Module One

Overview of
Corporate Finance

. 5
Learning Objectives

By the end of this module, you should be able to:

1. identify and explain the three major decisions in corporate
finance,

2. briefly explain the differences between a sole

proprietorship, a partnership, and a company,

3. describe what is financial management's key goal in a

profit-oriented business,

4. explain “agency problems” and describe some possible

ways to control and reduce them,

6
Learning Objectives

5. explain the role of financial markets, identify their

participants and distinguish between the different types of
financial markets,

6. distinguish between:

• ‘book value’ versus ‘market value’;

• ‘net profit’ versus ‘cash flow’;

• a ‘statement of financial position’ versus a ‘statement of

financial performance’;

7
 Chapter 1

Introduction to Corporate Finance

. 8
1. What is Corporate Finance?

Corporate Finance attempts to find the answers for

9
1. What is Corporate Finance?

Corporate finance attempts to find the answers to the

following questions:
– What investments should the firm take on?
THE INVESTMENT DECISION
– How a company can raise cash for the
required investments?
THE FINANCE DECISION
– Should/How dividends be paid?
THE DIVIDEND DECISION

10
1.a. Investment Decision
(aka Capital Budgeting)
Capital budgeting is the process of planning and
managing a firm’s investment in non-current assets (or
long-term assets)
The job of a Finance Manager is to identify good
investment opportunities, in which the value of Cash
flow generated by an asset exceeds the cost of that
asset.
Investment decision will involve evaluating the:
i. size of future cash flows;
ii. timing of future cash flows; and
iii. risk of future cash flows.

11
i/ Cash Flow Size
Important Note:

• For accounting purposes, sales may be recorded at the

time that “risks and benefits associated with the right to
own the products or goods” are transferred to the buyer;
• But cash flow will occur when actual payment is made.
• Similar concepts for costs/expenses
• Therefore estimation/calculation of cashflows (for both
in and out) required further adjustments from the
accounting reported figures.

12
i/ Cash Flow Size
Can you think about one typical example of difference
in recognizing sales vs cash flow?

Source: [Link]
13
ii/ Cash Flow Timing
Why cash flow timing matters?

a dollar today is
worth more than a
dollar tomorrow
Warren Buffett

14
ii/ Cash Flow Timing
E.g.: From your point of view, which project is more valuable?

Year Project A Project B

1 $0 $15 000

2 $15 000 $15 000

3 $15 000 $0

Total $30 000 $30 000

>> Without further information, it is impossible to say

which project is more valuable. We need to find out
“risk associated with the future cash flows”.

15
iii/Cash Flow Risk

The role of a Financial Manager is to deal with the

uncertainty associated with investment decisions.

Assessing the risks associated with expected future cash

flows is critical to investment decisions.

16
iii/ Cash Flow Risk
Which project is better, given estimated outcomes of each
market scenario as following?

Pessimistic Expected Optimistic

Project 1 $100 000 $300 000 $500 000

Project 2 -$200 000 $400 000 $1 000 000

>> Without further information, it is impossible to say

which project is more valuable. We need to find out
“timing of the future cash flows”.

17
1.b. Financing decision
A firm’s capital structure is the specific mix of debt and
equity used to finance a company’s operations.
Decisions need to be made on both the financing mix and
how and where to raise money (so that it will minimize
the cost of capital of the firm and thus maximize firm or
company/enterprise value).

Can you list out some typical examples of Debt & Equity
instruments?
Debt Equity
Bank loans Ordinary shares
Corporate bonds Preference shares
Commercial papers financing

18
1.c. Dividend decision
Involves the decision of whether to
• pay a dividend to shareholders or
• maintain the funds within the firm for greater internal
growth.

The final decision will depend on the policies of the firm.

This decision will have direct impact on shareholders’

wealth.

