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Corporate Finance & Financial Modelling

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Presentation on theme: "Corporate Finance & Financial Modelling"— Presentation transcript:

1 Corporate Finance & Financial Modelling
AFIN 209 Miss Faith Moono Simwami

2 06/02/2017

3 CLASSROOM EXPECTATIONS
06/02/2017 CLASSROOM EXPECTATIONS Attendance Communication Feedback Course Assessment Course Work Requirements Cell Phones Preparation – notes, calculators etc…

4 06/02/2017 Objectives Understand the nature and role of Financial Management. Understand the general Financial Environment and the Operation of Financial Systems. To develop the student’s ability to apply the tools of Financial Analysis and Interpret Results. To develop a working knowledge and understanding of the theoretical framework and analytical techniques involved in: Financing, Investment and Dividend Decisions Working Capital Management

5 Assessment Criteria FULL & PART TIME
06/02/2017 Assessment Criteria FULL & PART TIME Assignment 10% Class test 10% Mid-Term Exam 20% Final Exam 60%

6 Recommended Reading Ross et al.: Corporate Finance 9th Edition
9/19/2018 Ross et al.: Corporate Finance 9th Edition Pierre Vernimmen, Pascal Quiry et al.: Corporate Finance - Theory and Practice, 4th Edition Brealey, Myers & Myers: Principles of Corporate Finance J. Weston & E. Brigham: Essentials of Managerial Finance Ivo Welch: Corporate Finance: An Introduction John Wiley & Sons: Corporate Finance: Theory & Practice Van Harne: Finance Management & Policy Brigham & Cluster: Finance Management

7 SYLLABUS AN OVERVIEW OF CORPORATE FINANCE AND FINANCIAL MODELLING
06/02/2017 SYLLABUS AN OVERVIEW OF CORPORATE FINANCE AND FINANCIAL MODELLING FINANCIAL MARKETS FOREIGN EXCHANGE MARKET SOURCES OF FINANCE THE TIME VALUE OF MONEY BOND VALUATION STOCK VALUATION COST OF CAPITAL CAPITAL BUDGETTING RISK AND RETURN WORKING CAPITAL MANAGEMENT EFFICIENT MARKET HYPOTHESIS THEORY DIVIDEND POLICY LONG TERM SOURCES OF FINANCE INTERNATIONAL TRADE AND FINANCE Note: Additional sections may be added throughout the semester as advised by your Lecturer.

8 Why Are You Taking Corporate Finance?
06/02/2017 To prepare you for the Workplace of tomorrow. To give you the capacity to Understand the theory and Apply, in Real world situations To broaden your expectations of financial knowledge and Skills (i.e. Interpret financials, use Excel, write Financial reports etc…) To introduce you to Financial Terminology and concepts in Team Communication. To develop the student’s cross-functional capabilities. To develop the student’s Critical Thinking & Analytical Skills To broaden one’s potential for varied Career Prospects.

9 Corporate Finance As a Career
06/02/2017 Corporate Finance As a Career Compliance Officer Treasurer Controller Consultant SME – Finance Manager Financial Analyst Investment Officer Credit Analyst Business Analyst Lecturer!!!

10 Chapter 1 Will teach you to explain the following:
06/02/2017 What is Corporate Finance? The Goal of the Firm Corporate Governance Organization of the Financial Management Function

11 What is Corporate Finance?
06/02/2017 What is Corporate Finance? Generally defined as the activities involved in managing cash flows (money) in a business environment.

12 The 5 Basic Corporate Finance Functions
06/02/2017 The 5 Basic Corporate Finance Functions Financial Management Financing (Raising Capital) Risk Management Capital Budgeting Corporate Governance

13 Financing(Raising Capital)
Financial Management Managing firms’ internal cash flows and its mix of debt and equity financing, both to maximize the value of the debt and equity claims on firms’ and to ensure that companies can pay off their obligations when they come due. Risk Management Managing firms ’exposures to all types of risk, both insurable and uninsurable, in order to maintain optimum risk return trade-off s and thereby maximize shareholder value. 06/02/2017 Financing(Raising Capital) Raising capital to support companies’ operations and investment programs. Corporate Governance Developing ownership and corporate governance structures for companies that ensure that managers behave ethically and make decisions that benefit shareholders. Capital Budgeting Selecting the best projects in which to invest the resources of the firm, based on each project’s perceived risk and expected return.

14 The Three KEY Decisions in Financial Management
06/02/2017 The Three KEY Decisions in Financial Management Investment Decisions Financing Decisions Dividend Decisions

15 Most important of the three decisions
Investment Decisions 06/02/2017 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? These are decisions that have to do with the firm deciding on what investments it wishes to make. It also includes determining what assets to invest in. The decision making process involves selecting viable projects by applying investment appraisal techniques depending on the nature of the business the firm is involved in (E.g. Mining, retail, manufacturing or tourism. The Hurdle Rate – reflects the riskiness of the investment and the mix of debt and equity used to fund it. The Return – reflects the magnitude and timing of the cashflows as well as various associated risks.

