Fund.finance Lecture 1 Introduction 2011

8/13/2019 Fund.finance Lecture 1 Introduction 2011

1/28

FUND MENT LSOFFIN NCI L M N GEMENT

1


2/28

COURSE CONTENT

Topic 1. Introduction to Finance. Overview of orporate

Financing Decisions. Capital Markets and FinancialInstruments.

Topic 2.Time Value of Money and Present ValueConcept.

Topic 3.Valuing Debt and Equity Securities: Bond vs.Stock

Topic 4.Investment Evaluation. Capital BudgetingDecisions.

Topic 5.Risk and Return. Introduction to Portfolio Theory.

Topic 6.Long-term Financial Decisions: Capital Structureand Cost of Capital.

2


3/28

COURSE ASSESSMENT

3

Element Weight

1. In-class tests (2) 30%

2. Mid-term Exam 30%

3. Final Exam 40%

TOTAL 100%


4/28

RESOURCE

Required Textbook:Brealey, Myer & Allen, Fundamentals

of Corporate Finance, 6-th ed. McGraw Hill,2008

Selected web sites:TheStreet.com at www.thestreet.com

The CNNat www.money.cnn.com

Yahoo financeat www.finance.yahoo.com4
http://www.thestreet.com/http://www.money.cnn.com/http://www.finance.yahoo.com/http://www.finance.yahoo.com/http://www.money.cnn.com/http://www.thestreet.com/


5/28

INTRODUCTION TOFIN NCI L M N GEMENT

5

Lecture 1


6/28

INTRODUCTION TO FINANCIAL MANAGEMENTTopic cover

6

Forms of business organization

Goals of corporation

Major decisions of a firm

The role of financial manager in the organization

Agency problems

Some important trends

Business ethics


7/28

FORMS OF BUSINESS ORGINIZATION

Proprietor-

ship/Sole Pro.

Partnership Corporation S Corporation

Who owns

the business

The manager

(only one)

Partners

(two or more)

Shareholders

(unlimited)

Shareholders

(at most 100)

Are owners

and

managersseparate?

No No Yes Sometimes

How is the

owners

liabilities

Unlimited

(big

disadvantage)

Unlimited

(big

disadvantage)

Limited Limited

Are the

owners and

the business

taxed

separately

No - Individual

income tax

No - Individual

income tax

Yes - Corporate

income tax &

individual

income tax

No - Individual

income tax

7


8/28

PRIMARY GOAL OF A CORPORATION

Which one is the main goal of a corporation?

- Maximize the profit

- Maximize the market share

- Maximize EPS

- Maximize the value of shareholders wealth

8


9/28

PRIMARY GOAL OF A CORPORATION (CONT.)

Maximize the profit- May resulting from improper actions, affected by

accounting methods, subject to manipulation. E.g.Erron, Worldcom etc.

Maximize the market share:a strategy rather than objective.

Maximize EPS:May follow too high leverage tactic, vulnerable tofinancial distress.

9


10/28

PRIMARY GOAL OF A CORPORATION (CONT.)

Maximize shareholders wealth=> translate into maximizing the price of stocks.

=> Primary goal of a corporation Maximize shareholders wealth10

Prices of stock reflect expectation of investors about future

of a company.

Take into account riskiness of companies.

Focus on long-term value.


11/28

WHICH ONE DETERMINES SHAREHOLDERS

WEALTH?

Intrinsic values & Stock prices

- Intrinsic values: estimate of a stocks true value

based on accurate risk and return data.

- Stock price: market price of a stock trading in the

market, may based on improper information.

11


12/28


WEALTH? (CONT.)

12

Managerial actions, the economic

environment, and the political climate

True

investorreturns

true

risk

Perceived

investor returns

Perceived risk

Stocks intrinsic

value

Stocks market price

Market equilibrium:

Intrinsic value = stock price

O O


13/28


WEALTH? (CONT.)

13

Market price

Intrinsic value

Stock

undervalued

Stock

overvalued

Time

Stock

price


14/28

WHICH ONE DETERMINES SHAREHOLDERS WEALTH?

