BUSM4160 Managerial Finance

Topic 1: Introduction to Corporate Finance

Key Concepts and Skills

Know the basic types of financial
management decisions and the role
of the Financial Manager
Know the financial implications of the
various forms of business
organization
Know the goal of financial
management
Understand the conflicts of interest
that can arise between owners and
managers
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Topic Outline
What is Corporate Finance?
The Corporate Firm
The Importance of Cash Flows
The Goal of Financial Management
The Agency Problem and Control of the
Corporation
Regulation
Introduction to mathematics of finance
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What is Corporate Finance?

Corporate Finance addresses the
following three questions:
1. What long-term investments
should the firm choose?
2. How should the firm raise funds
for the selected investments?
3. How should short-term assets be
managed and financed?
4

Balance Sheet Model of the Firm

Total Value of Assets:

Current Assets

Total Firm Value to Investors:

Current
Liabilities
Long-Term
Debt

Fixed Assets
1 Tangible
2 Intangible

Shareholders
Equity

The Capital Budgeting Decision

Current
Liabilities

Current Assets

Long-Term
Debt
Fixed Assets
1 Tangible
2 Intangible

What long-term
investments
should the firm
choose?

Shareholders
Equity

The Capital Structure Decision

Current Assets

How should the

firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible
2 Intangible

Current
Liabilities
Long-Term
Debt

Shareholders
Equity

Short-Term Asset Management

Current Assets

Fixed Assets
1 Tangible
2 Intangible

Current
Liabilities
Net
Working
Capital

How should
short-term assets
be managed and
financed?

Long-Term
Debt

Shareholders
Equity

Financial Manager
The Financial Managers primary
goal is to increase the value of the
firm by:
1. Selecting value creating
projects
2. Making smart financing
decisions

Hypothetical Organisation Chart

Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
President and Chief
Operating Officer (COO)
Vice President and
Chief Financial Officer (CFO)

Treasurer

Controller

Cash Manager

Credit Manager

Tax Manager

Cost Accounting

Capital Expenditures

Financial Planning

Financial Accounting

Data Processing

10

The Corporate Firm

The corporate form of business is
the standard method for solving the
problems encountered in raising
large amounts of cash.
However, businesses can take other
forms.

11

Forms of Business Organisation

The Sole
Proprietorship
The Partnership
General Partnership
Limited Partnership

The Corporation

12

12

A Comparison
Corporation

Partnership

Liquidity

Shares can be easily

exchanged

Subject to substantial
restrictions

Voting Rights

Usually each share gets one

vote

General Partner is in charge;

limited partners may have
some voting rights

Taxation

Double

Partners pay taxes on

distributions

Reinvestment and dividend

payout

Broad latitude

All net cash flow is

distributed to partners

Liability

Limited liability

General partners may have

unlimited liability; limited
partners enjoy limited
liability

Continuity

Perpetual life

Limited life

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The Importance of Cash Flow

Firm

Firm issues securities (A)

Invests
in assets
(B)

Retained
cash flows (F)
Short-term debt
Cash flow
from firm (C)

Dividends and
debt payments (E)
Taxes (D)

Current assets
Fixed assets

Ultimately, the firm

must be a cash
generating activity.
RMIT

Financial
markets

Government

Long-term debt
Equity shares

The cash flows from

the firm must exceed
the cash flows from
the financial markets.
14

The Goal of Financial Management

What is the correct goal?
Maximize profit?
Minimize costs?
Maximize market share?
Maximize shareholder wealth?

15

The Agency Problem

Agency relationship
Principal hires an agent to represent
his/her
interest
Stockholders (principals) hire
managers (agents) to run the
company

Agency problem
Conflict of interest between principal
and agent
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Managerial Goals
Managerial goals may be different
from shareholder goals
Expensive perquisites
Survival
Independence

Increased growth and size are not

necessarily equivalent to increased
shareholder wealth
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Managing Managers
Managerial compensation
Incentives can be used to align
management and stockholder interests
The incentives need to be structured
carefully to make sure that they achieve
their intended goal

Corporate control
The threat of a takeover may result in
better management

Other stakeholders
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Regulation

The Securities Act of 1933 and the Securities Exchange Act

of 1934
Issuance of Securities (1933)
Creation of SEC and reporting requirements (1934)

Sarbanes-Oxley (Sarbox) (enacted by congress in 2002)

Increased reporting requirements and responsibility of
corporate directors
ASICs audit inspection program commenced after the
passing of the Corporate Law Economic Reform Program
(Audit Reform and Corporate Disclosure) Act 2004
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19

Quick Quiz
What are the three basic questions
Financial Managers must answer?
What are the three major forms of
business organization?
What is the goal of financial
management?
What are agency problems, and why
do they exist within a corporation?
What major regulations impact public
firms?

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Introduction to Financial Mathematics

What are the mathematical
requirements for this course?
Not much, but needs to have
some understanding
Can be picked up now if you do
not have the skills
See the interest rates examples
below
Which calculator to use?
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Interest rates
Borrowing and lending in the financial market depend to
a significant extent on the rate of interest. In economics
interest is a payment for the services of capital. It
represents a return on capital.
Interest is the price of hiring capital. Capital, as a factor
of production, takes the form of machinery, equipment or
any other physical assets used in production of goods.
There are two different types of interest rates:
simple interest, mostly used for short term interest
Compound interest, most often used.

22

Simple Interest rate

Example 1:
If the interest rate on a loan of $15000 is 7%
(simple), how much interest is due if the loan is due
in 7 months?
Answer: $612.5
Example 2:
Determine the simple interest on a 90-day loan of
8000 at 8.5%
Answer: $167.67

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Compound Interest rate

If the interest due is added to the principal at the end of each interest
period and thereafter earns interest, the interest is said to be
compounded.
Example: Determine the compound interest earned on $1000 for 2
years at 6% compounded semiannually.
At the end of
Compound interest
Accumulated value
the 1st interest period

$1000*3%=$30

$1030

the 2nd interest period

$1030*3%=$30.90

$1060.90

the 3rd interest period

$1060.90*3%=$31.83

$1092.73

the 4th interest period

$1060.9*3%=$32.78

$1125.51

Thus the compound interest earned on $1000 for 2 years at 6%

compounded semiannually is: $125.51, whereas the simple interest
earned on $1000 for 2 years at 6% is: $1000*6%*2=$120
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Compound Interest rate- contd

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Calculators
Must have:
either a scientific
calculator if you feel
comfortable with
formulas otherwise a
financial calculator

The recommended fin.

calculator is:
Sharp EL735s/EL738

Financial Calculators-contd
Sharp
EL 738

Latest Model

EL 735S

Latest Model

EL 735

Superseded Model (good)

EL 733A

Superseded Model (OK)

Casio
FC 100 & FC 200

FC 100 V & FC 200 V

Superseded Model (good)

-

Latest Models (good)

HP
10 B II

Current Model (OK)

20b

New model (appears more difficult to use).

Texas Instruments
BA II Plus - More difficult to use

Financial Calculators-contd
Clear the cash flow register
Sharp EL735S/738;-

2nd , ALPHA, 0, 0.

Sharp EL735;-

RCL, CFi, 2nd, CA, =

Sharp EL733A;-

2nd, CA, 2nd, TAB, 2

HP 10BII;- 2nd, C ALL, 1, 2nd, P/YR

Casio FC100/200

Shift, CLR, All, Yes, AC, Select Cash Mode

Texas BA 11Plus CF, 2nd , CLR WORK

2nd , RESET, ENTER