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1-1 Ana Jolovi ć, PhD spring 2011 Introduction to Financial Management.

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1 1-1 Ana Jolovi ć, PhD spring 2011 Introduction to Financial Management

2 Introduction to the course

3 1-3 Annotation Introductory course in financial management. Give students basic knowledge and understanding, focus their attention to certain issues they can further explore. Overview of finance concepts, terminology, and principles. Introduces students into modern methods of managing finance. Covers basic financial theories, application of those theories in life - financial management and investments.

4 1-4 Aims of the course General overview of finance and gradually introduce more detail on several concepts, financial instruments, and techniques used in financial decision making. The first part of the course focuses on basic financial data, reading and understanding financial statements, basic financial categories like cash flaw, revenues, costs, basic financial concepts, etc. The second part of the course deals with managing finance. The third part introduces students to investment part of finance.

5 1-5 The main objectives To introduce students to the world of finance in a way they can apply knowledge and be able to self-improve it after the course. To explain basic financial concepts such as the time value of money, asset valuation, and risk and return. To clarify basic financial instruments such as stocks and bonds. To prepare students to recognize relationship between finance and other business disciplines, as well as to be able to use synergy of those disciplines in decision making.

6 1-6 Learning methods, Quality and Cheating issues The course is taught in English and is structured as a combination of lectures, discussions, in-class activities and student presentations. It requires a substantial amount of preparation by the students and active involvement during class. The lecturer assures a variety of teaching methods and testing. The feedback from students will always be highly valued and appreciated. The teaching and testing methods are chosen taking into account the purpose of the minimization of cheating opportunities.

7 1-7 May 30 Overview of the Course Introduction to Finance Ch. 1 Why Finance is Important Creation of Value Investment Decision Financing Decision none Introduction to Managerial Finance May 31 Introduction to Finance Categories Financial Statements Financial Statements chapter scanned + Hurion Farm Basic terminology Financial Statements – definitions, logic, what can we see from statements Bring calculators (optional lap tops) Hurion Farm Case – how do we come up with financial statements

8 1-8 8 June 1Important Financial Concepts – Time Value of Money Ch. 2 Practice examples Time Value of Money Present Value (ordinary, annuity, mixed stream) Future Value (ordinary, annuity, mixed stream) Bring calculators (optional lap tops) and financial tables Time Value of Money – practice (calculator, financial tables and excel) June 2 Important financial concepts – risk and return Risk and Return - practice (calculator and excel) Ch. 2 Additional chapter scanned Return of an investment Return of a portfolio Risk of an investment Risk of a portfolio Bring calculators (optional lap tops)

9 1-9 June 3Risk and return – CAPM Ch. 3 Practice examples and mini cases CAPM Beta SML Bring calculators (optional lap tops) CAPM – practice

10 1-10 June 6 Basic financial analysis Financial Planning Ch. 12 and Ch. 13 Case for practicing Financial Ratios Financial Analysis Financial Planning Bring calculators (optional lap tops) Bring copy of the Case Practice ratios and pro forma statements June 7 Working Capital and Current Asset Management Practice - Working Capital and Current Asset Management Ch. 14 and Ch. 15 Case and examples for practicing Liquidity Working Capital Current Asset Managing Current Asset Bring calculators Bring copy of the case

11 June 8 Current Liability Management Ch. 16 Cases and examples for practicing Bring calculators Bring copy of the case Practice - Current Liability Management June 9 Capital Investment and Required Return Practice for midterm test – topics covered, excluding capital investments Ch. 6 Scanned chapters Methods for Evaluation NPV IRR Bring calculators (optional lap tops)

12 June 10 Midterm test Ch. 8Required return Weighted Average Required Return Company's Overall Cost of Capital Bring calculator and financial tables Capital Investment and Required Return

13 June 13 Capital Market Financing Foundations for Longer- Term Financing Ch. 17 Purpose and Function of Financial Markets Yield Curves and Their Use Pricing Default Risk Off Treasuries Bring calculators Practice - Yield Curves and Their Use June 14 Issuing SecuritiesCh. 19 Case for discussion Public Offering of Securities Selling Common Stock through a Rights Issue Information Effects Bring calculators Bring copy of the case