(CONT.)

Shareholdersconcern about market pricesof stocks,

sometimes they do not have enough information to identify

intrinsic values of stocks.

Stocks market price are fluctuated. Stock prices change every

minutes. Do they concern every m inutes?

Managersfocus on intrinsic valuesof stocks. They have inside

information => estimate intrinsic values more accurate than

investors.

Do shareholders and managers conflict?

How can their target meet together?

14


15/28

WHICH ONE DETERMINES SHAREHOLDERS WEALTH? (CONT.)

What happens if:

15

Market pricesof stock islowerthanintrinsic valuesof it (undervalued)?

This happens for a long time, a

company will be taken over byothers. Some investors perceive,they increasingly buy stocks.

Market pricesof stock ishigherthan

intrinsic valuesof it (overvalued)?Managers will sell their shares orissue more stock to raise fund,simultaneously some investors willsell their shares as well.


16/28

WHICH ONE DETERMINES SHAREHOLDERS WEALTH?

(CONT.)

From an automatic mechanism, in long run, market

prices of stocks have tendency to convert to its

intrinsic values.

And shareholders concern market prices of stocks

on average in long term.

Thus, shareholders and managers target can meettogether.

16


17/28

PRIMARY GOAL OF A CORPORATION

Therefore, managers should try to maximize

their stocks intrinsic value and then

communicate with shareholders

=> Result to intrinsic value high and actual stock

prices track close to the intrinsic value.

17


18/28

MAJOR DECISIONS OF A CORPORATION

18

Three maindecisions afirm deals

with:

Capitalbudgeting/invest-

ment decisionWhich

assets/projectsshould firm invest?

Financingdecision

Where and howthey can raisethe capital?

Dividend policy

How profitdistributed?


19/28

ROLE OF FINANCIAL MANAGER

19


20/28

ROLE OF FINANCIAL MANAGER (CONT.)

Chairman of the Board andChief Executive Officer (CEO)

Director and ChiefMarketing Officer (CMO)

Director andChief Financial Officer (CFO)

Treasurer Controller

Cash Manager

Capital Expenditures

Credit Manager

Financial Planning

Tax Manager

Financial Accounting

Cost Accounting

Data Processing

Board of Directors

20

Director and ChiefOperating Officer (COO)


21/28

AGENCY PROBLEMS

Agency problems between managers and

stockholders

E.g. luxury trips, cars, overstated profit, investing in

not promising projects etc.

Cause: the separation of ownership and

management.

Solutions: bind compensation plan with companys

performance.

21


22/28

AGENCY PROBLEMS (CONT.)

Compensation package:Bonuses, stock options

etc.

How should compensation plan be? Reasonable

Direct intervention

Threat of a takeover

=> Should be rewarded on the basis of the stocks

performance over the long run.

22


23/28


Agency problems between creditors and stockholder

- Creditors: willing to take less risk

- Shareholders: willing to take more risk

23

Creditors

Gains/losses

Companys performance

Shareholders

Gains/losses

Companys performance


24/28


Solutions: covenant, requirement of interest

coverage ratio etc.

24


25/28

IMPORTANT TRENDS

Three important trends:

Requirement of higher standard for financial

disclosures.

Globalization

Ever-improving information technology (IT)

25


26/28

BUSINESS ETHICS

Recent years, the increase in number of scandals

related to business ethics.

E.g. Enron, WorldCom, Madoff etc

Business ethics:standard of conduct ofbusiness.

Consequences of unethical behavior:

shareholders lose their wealth, firm may end upgoing to bankruptcy

26


27/28

BUSINESS ETHICS

How should employees deal with unethical

behavior?

Losing a job or ending up in jai l?

27


28/28

TUTORIAL QUESTIONS

Self-test 1.1, 2, 3

Quiz 1, 2, 3, 4 Problems 16, 18, 20

GOOD LUCK!

28

Fund.finance Lecture 1 Introduction 2011

Documents

Transcript of Fund.finance Lecture 1 Introduction 2011