Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

I. Overview of Corporate

Finance

1. Introduction to Corporate
   Finance

© The McGraw−Hill^37

Companies, 2002

Capital Budgeting The first question concerns the firm’s long-term investments.
The process of planning and managing a firm’s long-term investments is called capital
budgeting. In capital budgeting, the financial manager tries to identify investment
opportunities that are worth more to the firm than they cost to acquire. Loosely speak-
ing, this means that the value of the cash flow generated by an asset exceeds the cost of
that asset.
The types of investment opportunities that would typically be considered depend
in part on the nature of the firm’s business. For example, for a large retailer such as
Wal-Mart, deciding whether or not to open another store would be an important capital
budgeting decision. Similarly, for a software company such as Oracle or Microsoft, the
decision to develop and market a new spreadsheet would be a major capital budgeting
decision. Some decisions, such as what type of computer system to purchase, might not
depend so much on a particular line of business.
Regardless of the specific nature of an opportunity under consideration, financial
managers must be concerned not only with how much cash they expect to receive, but
also with when they expect to receive it and how likely they are to receive it. Evaluat-
ing the size, timing,and riskof future cash flows is the essence of capital budgeting. In

CHAPTER 1 Introduction to Corporate Finance 5

FIGURE 1.1

Board of Directors

Chairman of the Board and

Chief Executive Officer (CEO)

President and Chief

Operations Officer (COO)

Vice President

Production

Treasurer Controller

Cash Manager Credit Manager Tax Manager Cost AccountingManager

Capital

Expenditures

Financial

Planning

Financial

Accounting

Manager

Data Processing

Manager

Vice President

Finance (CFO)

Vice President

Marketing

A Simplified Organizational Chart.

The exact titles and organization differ from company to company.

capital budgeting

The process of planning

and managing a firm’s

long-term investments.