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Lec1 - Overview of Financial Management
Lec1 - Overview of Financial Management
Overview of Financial
Management and the Financial
Environment
Topics in Chapter
Forms of business organization
Objective of the firm: Maximize wealth
Determinants of fundamental value
Financial securities, markets and
institutions
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Finance & Financial
Management
All entities (households, businesses, governments)
earn/raise and spend/invest money. Finance is the art and
science of managing money. It is associated with the
process, institutions and instruments that facilitate the
transfer of money between entities.
Finance: Economics, Accounting (and Mathematics)
Economists developed the notion that an asset’s value is
determined by the future cash-flows that it generates. In fact,
finance as a separate discipline has grown out of economics.
Accountants help you assess the likely size of those cash-flows.
Mathematics is ubiquitous in any logical field of inquiry.
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Business Organization from Start-
up to a Major Corporation
Sole proprietorship
Partnership
Corporation
(More . .)
Starting as a Proprietorship
Advantages:
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages:
Limited life
Unlimited liability
Difficult to raise capital to support growth
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Starting as or Growing into a
Partnership
A partnership has roughly the same
advantages and disadvantages as a sole
proprietorship.
Becoming a Corporation
A corporation is a legal entity separate
from its owners and managers.
File papers of incorporation with state.
Charter
Bylaws
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Advantages and Disadvantages of
a Corporation
Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Double taxation
Cost of set-up and report filing
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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
control a company’s behavior towards its
directors, managers, employees,
shareholders, creditors, customers,
competitors, and community.
Corporate governance can help control
agency problems.
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Is maximizing stock price good for
society, employees, and customers?
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What determines a firm’s
fundamental, or intrinsic, value?
Intrinsic value is the sum of all the future expected free cash
flows when converted into today’s dollars:
FCF1 + FCF2 +… FCF∞
Value =
(1 + WACC)1 (1 + WACC)2 (1 + WACC)∞
Free cash flows (FCF) are the cash flows that are available (or free) for
distribution to all investors (stockholders and creditors).
Weighted Average Cost of Capital (WACC) is the average rate of return
required by all of the company’s investors. It is affected by risk & capital
structure of the firm, interest rates, and investors’ overall attitude toward risk
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Who are the providers (savers)
and users (borrowers) of capital?
Households: Net savers
Non-financial corporations: Net users
(borrowers)
Governments: Net borrowers
Financial corporations: Slightly net
borrowers, but almost breakeven
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Cost of Money
What do we call the price, or cost, of debt capital?
The interest rate
capital gain
Certain fundamental economic factors, economic
conditions and policies, and international factors affect
the demand and supply of loanable funds and their cost.
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Typical Rates (Continued)
Instrument Rate (April 2006)
U.S. T-notes and T-bonds 5.04%
Mortgages 6.15
Municipal bonds 4.66
Corporate (AAA) bonds 5.93
Preferred stocks 6 to 9%
Common stocks (expected) 9 to 15%
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Types of Orders
Instructions on how a transaction is to
be completed
Market Order– Transact as quickly as
possible at current price
Limit Order– Transact only if specific
situation occurs. For example, buy if price
drops to $50 or below during the next two
hours.
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THANKS
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