Some Fundamental Propositions about Corporate Finance

There are several fundamental arguments we will make repeatedly throughout this book.

1. Corporate finance has an internal consistency that flows from its choice of maximizing firm value as the only objective function and its dependence upon a few bedrock principles: risk has to be rewarded; cash flows matter more than accounting income; markets are not easily fooled; every decision a firm makes has an effect on its value.

2. Corporate finance must be viewed as an integrated whole, rather than as a collection of decisions. Investment decisions generally affect financing decisions, and vice versa; financing decisions generally affect dividend decisions, and vice versa. While there are circumstances under which these decisions may be independent of each other, this is seldom the case in practice. Accordingly, it is unlikely that firms that deal with their problems on a piecemeal basis will ever resolve these problems. For instance, a firm that takes poor investments may soon find itself with a dividend problem (with insufficient funds to pay dividends) and a financing problem (because the drop in earnings may make it difficult for them to meet interest expenses).

3. Corporate finance matters to everybody. There is a corporate financial aspect to almost every decision made by a business; while not everyone will find a use for all the components of corporate finance, everyone will find a use for at least some part of it. Marketing managers, corporate strategists human resource managers and information technology managers all make corporate finance decisions every day and often don't realize it. An understanding of corporate finance may help them make better decisions.

4. Corporate finance is fun. This may seem to be the tallest claim of all. After all, most people associate corporate finance with numbers, accounting statements and hardheaded analyses. While corporate finance is quantitative in its focus, there is a significant component of creative thinking involved in coming up with solutions to the financial problems businesses do encounter. It is no coincidence that financial markets remain the breeding grounds for innovation and change.

5. The best way to learn corporate finance is by applying its models and theories to real world problems. While the theory that has been developed over the last few decades is impressive, the ultimate test of any theory is in applications. As we show in this book, much, if not all, of the theory can be applied to real companies and not just to abstract examples, though we have to compromise and make assumptions in the process.

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