16 Financing Decisions What is the best type of financing?
These are decisions regarding, how the investment(s) selected will be financed. Firms have three options regarding where they source finances. They can source them internally by using retained earnings, borrowing from the debt capital market or issuing stocks (ordinary shares). The decision to use a specific source of finance is determined by the period of investment (long- term of short-term), use of funds for either capital investment or working capital requirements and desired capital structure for a given firm. That is, the balance between equity and debt used in financing the assets of the firm. 06/02/2017 What is the best type of financing? What is the best financing mix? How will the funds be physically acquired? The Optimal mix of debt and equity maximizes firm value. The Right Kind of debt matches the tenor of your assets.

17 Dividend Decisions 06/02/2017 These decisions involve determining a dividend policy for the firm which describes how the returns from the investment are distributed to shareholders as dividends. The policy describes when and how much of the profits are distributed as dividends including the mode of payment. As the finance manager performs these functions the overriding goal is to ensure that the firm’s value is maximized. What is the best dividend policy (e.g. dividend-payout ratio)? How much cash you can return depends upon current & potential investment opportunities How you chose to return cash to the owners will depend whether they prefer dividends or buybacks

18 What is the Goal of the Firm?
06/02/2017 Possible goals: Avoid bankruptcy and financial distress Minimize costs Maximize sales Maximize profits The best goal of a publicly traded firm: Maximize share price (Maximization of Shareholder Wealth) Value creation occurs when we maximize the share price for current shareholders.

19 06/02/2017 Why Traditional Corporate Financial Theory Focuses on Maximizing Stockholder Wealth Stock prices are easily observable and constantly updated (unlike other performance measures) Stock prices reflect the wisdom of decisions, short and long term and instantaneously The objective of stock price performance provides theory on: Allocation of resources across scarce uses How to finance these investments How much to pay in dividends

20 Strengths of Shareholder Wealth Maximization
06/02/2017 Takes account of: Current and future profits The timing, duration, and risk of profits Dividend policy and All other relevant factors. Share price serves as a barometer for business performance.

21 Shortcomings of Profit Maximization ( Maximizing earnings after taxes )
Problems Could increase current profits while harming firm (e.g., defer maintenance) Ignores changes in the risk level of the firm(Ignores risk) Does not fully consider cash flow timing

22 The Modern Corporation
06/02/2017 Modern Corporation Shareholders Management There exists a SEPARATION between owners and managers.

23 Management acts as an agent for the owners (shareholders) of the firm.
06/02/2017 Role of Management Management acts as an agent for the owners (shareholders) of the firm. An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf.

24 06/02/2017 The Agency Problem This is defined as a potential conflict of interest between the principals (shareholders) and the agents (managers).This is created when managers act in contrast to the expectations of the shareholders regarding the objective of wealth maximization. It is necessary for shareholders to put in place incentives to ensure that managers maximize shareholder wealth. One agency problem is that managers can use corporate funds for non-value maximizing purposes.

25 Managerial Incentives to Maximize Shareholder Wealth
06/02/2017 To ensure that managers act in line with shareholder expectation agency costs are incurred by firms. These costs take several forms: Expenditure to monitor managerial actions. E.G external audits Expenditure to structure the organization so that the possibility of undesirable managerial behavior will be limited.

26 Mechanism Applied to Force Managers to Act in the Shareholders Best Interest Include
06/02/2017 The threat of being fired. The threat of take over which takes the form a hostile takeover. When a new firm takes over another company, managers are usually replaced by these appointed by the new board. Management would want to avoid a takeover for fear of losing their jobs to competition. Structured managerial incentives, Which include executive share options, where executive, are given an opportunity to buy share in the future at some discounted price and performance shares awarded on the basis of performance using some criteria.

27 Corporate Social Responsibility
06/02/2017 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. Then shareholder wealth maximization remains the appropriate goal in governing the firm.

28 Corporate Governance 06/02/2017 Corporate governance: represents the system by which corporations are managed and controlled. Includes shareholders, board of directors, and senior management. Then shareholder wealth maximization remains the appropriate goal in governing the firm. Corporate governance is the system that is used to overcome problems associated with the separation of managers and owners (hence, the need to understand different forms of business). Core attributes: Delineation of the rights of shareholders and other core stakeholders; Clearly defined manager and director governance responsibilities to stakeholders; Identifiable and measurable accountabilities for the performance of the responsibilities; Fairness and equitable treatment in all dealings between managers, directors, and shareholders; and Complete transparency and accuracy in disclosures regarding operations, performance, risk, and financial position.

