Video Transcript: Introduction

Hello, welcome. This is the Introduction to Corporate Finance. We're looking to  develop your skills in a financial environment understanding more about  corporate finance. What is corporate finance? Corporate Finance is the financial analysis of pricing and product strategies. This is the marketing function of  corporate finance. We need to understand the pricing of our product and the  strategies involved so that we can market our product and continue to grow  revenues. Information for making better financial decisions are Accounting and  Information Systems. We need information systems in accounting to help us  understand how profitable or how unprofitable our business is, assessing and  increasing the financial value of human capital. We need to make sure that  we're making investments into our human capital our employees, to ensure that  they are maximizing the outputs as much as possible. Assessing the financial  payoff to creating and augmenting barriers to entry is our corporate strategy. We want to ensure that we insulate our organization and create barriers of entry to  competitors to enter the market, financial consequences of production and  operating decisions, which is the production and operations management of our  firm. So look into the balance sheet. This is a snapshot of how our company is  performing financially, how operations are going, as far as assets compared to  liabilities, and how much owners equity we have in our company that we can  distribute to shareholders. So you'll notice assets on the left hand side of the  balance sheet. Fixed assets are long lived real assets, plant, property,  equipment, current assets, short lived assets, is typically our inventory. What  we're selling financial investments, investments in securities and assets of other  firms. We can own stocks. We can own bonds, other securities from other firms  might be their preferred stock, assets which are not physical like patents and  trademarks. So intangible assets, we own a patent or a trademark on a logo or  on an invention, and we can insulate that from some body else taking our idea  liabilities, current liabilities, short term liabilities of the firm that might be  accounts payable, something that you've got on credit from another company,  as far as raw materials or something like that, for your input of operations. Debt  obligations of the firm could be bank loans. It could be issuing corporate debt,  things like that, other liabilities, other long term obligation, any kind of notes,  payable, things like that, and also equity in the firm, is we can either return,  retain that in earnings, and reinvest that equity that we've got, which is assets  minus liabilities, gives us owners equity. We can invest that equity back into our  company, or we can distribute that equity to shareholders, the financial view of  the firm. Again, this is just breaking down the balance sheet, assets in place,  existing investments, they generate cash flow today. This includes long, fixed  and short lived working capital, assets, plant, property, equipment, long lived,  fixed and short lived would be raw materials and materials that would be in  process to create your products, growth assets, expected value that will be  created by future investments. Are we going to reinvest capital into our company

so that we can grow. Are we going to invest in a company and buy their stock  because we expect them to grow? Those are growth assets, liabilities. So debt  fixed claim on cash flows. So our cash flow comes in, we have a fixed interest  rate that we pay on our debt, and as we pay that down, the interest rates stay  the same. Our payments stay the same because it's a fixed interest rate litter  little or no role in management. Fixed maturity. The fixed maturity is a five year  obligation, a 10 year obligation, 15, 20, 30 year obligation on our debt. So the  maturity when that debt comes to the end or to the end of its life, when it's all to  be paid back, that is maturity, anything, tax deductible, depreciation.  Amortization, things like that, equity residual claim on cash flows. So we capture the cash flows, we pay down the liabilities. What's left after we have our cash  flow and our assets, we subtract out the liabilities we have the equity, so now we can again disperse that equity to shareholders, or we can reinvest that capital  into the company, or we can do both first principles in the big picture. So  maximize the value of the firm. That is the goal of upper management. They  want to maximize the value for shareholders so we can continue to appreciate  our stock price. People will buy the stock. Our shareholders won't sell the stock,  and they'll remain owners into the business the investment decision invest in  assets that earn a great greater return then the minimum acceptable hurdle rate, so say market return on an ordinary annuity is 7% now we've got to make the  decision, do we want to go with the 7% investment, or do we want to look for  something more attractive that may offer a little more risk but a greater return,  like 10% the financing decision, find the right kind of debt for your firm and the  right mix of debt and equity to fund your operations. As a financial manager, you  want to make sure that you're not overloading yourself with a debt. You don't  want too many debt obligations that could run into cash flow problems in the  future. Let's say the economy takes a downturn, our revenues are cut by 20%  and now we have all these debt obligations because we're 70% leverage and  we can't pay the debt down. Now we have to file for bankruptcy or restructuring  of our debt, which will hurt our credit rating, which will cost us in future financing  capital, as far as raising interest rates, because our credit will go down. The  dividend decision if you cannot find investments that make your minimum  acceptable rate return the cash to your business owners. So if we can't reinvest  this capital at a return that is, you know, soothing our appetite for the return,  then we can re distribute those funds back to the shareholders and distribute  that in a dividend. Corporate Finance is common sense. There is nothing earth  shattering about the idea of any of these first principles that govern corporate  finance. After all, arguing that making a business investment that yields 9%  while the cost of financing the investment is 10% will not be a profitable  investment. That's common sense, right? We know that the investment is going  to yield 9% but the cost of financing that investment is 10% we've got a negative 1% as far as our return. It's not profitable. We don't want to take that investment.

