision-making on whether an investment will add value to the business.

How does the investment principle relate to risk?

The investment principle suggests that riskier investments should have a higher minimum acceptable return. The hurdle rate should reflect both the riskiness of the investment and the source of financing, whether debt or equity.

How do debt and equity differ in terms of their role in corporate finance?

Debt provides a first claim on a company’s cash flows and assets but offers little control over company operations. Equity, on the other hand, has a residual claim on cash flows and assets, with shareholders gaining control of the company’s decisions.

What is meant by the 'life cycle' of a business, and why is it important in corporate finance?

The life cycle of a business refers to the stages a company goes through, from growth to maturity to decline. Corporate finance decisions vary based on the stage of the business; for example, growth companies rely more on equity, while mature companies can afford to take on more debt and pay higher dividends.

Why does the instructor emphasize that corporate finance principles are universal?

Corporate finance principles apply across all types of businesses, whether public or private, large or small, developed or emerging markets. The core ideas are unchangeable and relevant globally, making them essential for any business to thrive.

How does the instructor plan to apply corporate finance principles in the course?

The instructor will use six companies, ranging from large corporations like Disney to small private businesses, to illustrate the application of corporate finance principles. These companies will serve as case studies to understand how different types of businesses make investment, financing, and dividend decisions.

What is the instructor's view on corporate finance as a discipline?

The instructor believes corporate finance is a practical, focused, and common-sense approach to maximizing a company’s value. While many businesses operate successfully without formal corporate finance education, understanding and applying these principles enhances decision-making and long-term business success.