The foundations of corporate finance

1. 1
Foundations of Corporate
Finance
By
Fatma Raouf, Ph.D.

2. Foundations of Corporate Finance:
I. Definition and Types of Finance.
II. Forms of Business Organizations
III. Bonds and Stocks
IV. Goal of the Corporation
V. Structure of Financial Markets
VI. Structure of Financial Market Instruments
VII. 2008-09 Financial Crisis
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3. I. Definition and Types of Finance:
 Definition of Finance:
● Finance is the economics of time and risk.
● Finance is based on the decision making
process faced by different users.
 Types of finance according to the type of user:
1. Personal Finance: decision making faced by
individuals.
2. Public Finance: decision making faced by
the government.
3. Corporate Finance: decision making faced
by corporation. 3

4. Definition and Types of Fin Cont.
 Corporate finance is characterized by 3
decisions:
1. Investment Decision: which project
should the firm invest in? Capital budgeting
analysis.
2. Financing Decision: How can we
finance this project? Capital structure of the
firm, cost of capital.
3. Working Capital Decision: How to
manage cash, securities, and inventories to
make sure your project is doing fine.
Working capital management. 4

5. II. Forms of Business Organizations:
1. Sole Proprietorship:
● Formed when one unincorporated
person, acting alone, conducts a
business.
● Has unlimited liability.
● Does not have to pay corporate
income tax.
● Limited life, subject to fewer
government regulations, difficult to
raise funds. 5

6. Forms of Business Organizations Cont.
2. Partnership:
● Formed when two or more unincorporated
individuals joined together to conduct business.
● Partners have unlimited liability. Exception:
♦ Limited Partnership: A hybrid form of
organization consisting of general partners and
limited partners (enjoy limited liability).
♦ Limited Liability Company (LLC): Another
hybrid where all owners enjoy limited liability
while avoiding double taxation of profits. Many
states allow one-person LLCs
● Partners do not pay corporate income tax.
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7. Forms of Business Organizations Cont.
3. Corporation:
● It is a legal entity set by one or more
individuals to engage in economic activity.
● Stockholders, owners of corporation, enjoy
limited liability.
● Pay corporate income tax (Except S
corporation). Double taxation of profit.
● Raise funds by issuing bonds and stocks.
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8. III. Bonds and Stocks:
Bonds (Debt Securities):
 Represent fixed claim on the real assets of
the corporation.
 The return promised to bondholders must be
paid first, with any residuals go to the
stockholders.
 Involves less risk of losing money.
 Bondholders are creditors to the corporation.
 Coupon bonds and discount bonds.
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9. Bonds Cont.
 Coupon Bond:
1. pays coupon payments and face value.
Face Value (par value or principal): A
specific amount of the money paid at
maturity.
Coupon Payments: Fixed amount of
money you receive periodically (annually
or semiannually) until maturity.
2. Buy at discount, premium, or par.
3. Examples: Corporate bonds, treasury bonds
9

10. Bonds Cont.
 Discount (Zero-Coupon) Bond:
1. Does not pay coupon payments. Pays face
value at maturity.
2. Buy it at discount.
3. Examples:
U.S. Treasury Bill
U.S. Savings Bonds
Long-term zero coupon bonds
10

11. Stocks:
Stocks (Equity Securities)
 Represent claim on the residual value of
the corporation
 The return promised is paid from the
remaining cash flows
 Involves more risk of losing money
 Shareholders are owners of the
corporation
 Common stocks and preferred stocks
11

12. Types of Corporations:
 Privately Owned (Closely Held) Corporation:
A corporation owned by few individuals who
are associated with the firm’s management.
Stocks are owned by the firms’ managers and
aren’t actively traded, closely held stocks.
 Publicly Owned Corporation:
A corporation owned by large number of
people who are not involved in its
management. Their stocks are called publicly
held stocks.
12

13. Types of Stock Market Transactions:
1. Trading in the outstanding shares of publicly
owned companies: the secondary market.
No new funds to the company.
2. Additional shares sold by the publicly owned
companies: the primary market. Companies
sell new shares to raise funds (as long as
the outstanding shares <authorized shares).
3. Initial public offerings by privately held
companies: The IPO market. When privately
held company decides to sell some of its
shares to the public in order to raise funds.
The company is said to be going public. 13

14. SPAC:
 Special Purpose Acquisition Company
(SPAC).
 Number of SPAC IPOs ↑ significantly in 2020.
 According to David Erickson at Wharton Bus
School at the Univ of Pennsylvania, as of
December 14, 2020, The number of SPAC
IPOs were > 50% higher than the number of
SPAC IPOs in the previous 4 years combined.
 Main advantage over traditional IPOs is flexibility.
Source: Will 2020 Be Seen as the Year of the SPAC Bubble? - Knowledge@Wharton (upenn.edu)
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15. How Does an IPO Work?
Source: http://money.cnn.com/interactive/markets/how-does-an-ipo-work/
 File Form S-1: The company must first file a Form S-1 with the U.S.
Securities and Exchange Commission (SEC), which includes basic
business and financial records.
 Choose Underwriters: A group of investment bankers are selected to
act as underwriters, who help in raising capital from investors.
 Exchange: A public stock exchange, such as the NYSE or the
NASADQ is selected, and a ticker symbol is chosen (such as FB for
Facebook).
 Road Show: The company and its underwriters make presentations to
investors in major cities, seeking buyers for large block of shares.
 Preparation: Once the SEC has approved the filing, the company and
its underwriters set the opening price and the number of shares that will
be sold.
 Go Public: The investment capital is transferred to the company and
investors get their shares. The next day, they begin selling those
shares on the public market.
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16. IPO Examples:
Google:
 The number one search engine
 IPO on 8/18/2004, filed with the SEC in April 04.
 Raised $1.67 billion
 Sold 19.6 million shares at $85 a share.
 Listed on the NASDAQ. Ticker symbol “GOOG.”
 On its first day of trading as a public company, Google’s shares 18%,
closed at $100.34, more than 22 million shares were traded.
 Google IPO was conducted as a Dutch auction.
 Currently at $1,854.30 16

