1. Slide 1 Introduction to Financial Management Definitions of Finance Financial Management Decisions and The Goal Forms of Business Organizations The Corporation and Financial Markets Ten Principles of Finance

2. Slide 2 Definition of Finance Finance is the study of how people allocate scarce resources over time. Two characteristics of financial decisions; Costs and benefits of financial decisions are spread out over time Costs and benefits are not known in advance Finance consists of concepts to help you organize your decision making process and quantitative models to help you evaluate alternatives

3. Slide 3 Financial Management Decisions and The Goal Capital Budgeting: What assets should be acquired? Capital Structure: What is the best way of financing the assets? Working Capital Management: Short-term asset and liability management

4. Slide 4 Financial Management Decisions and The Goal (Continued) The Goal of Financial Managers Maximize profits How to define profits Risks associated with maximizing profits are ignored Profits of this year or the next should be maximized? Maximize the market value of the existing owners’ equity

5. Slide 5 Forms of Business Organization

6. Slide 6 The Corporation and Financial Markets Corporation Cash Flows: Reinvested or Investors Secondary Market Government Tax Cash Securities Dividends, Interest etc.

7. Slide 7 The Corporation and Financial Markets (Continued) Primary Market Market in which new issues of a security are sold to initial buyers Secondary Market Market in which previously issued securities are traded Initial Public Offering (IPO) The first time the firm’s stock is sold to the general public Seasoned Equity Offering (SEO) A new stock offering by a firm that already has stock that is traded in the secondary market

8. Slide 8 Ten Principles of Financial Management Risk-Return Tradeoff Save and invest for future consumption Investments should provide appropriate compensation for forgone consumption

9. Slide 9 Ten Principles of Financial Management (Continued) 90% Large-company stocks13.3%20.1 Small-company stocks17.633.6 Long-term corporate bonds5.98.7 Long-term government5.59.3 Intermediate-term government5.45.8 U.S. Treasury bills3.83.2 Inflation3.24.5 -90% 0% Series Average Return Standard Deviation Distribution

10. Slide 10 Ten Principles of Financial Management (Continued) The Time Value of Money A dollar received today is more valuable than a dollar received in the future because of opportunity cost Costs and future benefits of investments should be measured in present values If present value of future benefits exceed costs, then investment should be made (Net Present Value (NPV)>0)

11. Slide 11 Ten Principles of Financial Management (Continued) Cash is King Cash flows not accounting profits are important Cash flows received can be reinvested by the firm Accounting problems-depreciation and matching of costs and expenses Incremental Cash Flows that Matter Incremental cash flows are direct consequence of taking a specific course of action

12. Slide 12 Ten Principles of Financial Management (Continued) Competitive Markets Project evaluation vs. value creation-investing for returns above same risk alternatives It is not easy to find projects that create wealth- competition Perfect market conditions: No entry and exit restrictions, No one producer or buyer large enough to affect prices, Identical products are manufactured, Production costs are identical, Everyone is informed about everything

13. Slide 13 Ten Principles of Financial Management (Continued) If markets are perfect then it is not possible to create wealth How can we make markets less competitive? Product Differentiation based on features, quality, image, service and distribution Cost Advantage through economies of scale, technology, corporate culture and input supply control

14. Slide 14 Ten Principles of Financial Management (Continued) Efficient Markets Price adjustments to new information is quick and correct Many profit driven investors Information arrival is random

15. Slide 15 Ten Principles of Financial Management (Continued) “Calwest Industrial Properties, a closely held real-estate concern, has agreed to acquire Cabot Industrial Trust (CTR) for about $1.06 billion plus the assumption of $925 million in preferred stock and debt, people familiar with the matter say. Under terms of the deal, Calwest would pay $24 a share for Boston-based Cabot. The price represents a 20% premium to Cabot's price in 4 p.m. trading Friday on the New York Stock Exchange, when its shares were changing hands at $19.95, down five cents for the day.” WSJ, October 29, 2001

16. Slide 16 Ten Principles of Financial Management (Continued)

17. Slide 17 Ten Principles of Financial Management (Continued) Agency Problem Separation of ownership and management Principal-Shareholders Agents-Managers Will managers work in the shareholders’ best interest? Preference toward size over profitability Excessive perquisites Attitudes toward risk

18. Slide 18 Ten Principles of Financial Management (Continued) Types of agency costs Costs of trying to get the agents to do what the principal want-monitoring costs Lost opportunities caused by conflicts too expensive to resolve Possible solutions Managerial compensation Control of the firm

19. Slide 19 Ten Principles of Financial Management (Continued) Taxes Bias Business Decisions After-tax cash flows received can be reinvested Favorable tax status for certain investments affects decisions Financial leverage is affected by tax status-interest payments are tax-deductible expenses

20. Slide 20 Ten Principles of Financial Management (Continued) Diversification Eliminates Certain Type of Risk Diversifiable/Firm Specific/Unsystematic Risk Non-diversifiable/Market/Systematic Risk Firm specific good news and bad news wash each other out

21. Slide 21 Ten Principles of Financial Management (Continued)

22. Slide 22 Ten Principles of Financial Management (Continued) Ethical Behavior is Doing the Right Thing Doing something that is viewed right by many people An action that is not prohibited by law can be unethical Unethical behavior might be costly