PART ONECHAPTER1Introduction to Corporate FinanceIn July 1999, Carleton “Carly” Fiorina assumed the position of CEO of Hewlett-Packard (HP). Investors were pleased with her view of HPs future: She promised 15 percent annual growth in sales and earnings, quite a goal for a company with five consecutive years of declining revenue. Ms. Fiorina also changed the way HP was run. Rather than continuing to operate as separate product groups, which essentially meant the company operated as dozens of minicompanies, Ms. Fiorina reorganized the company into just two divisions.In 2002, HP announced that it would merge with Compaq Computers. However, in one of the more acrimonious recent corporate battles, a group led by Walter Hewlett, son of one of HPs cofounders, fought the merger. Ms. Fiorina ultimately prevailed, and the merger took place. With Compaq in the fold, the company began a two-pronged strategy. It would compete with Dell in the lower-cost, more commodity-like personal computer segment and with IBM in the more specialized, high-end computing market.Unfortunately for HPs shareholders, Ms. Fiorinas strategy did not work out as planned; in February 2005, under pressure from HPs board of directors, Ms. Fiorina resigned her position as CEO. Evidently investors also felt a change in direction was a good idea; HPs stock price jumped almost 7 percent the day the resignation was announced.Understanding Ms. Fiorinas rise from corporate executive to chief executive officer, and finally to ex-employee, takes us into issues involving the corporate form of organization, corporate goals, and corporate control, all of which we discuss in this chapter.11.1 What Is Corporate Finance?Suppose you decide to start a firm to make tennis balls. To do this you hire managers to buy raw materials, and you assemble a workforce that will produce and sell finished ten-nis balls. In the language of finance, you make an investment in assets such as inventory, machinery, land, and labor. The amount of cash you invest in assets must be matched by an equal amount of cash raised by financing. When you begin to sell tennis balls, your firm will generate cash. This is the basis of value creation. The purpose of the firm is to create value for you, the owner. The value is reflected in the framework of the simple balance sheet model of the firm.The Balance Sheet Model of the FirmSuppose we take a financial snapshot of the firm and its activities at a single point in time. Figure 1.1 shows a graphic conceptualization of the balance sheet, and it will help intro-duce you to corporate finance.ros05902_ch01.indd 1 9/25/06 9:25:26 AM2 Part I OverviewThe assets of the firm are on the left side of the balance sheet. These assets can be thought of as current and fixed. Fixed assets are those that will last a long time, such as buildings. Some fixed assets are tangible, such as machinery and equipment. Other fixed assets are intangible, such as patents and trademarks. The other category of assets, current assets, comprises those that have short lives, such as inventory. The tennis balls that your firm has made, but has not yet sold, are part of its inventory. Unless you have overproduced, they will leave the firm shortly.Before a company can invest in an asset, it must obtain financing, which means that it must raise the money to pay for the investment. The forms of financing are represented on the right side of the balance sheet. A firm will issue (sell) pieces of paper called debt (loan agreements) or equity shares (stock certificates). Just as assets are classified as long-lived or short-lived, so too are liabilities. A short-term debt is called a current liability. Short-term debt represents loans and other obligations that must be repaid within one year. Long-term debt is debt that does not have to be repaid within one year. Shareholders equity represents the difference between the value of the assets and the debt of the firm. In this sense, it is a residual claim on the firms assets.From the balance sheet model of the firm, it is easy to see why finance can be thought of as the study of the following three questions:1. In what long-lived assets should the firm invest? This question concerns the left side of the balance sheet. Of course the types and proportions of assets the firm needs tend to be set by the nature of the business. We use the term capital budgeting to describe the process of making and managing expenditures on long-lived assets.2. How can the firm raise cash for required capital expenditures? This question con-cerns the right side of the balance sheet. The answer to this question involves the firms capital structure, which represents the proportions of the firms financing from current and long-term debt and equity.3. How should short-term operating cash flows be managed? This question concerns the upper portion of the balance sheet. There is often a mismatch between the timing of Long-term debtCurrent assetsFi