17. IPO Examples Cont.
Vonage:
 An Internet phone company (VoiP)
 IPO in May 2006
 Raised $531 million.
 Sold 31.25 million shares at $17 a share.
 Underwriter is Citigroup Global Markets Inc.
 Listed on the NYSE. Ticker symbol "VG."
 Currently around $13.39.
17

18. IPO Examples Cont.
MasterCard
 The #2 credit card issuer
 IPO in May 2006, Well-Anticipated
 Settled for $39 a share, below the forecasted
range of $40 to $43.
 Sold 61.52 million shares (46% of the
company). Raised $2.4 billion.
 Underwriters: Citigroup Global Markets and
Goldman Sachs.
 Listed on the NYSE. Ticker symbol "MA."
 Currently at $342.52. 18

19. IPO Examples Cont.
Visa
 The #1 credit card issuer
 IPO on March 18, 2008, Biggest IPO in the U.S.
and 2nd largest in the world.
 Settled for $44 a share, above the forecasted range of $37 to $42.
 Sold 406 million shares. Raised $17.9 billion. (U.S. Record)
 Underwriters: JPMorgan, Goldman Sachs, Bank
of America, Citigroup, Merrill Lynch, HSBC,
UBS, Wachovia, and Wells Fargo.
 Listed on the NYSE. Ticker symbol "V."
 Currently at $209.27. 19

20. IPO Examples Cont.
Facebook
 The social network. IPO on May 17, 2012.
 Raised $16 billion, making it the largest tech IPO and
the third largest IPO ever, after Visa (raised $19.7 billion
in March 2008) and GM (raised $18.1 billion in
November 2010).
 Sold 421.2 million shares at $38 a share.
 Underwriters are Morgan Stanley, Goldman Sachs, JP
Morgan Chase, and many other.
 Listed on the NASDAQ. Ticker symbol “FB."
 On its first day of trading, it closed at $38.23.
 Currently at $251.62. 20

21. IPO Examples Cont.
DoorDash
 The food-delivery company.
 IPO on December 8, 2020. Started trading 12/9/20
 Priced at $102 a share, above its original range of
$75 - $85 a share.
 Leading underwriters are Goldman Sachs and JP
Morgan Chase.
 Listed on the NYSE. Ticker symbol “DASH."
 Doordash was lunched in 2013 by a group of
Stanford students offering delivery in Palo Alto.
 Currently at $193.79. 21

22. IPO Examples Cont.
DoorDash
 DoorDash began trading on Wednesday
12/9/2020 at $182 per share.
 About 85% higher than its IPO price.
 Valuing the company at $70 billion.
 At $70 billion market cap, DoorDash is worth
almost as much as FedEx.
 DoorDash ended the trading day at about
$190 per share
22

23. IPO Examples Cont.
Airbnb
 The home-sharing (home-rental) company.
 IPO on December 9, 2020. Started Trading
12/10/20
 Priced at $68 a share, above its original range of
$44 - $50 a share.
 Leading underwriters are Goldman Sachs and
Morgan Stanley.
 Listed on the NASDAQ. Ticker symbol “ABNB."
 Currently at $159.47.
23

24. IPO Examples Cont.
Airbnb
 Airbnb began trading on Thursday
12/10/2020 at $146 per share.
 More than double its IPO price.
 Making the value of the company $100 billion.
 At $100 billion market cap, Airbnb is worth
more than Marriott and Hilton combined.
 At $100 billion market share, Airbnb is worth
more than Uber.
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25. Test Your Knowledge:
Leading Credit Cards in 2018
Leading Credit Card Issuers in the U.S., 2018
 JP Morgan Chase 16.1%
 Bank of America 11.8%
 Citigroup 11.7%
 American Express 11.6%
 Capital One 10.4%
 Discover 7.5%
 Wells Fargo 4.5%
 U.S. Bank 4.1%
Source: WalletHub Market Share by Credit Card Issuer (wallethub.com) 25

26. IV. Goal of the Corporation:
 Goal of the corporation is to maximize
the shareholders’ wealth, i.e., to
maximize the market value of their
shares.
 Shareholders don’t manage the
corporation, managers do. Managers
may have different goals than
maximizing the shareholders’ wealth 
Principal Agent problem
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27. Principal Agent Problem:
 Agency Relationship: A relationship in
which one or more individuals, called
principal, contracts with another
individual(s) or organization, called agent,
to perform a decision-making task for
them.
 The principal-agent problem (Agency
Problem): is a potential conflict of interest
between the agent (manager) and the
principal (outside stockholders or
debtholders).
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28. Principal Agent Problem Cont.
 Managers can be encouraged to act in
shareholders’ best interest through
incentives
1. Managerial Compensation:
a. Performance Shares
b. Executive Stock Options
2. Direct Intervention by Shareholders.
3. The Threat of Firing.
4. The Threat of Takeovers.
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