slide 1 introduction to financial management definitions of finance financial management decisions...
TRANSCRIPT
Slide 1
Introduction to Financial Management Definitions of Finance Financial Management Decisions and The Goal Forms of Business Organizations The Corporation and Financial Markets Ten Principles of Finance
Slide 2
Definition of Finance Finance is the study of how people allocate scarce
resources over time. Two characteristics of financial decisions; Costs and benefits of financial decisions are spread out
over time Costs and benefits are not known in advance
Finance consists of concepts to help you organize your decision making process and quantitative models to help you evaluate alternatives
Slide 3
Financial Management Decisions and The Goal Capital Budgeting: What assets should be
acquired? Capital Structure: What is the best way of
financing the assets? Working Capital Management: Short-term asset
and liability management
Slide 4
Financial Management Decisions and The Goal (Continued)
The Goal of Financial Managers Maximize profits How to define profits Risks associated with maximizing profits are ignored Profits of this year or the next should be maximized?
Maximize the market value of the existing owners’ equity
Slide 5
Forms of Business Organization
Ownership Form
Ease of Formation
Ability to Raise Funds
Management Personal Liability
Income Tax Treatment
Transfer of Ownership
Dissolution
Individual (Sole Proprietorship)
Simple and inexpensive
Limited Flexible, independent, may lack expertise
Unlimited Single Simple and inexpensive
Excellent
General Partnership
Moderately easy
Limited but superior to individual ownership
Designated partners
Unlimited Single Poor Fairly simple
Limited Partnership
Moderately difficult and expensive
Limited but superior to general partnership
General partners or agents
Limited for limited partners
Single Poor for general partners
Time consuming
Corporation Complex and expensive
Good Usually separate from ownership
Limited Double Superior
Simple but needs shareholders’ approval
Slide 6
The Corporation and Financial Markets
Corporation
Cash Flows: Reinvested or
Investors
Secondary Market
GovernmentTax
Cash
Securities
Dividends, Interest etc.
Slide 7
The Corporation and Financial Markets (Continued) Primary Market
Market in which new issues of a security are sold to initial buyers
Secondary Market Market in which previously issued securities are traded
Initial Public Offering (IPO) The first time the firm’s stock is sold to the general public
Seasoned Equity Offering (SEO) A new stock offering by a firm that already has stock that is
traded in the secondary market
Slide 8
Ten Principles of Financial Management Risk-Return Tradeoff
Save and invest for future consumption Investments should provide appropriate compensation
for forgone consumption
Slide 9
Ten Principles of Financial Management (Continued)
90%
Large-companystocks 13.3% 20.1
Small-companystocks 17.6 33.6
Long-termcorporate bonds 5.9 8.7
Long-termgovernment 5.5 9.3
Intermediate-termgovernment 5.4 5.8
U.S. Treasurybills 3.8 3.2
Inflation 3.2 4.5
-90% 0%
SeriesAverageReturn
StandardDeviation Distribution
Slide 10
Ten Principles of Financial Management (Continued)
The Time Value of Money A dollar received today is more valuable than a dollar
received in the future because of opportunity cost Costs and future benefits of investments should be
measured in present values If present value of future benefits exceed costs, then
investment should be made (Net Present Value (NPV)>0)
Slide 11
Ten Principles of Financial Management (Continued)
Cash is King Cash flows not accounting profits are important Cash flows received can be reinvested by the firm Accounting problems-depreciation and matching of
costs and expenses Incremental Cash Flows that Matter
Incremental cash flows are direct consequence of taking a specific course of action
Slide 12
Ten Principles of Financial Management (Continued)
Competitive Markets Project evaluation vs. value creation-investing for
returns above same risk alternatives It is not easy to find projects that create wealth-
competition Perfect market conditions: No entry and exit
restrictions, No one producer or buyer large enough to affect prices, Identical products are manufactured, Production costs are identical, Everyone is informed about everything
Slide 13
Ten Principles of Financial Management (Continued)
If markets are perfect then it is not possible to create wealth
How can we make markets less competitive? Product Differentiation based on features, quality,
image, service and distribution Cost Advantage through economies of scale,
technology, corporate culture and input supply control
Slide 14
Ten Principles of Financial Management (Continued)
Efficient Markets Price adjustments to new information is quick and
correct Many profit driven investors Information arrival is random
Slide 15
Ten Principles of Financial Management (Continued)
“Calwest Industrial Properties, a closely held real-estate concern, has agreed to acquire Cabot Industrial Trust (CTR) for about $1.06 billion plus the assumption of $925 million in preferred stock and debt, people familiar with the matter say. Under terms of the deal, Calwest would pay $24 a share for Boston-based Cabot. The price represents a 20% premium to Cabot's price in 4 p.m. trading Friday on the New York Stock Exchange, when its shares were changing hands at $19.95, down five cents for the day.” WSJ, October 29, 2001
Slide 16
Ten Principles of Financial Management (Continued)
Slide 17
Ten Principles of Financial Management (Continued)
Agency Problem Separation of ownership and management Principal-Shareholders Agents-Managers Will managers work in the shareholders’ best interest? Preference toward size over profitability Excessive perquisites Attitudes toward risk
Slide 18
Ten Principles of Financial Management (Continued)
Types of agency costs Costs of trying to get the agents to do what the
principal want-monitoring costs Lost opportunities caused by conflicts too expensive to
resolve Possible solutions
Managerial compensation Control of the firm
Slide 19
Ten Principles of Financial Management (Continued)
Taxes Bias Business Decisions After-tax cash flows received can be reinvested Favorable tax status for certain investments affects
decisions Financial leverage is affected by tax status-interest
payments are tax-deductible expenses
Slide 20
Ten Principles of Financial Management (Continued)
Diversification Eliminates Certain Type of Risk Diversifiable/Firm Specific/Unsystematic Risk Non-diversifiable/Market/Systematic Risk Firm specific good news and bad news wash each
other out
Slide 21
Ten Principles of Financial Management (Continued)
Slide 22
Ten Principles of Financial Management (Continued)
Ethical Behavior is Doing the Right Thing Doing something that is viewed right by many people An action that is not prohibited by law can be unethical Unethical behavior might be costly