14 June 15 Fixed-Income FinancingCh. 20 Mini case Practice example Features of Debt Types of Debt Financing Preferred Stock Bonds Risk and Return on Bonds Bring calculators (lap top optional) Bring copy of the case Practice – risk and return of a bond (calculations, excel) June 16 Stocks Practice - stock valuation Ch. 2 and scanned chapter Mini case Practice example Stocks Valuating Stocks Bring calculators (lap top optional) Bring copy of the case

15 Friday June 17 Market for corporate controlCh. 23 Readings Firm Control Merger and Acquisitions Corporate Voting Company Resistance none Final Exam

16 1-16 TYPE EVALUATION % Paper25 Final Exam 75 Total:100 All exams are closed book, but formulas will be provided (not including explanations). Bring a calculator! Paper assignments consist of cases and problems –submitted together at the deadline. Each group turns in a single copy. Homework needs to be given / sent to me until the deadline. Groups cannot be changed after the first assignment. Late homework is not accepted.

17 1-17 Every class You are expected to do the assigned readings before each class. Topics that are very important will be covered in great detail. In these cases, the readings serve to reinforce what is covered in class and to help you understand better, ask more questions to clear certain parts and will aid your understanding of material presented in class. However, time does not allow all topics to be covered in such detail. Therefore, the readings are necessary. You should bring your calculators and optional each group should have one lap top.

18 1-18 INTRODUCTION TO FINANCE 18

19 1-19 Why do we need finance? I will never work in finance! I will never be in business! I like only marketing and PR! I hate numbers! I am an artist! I will marry to someone who will take care of finance! …………………………………………… Please, add more to the list

20 1-20 Introduction IT’S EASIER TO SPEND THAN TO SAVE! Personal financial planning is an ongoing process—it changes as your financial situation and position in life change. Manage and control your finances with a personal financial plan. It helps you achieve financial and lifestyle goals.

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22 1-22 Importance of Personal Financial Planning Accumulate wealth for special expenses Save for retirement “Cover your assets” Invest intelligently Minimize tax payments

23 1-23 Five basic steps to personal financial planning 23

24 1-24 Step 1: Evaluate Your Financial Health Examine your current financial situation. How much money do you make? How much are you spending and on what? Use careful record keeping to track finances and spending.

25 1-25 Step 2: Define Your Financial Goals Write or formalize them Attach a financial cost to each one. When will you need the money to achieve the goal? Analyze and revise your goals.

26 1-26 Step 3: Develop a Plan of Action Flexibility: Plan for life changes and the unexpected. Liquidity Immediate use of cash by quickly and easily converting an asset. Protection Prepare for the unexpected with insurance. Minimize Taxes Keep more of what you earn.

27 1-27 Step 4: Implement Your Plan Stick to it. Use your financial plan as a road map to achieve goals. Keep goals in mind and work towards them.

28 1-28 Step 5: Review, Reevaluate, and Revise Review progress Reevaluate and revise for changes in your life Be prepared to formulate a different plan to meet your goals.

29 1-29 Short–Term Goals Accumulate Emergency Funds Equaling 3 Months’ Living Expenses Pay Off Bills and Credit Cards Purchase Insurance Purchase a Major Item Finance a Vacation

30 1-30 Intermediate-Term Goals Save for Older Child’s College Save for a Down Payment Pay Off Major Debt Finance Large Items (Weddings) Purchase a Vacation Home

31 1-31 Long-Term Goals Save for Younger Child’s College Purchase Retirement Home Create a Retirement Fund to Maintain Current Standard of Living Take Care of Elderly Family Members Start a Business

32 1-32 STAGE 1 The Early Years - A Time of Wealth Accumulation Prior to age 54 Develop a regular savings pattern: How much can be saved? Is that enough? Where should the savings be invested? Cost of raising children

33 1-33 STAGE 2 Approaching Retirement - The Golden Years Transition years between ages Depends on preparation for retirement. Reassess financial goals and decisions—retirement, insurance protection and estate planning.

34 1-34 STAGE 3 The Retirement Years After age 65, live off savings Retirement age depends on savings. Less risky investment strategy Consider extended nursing home protection. Estate planning decisions and documents are critical.

35 1-35 Thinking About Your Career A series of positions to show your skills. Is the job important, enjoyable, and satisfying? Does it provide for your desired lifestyle?

