chapter 1-finance.ppt

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FNC 2013Principle of Finance

Chapter 1

An Introduction to Financial

Management



Overview

1.What is Finance

2.Goal of the firm

3.Legal forms of Business Organizations

4.The Goal of the Financial Manager

5.The Four Basic rinci!les of Finance

2



Learning O"#ecti$es

1. %&entif' the goal of the firm.

2. %&entif' the (e' &ifferences "et)een 3ma#or legal forms of "usiness.

3. *n&erstan& the role of the financialmanager )ithin the firm an& the goal forma(ing financial choices.

4. Memorize the 4 !rinci!les of finance thatform the "asis of financial managementfor "oth "usinesses an& in&i$i&uals.

3



What is Finance?

+Finance is the study of how people andbusinesses evaluate investments andraise capital to fund them. (-- How to getand use money)

+ Three uestions addressed by the study of

!nance". What lon#-term investments should the !rmunderta$e? (capital budgeting decisions –how to spend the money?%

2. &ow should the !rm fund these investments?(capital structure decisions -- How to get the

money?%3. &ow can the !rm best mana#e its cash 'ows

as they arise in its day-to-day operations?(working capital management decisions –how to manage cash (liquid) money?%



Why study !nance

+ Marketing

, Bu&gets- mar(eting research- mar(eting financial!ro&ucts

+ Accounting

, ual accounting an& finance function- !re!aration offinancial statements

+ Management

, /trategic thin(ing- #o" !erformance- !rofita"ilit'

+ Personal finance

, Bu&geting- retirement !lanning- college !lanning- &a'0to0&a' cash flo) issues

)



Goal of the firm

+ The goal of the firm is maimization of

sharehol&er )ealth

or

+ Maimization of the !rice of the eisting

common stoc(

*



Three Types of +usinessOr#ani,ations



/ole ro!rietorshi!

+ %t is a "usiness o)ne& "' a single in&i$i&ual that isentitle& to all the firms !rofits an& is res!onsi"le for allthe firms &e"t.

+ There is no se!aration "et)een the "usiness an& theo)ner )hen it comes to &e"ts or "eing sue&.

+ /ole !ro!rietorshi!s are generall' finance& "'!ersonal loans from famil' an& frien&s an& "usinessloans from "an(s.

+ &$antages , as' to start

, 6o nee& to consult others )hile ma(ing &ecisions , Tae& at the !ersonal ta rate

+ isa&$antages , ersonall' lia"le for the "usiness &e"ts , 7eases on the &eath of the !ro!rietor

F/30001 iuren Wu



4artnership

+ general partnership is an association of t)o or more

!ersons )ho come together as co0o)ners for the

!ur!ose of o!erating a "usiness for !rofit.

+ There is no se!aration "et)een the !artnershi! an& the

o)ners )ith res!ect to &e"ts or "eing sue&.

+ &$antages

, 8elati$el' eas' to start

, Tae& at the !ersonal ta rate

, ccess to fun&s from multi!le sources or !artners

+ isa&$antages

, artners #ointl' share unlimite& lia"ilit'

5



Limite& artnershi!

+ %n limited partnerships- there are t)oclasses of !artners general an& limite&.

+ The general !artners runs the "usiness

an& face unlimite& lia"ilit' for the firms&e"ts- )hile the limite& !artners are onl'lia"le on the amount in$este&.

+ One of the &ra)"ac( of this form is that itis &ifficult to transfer the o)nershi! of thegeneral !artner.

F/30001 iuren Wu "0



7or!oration

+ 7or!oration is 9an artificial "eing- in$isi"le-intangi"le- an& eisting onl' in the contem!lationof the la).:

+ 7or!oration can in&i$i&uall' sue an& "e sue&-

!urchase- sell or o)n !ro!ert'- an& its !ersonnelare su"#ect to criminal !unishment for crimescommitte& in the name of the cor!oration.

+ 7or!oration is legall' o)ne& "' its currentstoc(hol&ers.

+ The Boar& of &irectors are electe& "' the firmssharehol&ers. One res!onsi"ilit' of the "oar& of&irectors is to a!!oint the senior management ofthe firm.

F/30001 iuren Wu ""



7or!oration ros ; 7ons

+ &$antages

, Lia"ilit' of o)ners limite& to in$este& fun&s

, Life of cor!oration is not tie& to the o)ner

, asier to transfer o)nershi! , asier to raise 7a!ital

+ isa&$antages

, Greater regulation

, ou"le taation of &i$i&en&s

"2



<'"ri& Organizations

+ These organizational forms !ro$i&e a cross"et)een a !artnershi! an& a cor!oration.

+ Limited liabilit compan =LL7> com"ines the

ta "enefits of a !artnershi! =no &ou"le taation ofearnings> an& limite& lia"ilit' "enefit ofcor!oration =the o)ners lia"ilit' is limite& to )hatthe' in$est>.

+ !"tpe corporation !ro$i&es limite& lia"ilit' )hile

allo)ing the "usiness o)ners to "e tae& as ifthe' )ere a !artnershi! , that is- &istri"utions"ac( to the o)ners are not tae& t)ice as is thecase )ith &i$i&en&s in the stan&ar& cor!orateform.

