Post on 12-Jan-2016
Financial Economics, FUIEMS, 2009
Engineering EconomicsEngineering Economics
Financial Economics, Accounting Financial Economics, Accounting & Corporate Finance& Corporate Finance
Financial Economics, FUIEMS, 2009
Financial economicsFinancial economics• Branch of economics studying the interrelation of financial
variables, such as shares, bonds and securities, and economics such as price, interest, inflation, tax. Financial economics concentrates on influences of real economic variables on financial ones.
• It includes
– Valuation
– Financial markets
– Financial institutions and regulations
Finance is the science of funds management Finance is the science of funds management
Financial Economics, FUIEMS, 2009
AccountingAccounting• Accounting is the art of communicating financial Accounting is the art of communicating financial
information about a information about a business entity to users. The
communication is generally in the form of
financial statements that show the economic resources
under the control of management.
• Accounting is thousands of years old. The earliest
accounting records were found in the Middle East which
date back more than 7,000 years
Financial Economics, FUIEMS, 2009
AccountingAccounting
• Accounting is a set of concepts and techniques that are Accounting is a set of concepts and techniques that are
used to measure and report financial information about used to measure and report financial information about
an economic unit. an economic unit.
• The information is potentially reported to a variety of The information is potentially reported to a variety of
different types of interested parties. These include different types of interested parties. These include
business managers, owners, creditors, governmental business managers, owners, creditors, governmental
units, financial analysts, and even employees. units, financial analysts, and even employees.
Financial Economics, FUIEMS, 2009
Users of Accounting InformationUsers of Accounting Information
• OwnersOwners
• LendersLenders
• Labor OrganizationsLabor Organizations
• CustomersCustomers
• Society groupsSociety groups
• Government Regulatory AgenciesGovernment Regulatory Agencies
Financial Economics, FUIEMS, 2009
Types of AccountingTypes of Accounting• Financial accountingFinancial accounting is concerned with reporting of is concerned with reporting of
information to parties outside the firm. In contrast, information to parties outside the firm. In contrast,
managerial accountingmanagerial accounting is primarily concerned with providing is primarily concerned with providing
information for internal management. information for internal management.
• Both financial accounting and managerial accounting Both financial accounting and managerial accounting
depend upon a strong information system to reliably depend upon a strong information system to reliably
capture and summarize economic data. capture and summarize economic data.
• Information technology has solved this problem during the Information technology has solved this problem during the
past 50 years. past 50 years.
• Now, accounting is more of a dynamic, decision-making Now, accounting is more of a dynamic, decision-making
discipline, rather than a bookkeeping task.discipline, rather than a bookkeeping task.
Financial Economics, FUIEMS, 2009
Accounting - LimitationsAccounting - Limitations
• Accounting data is not absolute or concrete. Accounting data is not absolute or concrete.
• Considerable amounts of judgment and estimation are Considerable amounts of judgment and estimation are
necessary to develop the specific accounting necessary to develop the specific accounting
measurements that are reported during a particular month, measurements that are reported during a particular month,
quarter, or year. quarter, or year.
• Accounting has not yet advanced to value a business (or a Accounting has not yet advanced to value a business (or a
business's assets). business's assets).
• The "reliability" of reported data, can pose a limitation on its The "reliability" of reported data, can pose a limitation on its
"relevance." "relevance."
Financial Economics, FUIEMS, 2009
TerminologiesTerminologies• Assets are the economic resources, and include such items as
cash, accounts receivable, inventories, land, buildings,
equipment.
• Liabilities are expenditures such as loans, and other obligations
arising in the course of business
• Owners' equity is the owner's "interest or profit " in the business.
It is equivalent to assets minus liabilities for a particular business.
• Fundamental Accounting Equation Assets = Liabilities +
Owners' Equity
• Balance Sheet is the key financial statement (sometimes called
the statement of financial position).
Financial Economics, FUIEMS, 2009
Financial Economics, FUIEMS, 2009
Major Financial StatementsMajor Financial Statements• Financial accounting information is conveyed through a Financial accounting information is conveyed through a
standardized set of reports. standardized set of reports.
• BALANCE SHEETBALANCE SHEET
• INCOME STATEMENTINCOME STATEMENT: It provides information about revenues : It provides information about revenues
generated and expenses incurred. generated and expenses incurred.