19
2. Corporate Form of
Business Organization

Sole Proprietorship

Partnership

Company

20
 2.a. Sole Proprietorship

* Easiest to start * Limited to life of owner

* Least regulated * Equity capital limited to

owner’s personal wealth
* Single owner keeps all the
profits * Unlimited liability for business
debts
* All business income is taxed
as personal income * Difficult to sell ownership
interest as it requires entire
transfer (can not transfer part
According to Law on Enterprises 2020 (Vietnam), a sole of business)
proprietorship is an enterprise owned by one individual who
has full control over the company’s operations and capital.

21
2.b. Partnership
A partnership is similar to a proprietorship, except there are ≥ 2
owners (partners).

• In a general partnership, all the partners

• share in gains or losses,
• have unlimited liability for all partnership debts, not just
some particular share.
• In a limited partnership,
• one or more general partners will run the business and
have unlimited liability, but
• there will be one or more limited partners who will not
actively participate in the business. A limited partner’s
liability for business debts is limited to the amount that
partner contributes to the partnership.
• This form of organization is common in real estate
ventures, for example.

22
2.b. Partnership
Þ Advantages and disadvantages are basically the same as
those for a proprietorship.
• Advantages:
• Easy and inexpensive to form
• All income is taxed as personal income to the partners,
• Disadvantages:
• the amount of equity that can be raised is limited to the
partners’ combined wealth
• unlimited liability for business debts on the part of the
owners
• Limited life: the partnership terminates when a partner
sells out or dies
• A limited partner’s interest can be sold without dissolving
the partnership, but finding a buyer may be difficult.

23
2.b. Company

* Limited liability * Separation of ownership and

* Unlimited life management

* Double taxation (income
* Separation of ownership and taxed at the corporate rate and
management then dividends taxed at the
personal rate)
* Transfer of ownership is easy

* Easier to raise capital

24
Discussion

1. What are legal forms of business in Vietnam?

2. How dividends for individuals are taxed in

Vietnam?

25
Discussion

1. What are legal forms of business in Vietnam?

• Limited-liability company
• Joint-stock company
• Partnership (e.g. law firms, audit firms)
• Representative office of an oversea company
• Branch of an oversea company
• Branch ≠ Representative in that Branch is
permitted to conduct commercial activities in
Vietnam.
• Business Corporate Contracts (BCC)
• Public and Private Partnership Contracts: BOT, BT,
…

26
Discussion
1. How dividends for individuals are taxed in Vietnam?
• Cash dividends: PIT 5%
• Share dividends: not subject to PIT as at the effective
date, but will be subjected to 5% PIT when
selling/transferring such shares

27
3. Goal of Financial Mgmt.

What are possible Goals of Financial Management?

❑ Survival
❑ Avoid financial distress and bankruptcy
❑ Beat the competition
❑ Maximise sales or market share
❑ Minimise costs
❑ Maximise profits
❑ Maintain steady earnings growth

28
Problems With These Goals

Each of these goals presents problems.

These goals are either associated with

• increase profitability (e.g. increase sales, market shares,
minimize cost) or
• reducing risk (e.g. avoid distress)

➔ It is necessary to find a goal that can encompass both

profitability and risk.

29
The Firm’s Objective

If we assume that shareholders buy shares because they

seek to gain financially, then …

The goal of financial management is to maximize

shareholder’s wealth (i.e., maximize market value of
owners’ equity)

This goal overcomes the problems encountered with the

goals outlined above.

30
Interrelationship of the 03 decisions
and the firm’s objective
Source of Funds Use of Funds
Cash inflows Cash outflows

Cash flows Asset

Dividends or
generated from acquisition &
Funding + = + Debt/interest
business operational
payment
operations spending

F X I D

Financing Dividend
Investment Decision
decision decision

Þ Change in one decision will affect at least one other decision.

Þ What happen if management wants to increase the dividends?

31
4. Agency Problem

• The agency relationship is the relationship between

shareholders (owners) and management of a company.

• The agency problem: conflict of interests between

shareholders and management (i.e. when managers
may not act in the best interest of shareholders).

• Agency costs refer to the direct and indirect costs

arising from this conflict of interest.