It's pretty common sense. Finance managers should recognize that the cost of  financing an investment is greater than the return on the investment. Then the  firm should not make the investment. We want to make sure that our costs are  always lower than our return, so that we can make a profit, so that we can pay  shareholders, or we can grow our company. Then for the firm, can consider what 

to do next with the free cash flow. It can choose another investment option that  is more advantageous for the firm, or it can return the excess capital back to the  shareholders, or it can do a little bit of both, corporate finance is focused.  Corporate Finance focuses on maximizing the value of the firm, maximizing the  value for the shareholders. The value of our firm is pricing to the share of our  stock, which is obtained by our financial metrics, how profitable we are. How are we hitting our growth targets, things like that. As a result of this, the singular  objective finance managers can choose the correct investment strategy given  various investment decision rules, they can determine the correct mix of debt  and equity financing for a specific business. Again, you want to make sure that  you're not overloading yourself with debt and that you're maintaining a good  debt to equity ratio, examine the correct amount of cash that should be returned  to shareholders and the correct amount of cash to be reserved for retained  earnings. Retained earnings is what we bring back into the company for  reinvestment. So let's focus on the changes across the life cycle. So we can see here we've got an example of the balance sheet. So in the Assets column on the left, we've got 1.5 billion already invested. I'm sorry that's 15 billion already  invested, 3 billion investments yet to be made. So we're holding that 3 billion in  cash. Liabilities 7 billion. We've got some kind of debt obligation, long term,  short term debt obligation for 7 billion. So if we look, we have 15 billion plus 3  billion is 18 billion. And you'll notice the 18 billion minus the 7 billion, 11 billion.  So assets minus liabilities gives you the equity. But the real equation, in this  sense, is liabilities plus equity equals assets. That is the true balance sheet  equation. So assets should equal liabilities plus equity, liabilities plus equity  should equal assets, as it does in this example. So now let's look at this next  example on the bottom of LinkedIn financial balance sheet. So they've got  investments already made at .25 million, because they are in different phases of  the life cycle. You can see the difference between investments already made,  between the two company, con Ed's got 15 million investments already made.  Where LinkedIn is I got .25 billion investments already made. Why? Because  Con Ed is early in the stage of their life cycle. The investments already made are large. So they're large capital inflows in the beginning of a startup, because  you've got to get your processes in place, you've got to get your plant, property,  equipment going, buy your raw materials, hire your labor. So all of those are  capital intensive things. So that is why con Ed's balance sheet has got a greater  sum of investments already made than LinkedIn. Now LinkedIn has got a lot of  cash because they're much further along in their life cycle. You can see 

investments yet to be made, 13.35 billion. Right? They mean they're holding on  to 13.35 billion in cash, ready to make this investment into whatever they want.  So you look over now look LinkedIn is debt free, zero debt. So they are way into  the maturity phase, past their growth phase. They've paid down all their debt.  Now look at their equity, 13.6 billion. They can either reinvest that money back  into LinkedIn, or they can distribute back to shareholders. My guess is, because  they're so far along in the maturity process, in the growth phase, in the life cycle, they will retain will they will return that 13.6 to shareholders. So you can see,  Con Ed still has high liabilities at 7 billion. So they're still getting ramped up in  operations. They're still borrowing debt. Now one good thing, they are in a  healthy position, because their debt to equity is positive. On the equity side,  right? It's almost two to one debt to equity, probably more like 1.7 to one equity  to liability. So they are in pretty good shape. They can pay down their debts right now and still have a comfortable cash cushion. Corporate Finance is universal.  Every business, small or large, public or private US or emerging market, has to  make investment financing and dividend decisions. We all have to do that as  financial managers. We've got to make sure that we understand the market that  we're participating in and what kind of decisions we have to make to ensure we  are profitable. While the constraints and challenges that firms face can vary  dramatically across firms. The first principles do not change. A publicly traded  firm has greater access to capital markets and a more diversified investor base.  They may have a much lower cost of debt, which is the interest they pay on that  debt. It costs them less because the interest rates are lower and equity than a  private business, right? Because a publicly traded firm, they raise capital quickly in the capital markets, because they can leverage their business operations to  have collateral for their debt, or they can issue more stock to raise capital in  equity markets, but both publicly traded and private firms should look for the  financing mix that minimizes their cost of capital the most a firm in an emerging  market may face, the greater uncertainty when assessing new investments than  a firm in a developed market, both firms should invest only if they believe they  can generate higher returns on their investments than they face their respective  and very difficult hurdles. Everybody's going to face hurdles, but they want to  make sure that they're making the investments they can generate higher returns