"3



F/30001 iuren Wu "



The Goal of the Financial Manager

+ The goal of the financial manager must "e consistent )iththe mission of the cor!oration.• To maimize firm $alue sharehol&ers )ealth =as

measure& "' share !rices>.+ While managers ha$e to cater to all the sta(ehol&ers =such

as consumers- em!lo'ees- su!!liers etc.>- the' nee& to!a' !articular attention to the o)ners of the cor!oration-i.e.- sharehol&ers.

+ %f managers fail to !ursue sharehol&er )ealthmaimization- the' )ill lose the su!!ort of in$estors an&len&ers. The "usiness ma' cease to eist an& ultimatel'-the managers )ill lose their #o"s?

")



7or!orate Mission /tatements

am!les

+ 9To achie$e sustaina"le gro)th- )e ha$e esta"lishe& a

$ision )ith clear goals Maimizing return to

sharehol&ers )hile "eing min&ful of our o$erall

res!onsi"ilities: =!art of 7oca07olas mission statement>

+ 9Our final res!onsi"ilit' is to our stoc(hol&ers @)hen

)e o!erate accor&ing to these !rinci!les- the

stoc(hol&ers shoul& realize a fair return: =!art of

Aohnson ; Aohnsons cre&o>+ 9O!timize for the long0term rather than tr'ing to !ro&uce

smooth earnings for each uarter: 00 Google.

"*



The Four Basic rinci!les of

Finance

1. Mone' has a time $alue. , &ollar recei$e& to&a' is more $alua"le than a &ollar recei$e& in the

future =&ue to interests- in$estment returns-@>

2. There is a ris(0return tra&e0off.

, One shall ta(e etra ris( onl' if one e!ects to "e com!ensate& for etrareturn.

3. 7ash flo)s are the source of $alue. , rofit is an accounting conce!t &esigne& to measure a "usinesss

!erformance o$er an inter$al of time. , 7ash flo) is the amount of cash that can actuall' "e ta(en out of the

"usiness o$er this same inter$al.

4. Mar(et !rices reflect information. , %n$estors res!on& to ne) information "' "u'ing an& selling their

in$estments.

"



Ten 4rinciples That Form The

Foundations of Financial6ana#ement

9@although it is not necessar' to un&erstan& finance

in or&er to un&erstan& these !rinci!les- it is

necessar' to un&erstan& these !rinci!les in or&er to

un&erstan& finance.:



rinci!le 1 The 8is(08eturn

Tra&e0off

+ We )ont ta(e on a&&itional ris( unless )e

e!ect to "e com!ensate& )ith a&&itional

return.+ %n$estment alternati$es ha$e &ifferent

amounts of ris( an& e!ecte& returns.

+The more ris( an in$estment has- the higherits e!ecte& return )ill "e.

4earson 4rentice &all Foundations of Finance



rinci!le 2 The Time Calue of

Mone'

+ &ollar recei$e& to&a' is )orth more than a

&ollar recei$e& in the future.

+ Because )e can earn interest on mone'

recei$e& to&a'- it is "etter to recei$e mone'

earlier rather than later.




rinci!le 3 7ashD6ot rofits

+ 7ash Flo)- not accounting !rofit- is use& as our

measurement tool.

+ 7ash flo)s- not !rofits- are actuall' recei$e& "'the firm an& can "e rein$este&.




rinci!le 4 %ncremental 7ash

Flo)s

+ %t is onl' )hat changes that counts

+ The incremental cash flo) is the

&ifference "et)een the !ro#ecte& cash

flo)s if the !ro#ect is selecte&- $ersus

)hat the' )ill "e- if the !ro#ect is not

selecte&.




rinci!le 5 The 7urse of

7om!etiti$e Mar(ets

+ %t is har& to fin& ece!tionall' !rofita"le !ro#ects

+ %f an in&ustr' is generating large !rofits- ne) entrants

are usuall' attracte&. The a&&itional com!etition an&a&&e& ca!acit' can result in !rofits "eing &ri$en &o)n

to the reuire& rate of return.

, ro&uct ifferentiation- /er$ice an& Eualit' can

insulate !ro&ucts from com!etition




rinci!le fficient 7a!ital

Mar(ets

+ The mar(ets are uic( an& the !rices are

right.

+ The $alues of all assets an& securities at an'

instant in time full' reflect all a$aila"le

information.




rinci!le The genc' ro"lem

+ Managers )ont )or( for the o)ners unless it is in

their "est interest

+ The se!aration of management an& the

o)nershi! of the firm creates an agenc' !ro"lem.

, Managers ma' ma(e &ecisions that are not in line )ith

the goal of maimization of sharehol&er )ealth.




rinci!le H Taes Bias Business

ecisions

+ The cash flo)s )e consi&er are the

after0ta incremental cash flo)s tothe firm as a )hole.




rinci!le I ll 8is( is 6ot ual

+ /ome ris( can "e &i$ersifie& a)a'-

an& some cannot+ The !rocess of &i$ersification can

re&uce ris(- an& as a result-

measuring a !ro#ects or an assetsris( is $er' &ifficult.




rinci!le 1J thical Beha$ior %s oing the 8ight

Thing- an& thical ilemmas re $er')here in

Finance

+ ach !erson has his or her o)n set

of $alues- )hich forms the "asis for!ersonal #u&gments a"out )hat is

the right thing


chapter 1-finance.ppt

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