32
4. Agency Problem
Though shareholders and managers want the company to be
successful, their interests may not be always aligned

What may shareholders want …? What may managers want …?

High shareholders returns (e.g. High compensation
shares’ price increase or high
dividend payment) (Personal) Good reputation

Good risk/return ratio (high risk Job security

+ high return)

33
4. Agency Problem
Discussion:

Take an example to illustrate agency problem?

If managers want:

• High salary ➔ may lead to expensive compensation plan

• Reputation ➔ may lead to pursuit aggressive topline

growth (e.g. revenue, market shares) instead of
profitability

34
Assume you are the major shareholder of a company,
how do you know if your Manager is acting in the best
interest of shareholders?

The answer to this will depend on two factors:

– how closely the management’s goals are
aligned with shareholder goals?; and
– can management be replaced (easily) if it does
not pursue shareholders’ goal?

35
Alignment of Goals
The conflict of interests can be mitigated by:
– monitoring of management (i.e. corporate
governance);
– practicing transparency to mitigate
misunderstandings (e.g. presenting to the BoD all
matters regarding the decision-making process, to
ensure mutual understanding of all available
options before making the final decision)
– compensation schemes for management,
e.g: salary, incentive such as bonus, stock options
for management (ESOP), etc.

36
Discussions
• What is ESOP? Employee Stock Options Plan
• ESOP is a system under which: the employees
of a company are generally given the right to
acquire the shares of the company at
bargain/concessional prices.
• What are benefits of ESOP to shareholders?
• Align managements and shareholders’ goals
• Prevent competitors to hunt company’s talents
because stocks given to the employee can be
sold after a certain lock-in period, which is
generally more than 1 year.

37
Structure of Financial Markets

Financial Markets

Short-term securities (<= 1 year) Long-term securities (> 1 year)

Money market Capital market

Primary Market Secondary Market

is where original securities are sold is where investors buy and sell
(e.g. IPO - investor gets securities securities from other investors
directly from the company) (e.g. HOSE, HNX)

38
 Cash Flows Between the Firm
and the Financial Markets
A. Firm issues
securities to raise
cash (the financing
decision) Total Value of the Firm
Total Value of to Investors in
Firm’s Assets the Financial Markets
B. Firm invests in
assets (capital
budgeting) Financial Markets:
B. Firm invests A. Firm issues securities
C. Firm’s • Short-term debt
in Assets
operations
generate cash flow • Current Assets • Long-term debt
(Cash,
Inventories, E. Retained cash flows • Equity shares
D. Cash is paid to
Account
Gov as taxes
Receivables)
C. Cash flow from
• Fixed Assets F. Dividends and debt payments
E. Retained cash firm’s assets
(Buildings,
flows are re- Equipment,
invested in firm Machinery)

F. Cash is paid out

to investors in the
form of D. Government
interests/dividends

39
Financial Markets
• Financial markets bring together the buyers and
sellers of debt and equity securities.
• Money markets involve the trading of short-term
securities (i.e. financial instruments with high
liquidity and short-term maturity; e.g. certificate of
deposit, interbank loans, commercial paper,
Treasury bills)
• Capital markets involve the trading of long-term
securities (such as stocks, bonds)
• Primary markets involve the original sale of securities.
• Secondary markets involve the continual buying and
selling of already issued securities.

40
Financial Markets
__________ consists of the organizations, institutions that
provide long-term financing.
(a) Capital market
(b) Money market
(c) Primary market
(d) Secondary market

Stock exchange is known as __________ for securities.

(a) Primary market
(b) Secondary market
(c) Capital market
(d) None of the above

41
 Chapter 2

Financial Statements, Taxes and

Cash Flow

. 42
4
2
The Balance Sheet

43
The Balance Sheet

• Shows a firm’s accounting value on a particular date.

Assets = Liabilities + Shareholders’ Equity

=> Assets - Liabilities = Shareholders’ Equity

• In an accounting, shareholders’ equity is defined as

this residual portion after creditors are paid
• More important, it is also true in an economic sense:
If the firm sells its assets and pays its debts,
whatever cash is left belongs to the shareholders.