• THE STATEMENT OF RETAINED EARNINGSTHE STATEMENT OF RETAINED EARNINGS: It shows how : It shows how
retained earnings increased and decreased in response to retained earnings increased and decreased in response to
events that impacted income. Retained earnings is reduced by events that impacted income. Retained earnings is reduced by
dividends paid to shareholders. dividends paid to shareholders.
• STATEMENT OF CASH FLOWSSTATEMENT OF CASH FLOWS: The statement of enterprise's : The statement of enterprise's
cash flow. This statement reveals how cash is generated and cash flow. This statement reveals how cash is generated and
expended during a specific period of time.expended during a specific period of time.
Financial Economics, FUIEMS, 2009
Financial Economics, FUIEMS, 2009
Corporate FinanceCorporate Finance
Corporate finance is an area of finance dealing with
financial decisions made by business enterprises and the
tools and analysis used to make these decisions. The
primary goal of corporate finance is to maximize
corporate value while managing the firm's financial risks.
Finance is the science of funds management
Financial Economics, FUIEMS, 2009
What is Corporate Finance?What is Corporate Finance?
• Every decision that a business makes has financial
implications, and any decision which affects the finances
of a business is a corporate finance decision.
• Defined broadly, everything that a business does fits
under the corporate finance.
• Regardless of your job, understanding and being able to
analyze corporate decisions is important
Financial Economics, FUIEMS, 2009
Corporate FinanceCorporate Finance
Corporate Finance addresses the following three questions:Corporate Finance addresses the following three questions:
1.1. What long-term investments should the firm engage What long-term investments should the firm engage
in?in?
2.2. How can the firm raise money for the required How can the firm raise money for the required
investments?investments?
3.3. How much short-term cash flow does a company How much short-term cash flow does a company
need to pay its bills?need to pay its bills?
Financial Economics, FUIEMS, 2009
Three major decision in corporate Three major decision in corporate financefinance
• The investment decision– What makes for a good investment?
• The financing decision– Where do firms raise/acquire the funds for value-
creating investments?– What mix of owner’s money (equity) or borrowed
money (debt) should the firm use?• The dividend decision
– How much of a firm’s funds should be reinvested in the business and how much should be returned to the owners?
Financial Economics, FUIEMS, 2009
First Principle of Corporate FinanceFirst Principle of Corporate Finance
• Invest in projects that yield a return greater than the
minimum acceptable rate
• If there are not enough investments that earn the MARR,
return the cash to stockholders.
• These decision criteria will be consistent with the
objective of the firm: Maximize the Value of the
Firm
Financial Economics, FUIEMS, 2009
Corporate Governance and Managerial Corporate Governance and Managerial DecisionsDecisions
• Managers making decisions that are consistent with the
firm objective of firm value maximization is predicated on
the assumption that managers will act in the best interest
of shareholders
• Corporate governance addresses the relationships
between the various stakeholders in the firm
Financial Economics, FUIEMS, 2009
Finance is not a science…
• Often times, decision inputs are subjective
• Experience allows us to become more confident about our inputs
Financial Economics, FUIEMS, 2009
Corporate finance - Key functionsCorporate finance - Key functions
• Planning for future funding• Manage bank relationships• Ensure corporate profit• Proportion the liabilities• Risk and valuation analysis • Commercial input to negotiations with partners• Rating agency liaison
Financial Economics, FUIEMS, 2009
Financial Markets Financial Institutions Financial Instruments
Financial Institutions
(Banks)
Primary market
Secondary market
Consumers (Savers)
Firms (Spenders)
Financial Markets
CD’s $
$ $
$
exchange ownership
Short term Long term
Stocks & Bonds
Stocks & Bonds
real investment
Loans
$
Investment Environment
Financial Economics, FUIEMS, 2009
ValuationValuation• Determination of the fair value of an asset
– How risky is the asset? (identification of the asset-
appropriate discount rate)
– What cash flows will it produce? (discounting of
relevant cash flows)
– How does the market price compare to similar assets?
(relative valuation)
– Are the cash flows dependent on some other asset or
event? (derivatives, contingent claim valuation)