29 Board of Directors Typical responsibilities: Set company-wide policy;
06/02/2017 Typical responsibilities: Set company-wide policy; Advise the CEO (chief executive officer) 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.

30 Forms of Business Organizations
06/02/2017 The form of business will dictate, in part, the relationship between the owners of the business and management. The degree of separation may be minimal (e.g., sole proprietorship), or significant (e.g., large corporation). When there is a separation between owners and managers, there is a potential for agency problems, which may affect the value of the business. We will examine three business forms: the sole proprietorship, the partnership, and the corporation.

31 THE THREE BASIC FORMS OF BUSINESS ORGANIZATION
06/02/2017 Sole Proprietorships Partnerships (general and limited) Corporations

32 The Business Environment
06/02/2017 Sole Proprietorship – A business form for which there is one owner. This single owner has unlimited liability for all debts of the firm. Oldest & Most numerous form of business organization. Business income is accounted for on your personal income tax form.

33 Sole Proprietorship Advantages Disadvantages Easiest to start
06/02/2017 Advantages Easiest to start Least regulated Single owner keeps all the profits Single tax filing on individual form Disadvantages Unlimited liability Hard to raise additional capital Transfer of ownership difficulties Limited to life of owner There is often little separation between the owner and the manager(s) of the business; often, one in the same. Therefore, there is not much of an opportunity for a conflict of interest between the owner and manager(s)

34 Partnership 06/02/2017 Partnership – A business form in which two or more individuals act as owners. Business income is accounted for on each partner’s personal income tax form. The partnership is a natural extension from the sole proprietorship, with more than one owner. The owners often are managers of the business, with a partnership agreement, so there is little separation between owners and managers. Hence, there are few opportunities for conflicts of interest among partners and management.

35 Types of Partnerships 06/02/2017 General Partnership – all partners have unlimited liability and are liable for all obligations of the partnership. Limited partnership – limited partners have liability limited to their capital contribution (investors only). At least one general partner is required and all general partners have unlimited liability.

36 Partnership Advantages Disadvantages Can be simple
06/02/2017 Advantages Can be simple Low setup cost, higher than sole proprietorship Relatively quick setup Limited liability for limited partners Disadvantages Unlimited liability for the general partner Difficult to raise additional capital, but easier than sole proprietorship Transfer of ownership difficulties

37 Corporation 06/02/2017 Corporation – A business form legally separate from its owners. An artificial entity that can own assets and incur liabilities. For example, a corporation can enter into contracts. Corporations account for most business revenue around the world. Business income is accounted for on the income tax form of the corporation. The corporation is a legal entity, with major decisions made by the board of directors. The members of the board of directors are elected by shareholders. The board of directors monitor the company’s management on behalf of the shareholders. Because of this agency relationship, there are potential conflicts between the agents (the management and the members of the board of directors) and the owners (the shareholders).

38 Corporation Disadvantages Advantages
06/02/2017 Disadvantages Corporations are more highly regulated than are partnerships or sole proprietorships. Separation of owners and managers. There are costs to this agency relationship arising from conflicts of interest. Double taxation More difficult to establish More expensive to set up and maintain Advantages Easier to raise large quantities of capital Grant ownership stakes (that is, issue stock) or borrow (that is, issue bonds). Owners need not know how to run the business. The corporation hires experts to manage the business. Limited liability Easy transfer of ownership Unlimited life

39 Forms of business and conflicts of interest
06/02/2017

40 06/02/2017

41 Summary 06/02/2017 Corporate governance is the system of principles, policies, procedures, and clearly defined responsibilities and accountabilities. The objectives of a corporate governance system are (1) to eliminate or mitigate conflicts of interest among stakeholders, particularly between managers and shareholders, and (2) to ensure that the assets of the company are used efficiently and productively and in the best interests of the investors and other stakeholders. The failure of a company to establish an effective system of corporate governance represents a major operational risk to the company and its investors. 8. Summary

42 Summary (continued) 06/02/2017 The specific sources of conflict in corporate agency relationships are manager-shareholder. The responsibilities of board members, both individually and as a group, are to establish corporate values and effective governance structures for the company. 8. Summary (continued)

43 Summary (continued) 06/02/2017 Companies committed to corporate governance often provide a statement of corporate governance policies. Analysts should assess: the code of ethics; statements of the oversight, monitoring, and review responsibilities of directors; statements of management’s responsibilities with respect to information and access of directors to internal company functions; reports of directors’ examinations, evaluations, and findings; board and committee self-assessments; management self-assessments; and training policies for directors. Weak corporate governance systems give rise to risks including accounting risk, asset risk, liability risk, and strategic policy risk. 8. Summary (continued)


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