Académique Documents
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Education Objectives
1. What is Finance? Know the basic types of financial management decisions and the role of the financial manager 2. Know the financial implications of the different forms of business organization 3. Know the goal of financial management 4. Understand the conflicts of interest that can arise between owners and managers (agency relationships) 5. Understand the various types of financial markets
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What is Finance?
A discipline concerned with determining value (what something is worth today) and making decisions based on that value assessment. The finance function allocates resources, including the acquiring, investing, and managing of resources.
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Investments
The study of financial transactions from the perspective of investors outside the firm. Examples: How do we assess the risk of various financial securities? How do we manage a portfolio (a grouping) of financial securities to achieve a stated objective of the investor? How do we evaluate portfolio performance?
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Corporate Finance
Corporate Finance addresses the following: What long-term investments should the firm take on? (capital budgeting decision) Where will we get the long-term financing to pay for the investment? (capital structure decision) How will we manage the everyday financial activities of the firm? (working capital management decision) Examples of Financial decisions affecting firms: Dell computer expands its product line. Gap builds additional stores. Nike closes a production plant in Asia. Ford borrows $3 billion. Perot Systems issues stock valued at $3 billion.
The World
Financial Intermediaries
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(2)
Financial Manager
(4a)
(3)
(1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors
(4b)
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The question here is how will the firm fund that investment?
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Current Assets
Shareholders Equity
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How can the firm raise the money for the required investments?
Long-Term Debt
Shareholders Equity
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Current Assets
Long-Term Debt
How much shortterm cash flow does a company need to pay its bills?
Shareholders Equity
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Assets
Or
25% Debt 75% Equity 70% Debt 30% Equity
Or...
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An Organization Chart
Financial Manager
The top financial manager within a firm is usually the Chief Financial Officer (CFO)
Treasurer: oversees cash management, credit management, capital expenditures and financial planning Controller: oversees taxes, cost accounting, financial accounting and data processing
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Sole Proprietorship
Under this organization method, an individual owns and manages the business Disadvantages Advantages Easiest to start Least regulated Single owner keeps all the profits Taxed once as personal income Limited to life of owner Equity capital limited to owners personal wealth Unlimited liability Difficult to sell ownership interest
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Partnership
Under this organization method, a group of individuals collectively own and manage the business. A partnership has roughly the same advantages and disadvantages as a sole proprietorship. Advantages Two or more owners More capital available Relatively easy to start Disadvantages Unlimited liability General partnership Limited partnership
Income taxed once as personal Partnership dissolves when one income partner dies or wishes to sell Difficult to transfer ownership
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Corporation
A corporation is created via Articles of Incorporation. These: Set out the purpose of the business. Establish the number of shares that can be issued. Set the number of directors to be appointed. Ownership and management are separated. A corporation issues equity shares. The holders of these shares are the owners of the firm. Although stockholders own the corporation, they do not necessarily manage it. Instead they vote to elect a Board of Directors (BOD). The BOD represents the shareholders and in this vein, (i) selects the management team, (ii) appoints the auditors and (iii) is responsible 27 for checking/monitoring managements actions.
Assets
Debt Equity
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Corporation
Advantages
Limited liability Unlimited life Separation of ownership and management Transfer of ownership is easy Easier to raise capital
Disadvantages
Separation of ownership and management (and the resulting potential for agency costs) Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate)*
* Not for Singapore
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Corporation
Private Companies firms shares are usually closely held, i.e., ownership is closely held by a relatively small number of shareholders and shareholders often include the companies original founders, some financial backers (e.g., venture capitalists) and others. Shares are not traded on any exchange. Public Companies firms shares are listed on a stock exchange, whereby the companys shares are widely dispersed and traded in the secondary markets.
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The market price is based on perceived information as seen by the marginal investor in the market trying to assess an assets intrinsic value (can be theoretically incorrect). 36
Capital Budgeting
Capital Structure
Agency problem
Conflict of interest between principal and agent
Agency Costs
Direct agency costs
expenditures that benefit management: car and accommodation, big office, high pay monitoring costs: auditors, audit committee, corporate governance
Agency Costs Example: HSBC Faces Investor Anger Over Proposed Pay Rise For Top Team
by Katherine Griffiths, Miles Costello,16/2/2010
HSBC, the global bank that has been praised for its handling of the financial crisis, has clashed with shareholders over a proposed pay rise for its executive team. Investors are understood to be particularly unhappy with the sum that HSBC wants to pay Michael Geoghegan, its chief executive, who relocated his office to Hong Kong on February 1. HSBC will pay Michael Geoghegan, chief executive, an extra 800,000 a year in "allowances" and "benefits in kind" for moving his family from London to Hong Kong.
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2.
3.
4.
Good corporate governance requires you to view organizations as a web of relationships between and among various stakeholders and to manage their interests in a responsible manner.
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Capital markets
where equity and long-term debt claims are traded usually auction markets like the Singapore Exchange
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One of China's biggest banks is on track to become the largest IPO in history. Agricultural Bank of China, a lender which boasts more customers than the entire U.S. population, has raised $19.2 billion from investors, according to an individual familiar with the matter.
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Share Issuance
Retained Earnings
Bank Borrowing
Bond Issuance
Residual Claims
Contractual Obligations
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Summary
1. The scope of financial studies involves business finance, financial markets and investments. 2. Business finance involves investment and financing decisions & working capital management. 3. The goal of financial management is to make decisions that maximise the market value of the equity or owners wealth. 4. There are conflicts of interest between shareholders and managers - agency costs
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