1. Business Finance
Michael Dimond

2. Introduction What this class will cover
How do I get an A in this class?
Relevance
Schedule
Tools & resources

3. Doing Online Problems & Quizzes

4. Essential issues of financial management
Purpose of business
To create wealth for the owner.
A business may also serve some other purpose, but if the business is not profitable these other functions will eventually fail.
Jobs will be lost
Benefits to society will be eliminated
Improvements to the planet will stop
Purpose of financial management
To increase shareholder wealth.
The fundamental question
The fundamental question which must be asked in any business situation is, “what is this worth?”

5. Just to clear up this misconception…
Should managers only take actions which increase the share price?
Hey, it worked for Enron… wait, what?
How about GM?
Okay, how about the Mars Candy Company?

6. The goal is to increase value
Managers should only take actions which increase value, not just share price.
Share price should accurately reflect the value of a publicly traded company, but…
What if the investors are wrong?
What if the company is privately held?
How do we determine value?

7. The "Magic" Machine Consider the following scenario:
Note: This is not a trick question, merely a framework to help you think about the subject.
Consider the following scenario:
You have the opportunity to buy a machine which is guaranteed to produce $100 per month for the next five years. There are no operating costs and the device will vanish at the end of that time.
How much would you pay for this?
What factors influence your decision?

8. The "Magic" Machine Consider the following scenario:
Note: This is not a trick question, merely a framework to help you think about the subject.
Consider the following scenario:
You have the opportunity to buy a machine which is guaranteed to produce $100 per month for the next five years. There are no operating costs and the device will vanish at the end of that time.
How much would you pay for this?
What factors influence your decision?
You have 5 minutes…
What did you decide?
What drove your decision?

10. Basic return: reward ÷ cost
At its simplest, return is the reward you receive divided by the price you pay.
For example, if you buy something for $1,000 and sell it for $1,100…
How much is the reward?
What was the price?
What is the return?

11. Uncertainty = Risk Risk is another word for uncertainty.
Things rarely happen exactly as anticipated. There is a possibility an outcome will be…
Better than expected (upside risk)
Worse than expected (downside risk)
People in general tend to avoid significant amounts of risk
Investors are risk averse
Essential Issues in Corporate Governance
Corporation vs other types of business entities
Board of directors
Managers
Agency cost

12. Risk vs Price
Think again about the so-called magic machine. If the $100 monthly cash flow was not guaranteed, how would this affect the price you are willing to pay?

13. Price vs Return
If we think of return as the reward divided by the price, we can see how the change in price affects the return:
100/1000 = 10%
100/900 = 11%
100/1100 = 9%
What about a change in total value over time?
In the previous example, you bought something for $1,000 and later sold it for $1,100. The change in value was $100 ($1,100 - $1,000)
You can also compute the return this way:
1100/1000 – 1 = 10%

14. Risk vs Return As risk increases, the price decreases
As price decreases, return increases
:. As risk increases, return increases
Remember, return is the return demanded by investors, not a guaranteed result

15. Required Rate of Return
Risk & Return always correlate: Investors will find a price to give them a return which compensates them for the risk they are willing to bear: the Required Rate of Return.
The Required Rate of Return may have many labels. For example:
Ke rs i Re E(r) WACC rd Kd “Hurdle Rate”

16. Understanding financial statements
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Shareholders’ Equity