36 1-36 Choosing a Major and a Career Effective self-assessment Interests, skills, values, personal traits Desired lifestyle Research career alternatives and match with your skills and interests Research potential earnings

37 1-37 Table 1.2 What Different College Majors Earn

38 1-38 What Determines Your Income? Skills Education The wealthy are married

39 1-39 Figure 1.5 Education and Earnings

40 1-40 TEN PRINCIPLES OF PERSONAL FINANCE The foundation of personal finance

41 1-41 Principle 1: The Best Protection Is Knowledge Understand the basics of personal finance. Take responsibility for your lifetime financial plan. Seek professional advice wisely.

42 1-42 Principle 2: Nothing Happens Without a Plan Easier to think about spending than about saving. Saving must be planned. Putting off a financial plan means goals are harder to achieve.

43 1-43 Principle 3: The Time Value of Money Money received today is worth more than money received in the future. Understand how savings and investments grow over time Understand compound interest. Understand spending now and paying later

44 1-44 Table 1.4 Importance of Starting Early—Just Do It!—to Accumulate $1 Million by Age 67 Investing Your Money at 12%

45 1-45 Principle 4: Taxes Affect Personal Finance Decisions Know the effect of taxes on the rate of return of investments Compare investment alternatives on an after-tax basis. Understand tax laws.

46 1-46 Principle 5: Stuff Happens, or the Importance of Liquidity Plan for unexpected events Have money or liquid funds available Liquid funds should cover 3 to 6 months of living expenses

47 1-47 Principle 6: Waste Not, Want Not - Smart Spending Matters Differentiate want from need Do homework before the purchase Make the purchase at the best price Maintain your purchase

48 1-48 Principle 7: Protect Yourself Against Major Catastrophes Have the right kind of insurance before a tragedy occurs. Know your insurance policy coverage. Focus insurance on major catastrophes which can be financially devastating.

49 1-49 Principle 8: The Risk and Return Go Hand in Hand Saving and investing grows money. Investors demand a minimum return above anticipated inflation. Investors demand higher return for added risk. Diversification by spreading money in several investments reduces risk

50 Figure 1.6 The Risk-Return Trade-Off

51 1-51 Principle 9: Mind Games and Your Money Behavioral biases lead to big financial mistakes. Mental accounting impacts financial decisions. “Sunk cost effect” pours good money after bad money because of bias.

52 1-52 Principle 10: Just Do It! Taking the first step towards your goals is difficult. The following steps become easier. First step is to pay yourself first—save then spend. Saving early can make a big difference.

53 1-53 Chapter 1 The Role of Financial Management

54 1-54 After studying Chapter 1, you should be able to: 1. Explain why the role of the financial manager today is so important. 2. Describe "financial management" in terms of the three major decision areas that confront the financial manager. 3. Identify the goal of the firm and understand why shareholders' wealth maximization is preferred over other goals. 4. Understand the potential problems arising when management of the corporation and ownership are separated (i.e., agency problems). 5. Demonstrate an understanding of corporate governance. 6. Discuss the issues underlying social responsibility of the firm. 7. Understand the basic responsibilities of financial managers and the differences between a "treasurer" and a "controller."

55 1-55 Why should I care about Financial Management ? Prepare for the workplace of tomorrow. Broadening expectations of financial knowledge and skills. Use and understand financial terminology and concepts in team communication. Developing cross-functional capabilities. Critical thinking.

56 1-56 The Role of Financial Management What is Financial Management? The Goal of the Firm Corporate Governance Organization of the Financial Management Function

57 1-57 What is Financial Management? Concerns the: acquisition, financing, and management overall goal of assets with some overall goal in mind.

58 1-58 Investment Decisions Most important of the three decisions.Most important of the three decisions. What is the optimal firm size? What specific assets should be acquired? What assets (if any) should be reduced or eliminated?

59 1-59 Financing Decisions Determine how the assets (LHS of balance sheet) will be financed (RHS of balance sheet).Determine how the assets (LHS of balance sheet) will be financed (RHS of balance sheet). What is the best type of financing? What is the best financing mix? What is the best dividend policy (e.g., dividend- payout ratio)? How will the funds be physically acquired?

60 1-60 Asset Management Decisions How do we manage existing assets efficiently? Financial Manager has varying degrees of operating responsibility over assets. Greater emphasis on current asset management than fixed asset management.

61 1-61 What is the Goal of the Firm? Maximization of Shareholder Wealth! Value creation occurs when we maximize the share price for current shareholders.

