Presentation on theme: "Overview of Financial Management and the Financial Environment"— Presentation transcript:
1 Overview of Financial Management and the Financial Environment CHAPTER 1Overview of Financial Management and the Financial Environment
2 Areas in FinanceCorporate financeInvestmentFinancial markets
3 Topics in Chapter Forms of business organization Objective of the firm: Maximize wealthDeterminants of fundamental valueFinancial securities, markets and institutions
4 Why is corporate finance important to all managers? Corporate finance provides the skills managers need to:Identify and select the corporate strategies and individual projects that add value to their firm.Forecast the funding requirements of their company, and devise strategies for acquiring those funds.
5 Business Organization from Start-up to a Major Corporation Sole proprietorshipPartnershipCorporation(More . .)
6 Starting as a Proprietorship One owner (the manager)Advantages:Ease of formationSubject to few regulationsNo corporate income taxes, but personal income taxesDisadvantages:Unlimited liabilityDifficult to raise capital to support growth
7 Starting as or Growing into a Partnership More than one owner.A partnership has roughly the same advantages and disadvantages as a sole proprietorship.Limited partnership in some cases.
8 Becoming a Corporation A corporation is a legal entity that separates its owners from managers.File papers of incorporation with state.Charter (name, types of business, amount of capital, directors…)Bylaws (a set of rules by the founders)
9 Advantages and Disadvantages of a Corporation Unlimited lifeEasy transfer of ownershipLimited liabilityEase of raising capitalDisadvantages:Double taxationCost of set-upstricter regulation
10 Becoming a Public Corporation and Growing Afterwards Initial Public Offering (IPO) of StockRaises cashAllows founders and pre-IPO investors to “harvest” some of their wealthSubsequent issues of debt and equity
11 Agency Problems and Corporate Governance Agency problem: managers may act in their own interests and not on behalf of owners (stockholders)Corporate governance is the set of rules that monitor and control a company’s (mainly the management’s) behavior. Corporate governance can help control agency problems.
12 What should be management’s primary objective? The primary objective should be shareholder wealth maximization, which translates to maximizing the stock price.
13 What determines a firm’s value? The cash flows generated in the future.
14 What three aspects of cash flows affect an investment’s value? Amount of expected cash flows (bigger is better)Timing of the cash flow stream (sooner is better)Why is timing important?Risk of the cash flows (less risk is better)
15 Free Cash Flows (FCF)Free cash flows are the cash flows that are available (or free) for distribution to all investors (stockholders and creditors).
16 Cost of Capital (1) The cost to finance the firm and operation. Cost of equity vs. cost of liability (debt).Weighted average cost of capital (WACC)
17 Cost of Capital (2)What do we call the price, or cost, of debt capital?The interest rateWhat do we call the price, or cost, of equity capital?Cost of equity = Required return = dividend yield + capital gain
18 A firm’s fundamental value Intrinsic value is the sum of all the future expected free cash flows when converted into today’s dollars:Value = … +FCF1FCF2FCF∞(1 + WACC)1(1 + WACC)∞(1 + WACC)2
20 Who are the providers (savers) and users (borrowers) of capital? HouseholdsNon-financial corporationsFinancial corporationsGovernments
21 What economic conditions affect the cost of money? Federal Reserve policiesBudget deficits/surplusesLevel of business activity (recession or boom)International trade deficits/surpluses
22 What international conditions affect the cost of money? Country risk. Depends on the country’s economic, political, and social environment.Exchange rate risk. Non-dollar denominated investment’s value depends on what happens to exchange rate.
23 Financial Markets (1) Primary market: Secondary market: Markets in which companies raise money by selling securities to investors.Every security sells only once in the primary market.Example: IPOSecondary market:Markets in which already issued securities trade.Trading is among investors.
24 Financial Markets (2)Money market: markets for trading of debt securities with less than one-year maturity.Capital markets: market for trading of intermediate-term and long-term debt and common stock.Spot markets: securities are bought and sold for ‘on-the-spot’ delivery.Futures markets: trading takes place now, but full payment and delivery of the asset takes place in the future, e.g., 6 months or 1-year.
25 Financial Securities Money Market Securities Capital Market Securities Treasury Bill (T-bill); Commercial paper; negotiable CD by banksCapital Market SecuritiesBonds, Mortgages, StocksDerivative SecuritiesFutures, Options, Swaps, Forwards
26 Debt vs. Equity Debt security Equity security 1) Holder is a creditor of the firm.No say in running of the firm.1) Holder is an owner of the firm.Have a say in running of the firm (by voting).2) Fixed payment.2) Payment is not fixed. No guaranteed cash flow from firm.3) Receives payment before anything is paid to equity holders.3) Receives what’s left over after all debt holders/creditors are paid.4) If firm cannot pay, debt holders will take over ownership of firm assets.4) If firm cannot pay debt holders, loses control of firm to debt holders.5) Limited liability.
27 What are some financial institutions? Commercial banksInvestment banksSavings & Loans, mutual savings banks, and credit unionsLife insurance companiesMutual fundsPension fundsHedge funds and private equity funds
28 Types of Stock Transaction Orders Instructions on how a transaction is to be completedMarket Order– Transact as quickly as possible at current priceLimit Order– Transact only if specific situation occurs. For example, buy if price drops to $50 or below during the next two hours.
29 Auction MarketsParticipants have a seat on the exchange, meet face-to-face, and place orders for themselves or for their clientsNYSE and AMEX are the two largest auction markets for stocks.
30 Dealer Markets“Dealers” keep an inventory of the stock (or other financial asset) and place bid and askOften many dealers for each stockComputerized quotation system keeps track of bid and ask prices, but does not automatically match buyers and sellers.Examples: Nasdaq
31 Over the Counter (OTC) Markets In the old days, securities were kept in a safe behind the counter, and passed “over the counter” when they were sold.Now the OTC market is the equivalent of a computer bulletin board (e.g., Nasdaq Pink Sheets), which allows potential buyers and sellers to post an offer.No dealersVery poor liquidity
32 Financial Securities Quotation Quotes can be found in a variety of print sources (Wall Street Journal) and online sources (Yahoo!Finance, CNNMoney).
33 After Chapter Homework Questions: (1-3)Mini case: b, c, d, e, f.