44
 The Balance Sheet

the assets
can be converted
to cash
within 12 months

45
Liquidity

• The assets on the balance sheet are listed in order

of liquidity
• Liquidity refers to the speed and ease with which,
an asset which can be converted to cash, without
significant loss of value, in the normal course of
business.
• The more liquid a business is, the less likely it is to
experience financial distress BUT liquid assets
(such as Account Receivables, Inventory, Short-
term deposit) are less profitable to hold.

46
The Balance Sheet

Discussion:
• How dairy cows are recorded to Balance of Vinamilk
(VNM)?
• What could be intangible assets of Vinamilk?

47
The Balance Sheet
• How dairy cows are recorded to Balance of Vinamilk
(VNM)? -> Tangible Fixed Assets

48
The Balance Sheet
• What could be intangible assets of Vinamilk?

49
Debt vs Equity

• Creditors have first claim on a firm’s cash flow;

equityholders have a residual claim.

• Financial leverage increases the potential reward to

shareholders, but also increases the potential for
financial distress and business failure (will be
analyzed further in “Du Pont Identity” of Chapter 3)

50
‘Book value’ vs ‘Market Value'
• The values shown on the balance sheet for the firm’s assets
are book values and generally are not what the assets are
actually worth.
• In other words, assets are “carried on the books” at what the
firm paid for them, no matter how long ago they were
purchased or how much they are worth today.
• For financial managers :
• the accounting value of the stock is not an especially
important concern;
• the market value matters -> whenever we speak of the
value of an asset or the value of the firm, we will
normally mean its market value (or the price that the
asset would be transferred in the current market place)

51
‘Book value’ vs ‘Market Value'

Book Market Book Market

Assets Liabilities and Equity

Net working $1 000 $1 000 Long-term $1 400 $1 400
capital debt
Fixed assets $1 700 $2 400 Equity $1 300 $2 000

Total $2 700 $3 400 Total $2 700 $3 400

52
Income Statement
• Measures a firm’s performance over a period of time.

Revenues - Expenses = Profit

• Profits are either

– paid to shareholders as cash dividends, or
– retained in the firm as ‘retained earnings’ (to
re-invest for future growth)

53
Balance Sheet - Example
Begin End Begin End
Cash $100 $150 Creditors $100 $150
Debtors 200 250 Notes payable 200 200
Inventory 300 300 Current liabilities 300 350
Current assets $600 $700 Long term debt $400 $420
Net fixed Capital 50 60
assets 400 500 Retained earnings 250 370
$300 $430
Total assets $1000 $1200 Liabilities & equity $1000 $1200

54
54
 Income Statement -
Example
$
Sales 2,000
Costs (1,400)
Depreciation (100)
EBIT (operating income) 500
Interest (100)
Taxable Income 400
Taxes (200)
Profit 200
Dividends (80)
Addition to retained earnings 120

. 55
55
 Profit vs Cash flows
The figures on the Income Statement will differ from actual cash
inflows and outflows during a period due to:
– Revenues and costs being recorded when they are
realised, not when they are received or paid.
– The existence of non-cash items such as depreciation
and pre-paid expense allocation.

. 56
56
 Retained earnings
When firms make profits (or loss), where does it show in the balance
sheet??
Retained earnings

Retained earnings is one of the items in ‘shareholders’ equity part of the

balance sheet. It can be roughly calculated as:
Retained earnings = Beginning balance + net profit in the year - dividends

Example: In 2010, XYZ Co. has the retained earnings of $14,500,000.

In year 2011, XYZ make a net loss of $1,000,000. In the same year, in
spite of making loss, the firm decide to pay the dividend of $500,000 to
shareholders. What will be the retained earnings shown in the 2011
balance sheet?

=> Retained earnings = 14,500,000 - 1,000,000 - 500,000

= 13,000,000

. 57