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While it markets its products around the world for manufacturing high-grade paper,
we will use it to illustrate some of the questions that have to be dealt with when
analyzing a company in an environment where inflation is high and volatile, and
where the economy itself is in transition.
4. Deutsche Bank: Deutsche Bank is the leading commercial bank in Germany and is
also a leading player in investment banking with its acquisition of Morgan Grenfell,
the U.K investment bank, and Banker™s Trust in the United States. We will use
Deutsche Bank to illustrate some of the issues the come up when a financial service
firm has to make investment, financing and dividend decisions.

A Resource Guide
In order to make the learning in this book as interactive and current as possible,
we will employ a variety of devices:

The first are illustrative examples using the four companies described above, where

we will apply corporate finance principles to these firms. These examples will be
preceded by the symbol ✍
The second are spreadsheet programs that can be used to do some of the analysis that

will be presented in this book. For instance, there are spreadsheets that calculate the
optimal financing mix for a firm as well as valuation spreadsheets. These will be

preceded by the symbol
The third supporting device we will use are updated data on some of the inputs that

we need and use in our analysis that is available on the web site for this book. Thus,
when we estimate the risk parameters for firms, we will draw attention to the data set
that is maintained on the web site that reports average risk parameters by industry.

These data sets will be preceded by the symbol
At regular intervals, we will also stop and ask readers to answer questions relating to

a topic. These questions, which will generally be framed using real world examples,
will help emphasize the key points made in a chapter. They will be preceded by the
symbol ˜
Finally, we will introduce a series of boxes titled “In Practice”, which will look at

issues that are likely to come up in practice and ways of addressing these issues.
These will be preceded by the symbol „.

Some Fundamental Propositions about Corporate Finance
There are several fundamental arguments we will make repeatedly throughout this
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.

This chapter establishes the first principles that govern corporate finance. The
investment principle, that specifies that businesses invest only in projects that yield a
return that exceeds the hurdle rate, the financing principle, that suggests that the right
financing mix for a firm is one that maximizes the value of the investments made and the
dividend principle, which requires that cash generated in excess of “good project” needs
be returned to the owners, are the core for what follows.


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