62 1-62 Corporate Social Responsibility Discussion Class Discussion What role should CSR and/or sustainability have on living the “goal of the firm”? Class Discussion: What role should CSR and/or sustainability have on living the “goal of the firm”? Corporate Social Responsibility (CSR): A business outlook that acknowledges a firm’s responsibilities to its stakeholders and the natural environment. Sustainability: Meeting the needs of the present without compromising the ability of future generations to meet their own needs.

63 1-63 What Goals do some Firms have? “Creating superior shareholder value is our top priority.” Associated Banc-Corp 2006 Annual Report. “The desire to increase shareholder value is what drives our actions.” Phillips 2006 Annual Report. “FedEx’s main responsibility is to create shareholder value.” FedEx Corporation, SEC Form Def 14A for the period ending 9/25/2006. “… the Board of Directors plays a central role in the Company’s corporate governance system; it has the power (and the duty) to direct Company business, pursuing and fulfilling its primary and ultimate objective of creating shareholder value.” Pirelli & C. S.p.A. Milan Annual Report 2006.

64 1-64 Shortcomings of Alternative Perspectives Could increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy T-bills, etc.). Ignores changes in the risk level of the firm. Profit Maximization Maximizing a firm’s earnings after taxes.Problems

65 1-65 Shortcomings of Alternative Perspectives Does not specify timing or duration of expected returns. Ignores changes in the risk level of the firm. Calls for a zero payout dividend policy. Earnings per Share Maximization Maximizing earnings after taxes divided by shares outstanding.Problems

66 1-66 Strengths of Shareholder Wealth Maximization Takes account of: current and future profits and EPS; the timing, duration, and risk of profits and EPS; dividend policy; and all other relevant factors. Thus, share price serves as a barometer for business performance.

67 1-67 The Modern Corporation There exists a SEPARATION between owners and managers. Modern Corporation Shareholders Management

68 1-68 Role of Management agent Management acts as an agent for the owners (shareholders) of the firm. agent An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf.

69 1-69 Agency Theory agency theory Jensen and Meckling developed a theory of the firm based on agency theory. Agency Theory Agency Theory is a branch of economics relating to the behavior of principals and their agents.

70 1-70 Agency Theory incentives monitor Principals must provide incentives so that management acts in the principals’ best interests and then monitor results. stock options, perquisites, bonuses Incentives include, stock options, perquisites, and bonuses.

71 1-71 Corporate Social Responsibility socially responsible Wealth maximization does not preclude the firm from being socially responsible at the corporate level. Assume we view the firm as producing both private and social goods. shareholder wealth maximization Then shareholder wealth maximization remains the appropriate goal in governing the firm.

72 1-72 Corporate Governance Corporate governance: represents the system by which corporations are managed and controlled. Includes shareholders, board of directors, and senior management. shareholder wealth maximization Then shareholder wealth maximization remains the appropriate goal in governing the firm.

73 1-73 Board of Directors Typical responsibilities: Set company-wide policy; Advise the CEO and other senior executives; Hire, fire, and set the compensation of the CEO; Review and approve strategy, significant investments, and acquisitions; and Oversee operating plans, capital budgets, and financial reports to common shareholders. CEO/Chairman roles commonly same person in US, but separate in Britain (US moving in this direction).

74 1-74 Sarbanes-Oxley Act of 2002 Sarbanes-Oxley Act of 2002 (SOX): addresses corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. Imposes new penalties for violations of securities laws. Established the Public Company Accounting Oversight Board (PCAOB) to adopt auditing, quality control, ethics, disclosure standards for public companies and their auditors, and policing authority. Generally increasing the standards for corporate governance.

75 1-75 Organization of the Financial Management Function Board of Directors President (Chief Executive Officer) Executive Vice President (Operations) Executive Vice President (Marketing) Executive Vice President (Finance - CFO)

76 1-76 Vice President (Treasurer) Capital Investment Cash Management Commercial/investment banking relationships Credit Management Dividend Disbursement Financial Analysis/Planning Investor Relations Mergers and Acquisitions Pension Management Insurance/Risk Management Tax Analysis/Planning Organization of the Financial Management Function EVP of Finance Controller Cost Accounting Cost Management Data Processing General Ledger Government Reporting Internal Control Preparing Financial Statements Preparing Budgets Preparing Forecasts


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