[SOUND] So let's start talk about how companies finance investments. Corporate Finance 1 was about spending cash, we talked about topics such as the net present value, the internal rates of return, cost of capital. What we're going to do in this course is, we're going to talk about how companies raise cash to finance the spending. Issues like debt financing, equity financing, risk management, so this is going to be the topics we're going to talk about. After all, cash doesn't grow on trees, so it's very important to think about how companies raise the cash there that is going to fund their activities. Which investments are we thinking about? We're going to focus mostly on financing new investments, such as research and development, R&D, and mergers and acquisitions, M&A. We actually have a couple examples in Module 4, where we're going to do some case studies focussed on R&D and M&A. But it's important to notice upfront that companies also need to raise capital for other activities. For example, refinancing existing debt, you may want to refinance your debt to lower interest rates, for example. Debt forces companies to go to capital markets. You might even have to raise capital to make payments to suppliers in some cases. All right, or you might simply want to reoptimize your capital structure. Maybe you think you don't have enough debt, you want to increase your leverage, or you want to reduce your leverage. Debt, again, is going to force companies to go to capital markets and raise some finance. In this module, Module 1, our initial step is going to be to think about the most basic decision that companies have to make. Which is to think about whether companies are going to raise capital by issuing debt, right, to get a loan from a bank, or to issue a bond in public markets, or whether companies are going to issue equity. Companies are going to raise capital by giving ownership to investors and raise capital from investors. Debt or equity, that's going to be the key topic of Module 1. What we'll learn first is we're going to talk about how debt and equity financing affect the financial statements that we were talking in Corporate Finance I. Right, so we're going to learn how debt and equity financing change income, cash flow statements, how they change companies' profits. We're going to compute the net present value of both debt and equity issuance. Remember that net present value is the key tool that we have to analyze corporate decisions. We can also use NPV to think about that inequity. And then we're going to talk about true mistakes that practitioners make, that students make, when they are thinking about capital structure. The first one is that dilution is an illusion. There is no such thing as dilution. The number of shares outstanding actually does not matter. We're going to talk about that. And then we're going to talk about why that issuance is not mechanically going to reduce the cost of capital. Our math, in this case, the math is actually misleading. Usually, math is right, but math can also get, mathematics that I'm talking about, mathematics can also get you to the wrong place. And here you are going to see that doing a simple calculation can actually give you the wrong answer. Then we're going to talk about the key relationship between debt and systematic risk, right? The idea is that debt is going to increase a company's data, which is behind the logic in a key result in Corporate Finance, which is the Modigliani and Miller proposition. The Modigliani and Miller proposition is going to show you why issuing that will not necessarily reduce the cost of capital. Then we're going to move on and talk about research. As I mentioned in the introduction of this course, this course is going to draw a lot on the research that we researchers have done about capital structure and other topics in the last few years. The first issue you're going to learn is that equity issuance stands to cause a decrease in stock prices. I'm going to show you some data that shows this. Perhaps because of this effect of equity issuance on stock prices, companies are reluctant to issue equity to finance projects. Then we're going to talk about how that affects profits, and one of the key effects is going to be through taxes. We're going to calculate the effect of leverage on taxes and how leverage affects our ultimate measure of profitability, which is OPAT, operating profit after taxes. And then we're going to talk about other effects that might mitigate disadvantage of that, like personal taxes and cost of financial distress, right? Costs of financial distress are going to increase with leverage because leverage increases distress risk. And ultimately, what we're going to end up with is a model that we call the tradeoff theory of capital structure, which balances the costs and benefits of having higher leverage. And I'm going to show you this model, talk about some data, some recent research about the trade-off model. And then what we're going to do following up, in future models of this course, is to try to use the trade-off theory to analyze firms' capital structure choices in the real world [SOUND]
