Financial Management

Lecture 1: Course Information & Overview

Professor Andrea Vedolin

ETH Zürich
 Today

Important information & Class rules

Class objectives

Class overview

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 Contact Info

Office: Scheuchzerstrasse 7

Zoom: https://bostonu.zoom.us/my/vedolin

Email: avedolin@ethz.ch

Office Hours: By appointment

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 Course Material and Prerequisites

Required material:

book “Corporate Finance” by J. Berk and P. DeMarzo (Pearson)

class material (slides, notes, practice problems, articles, syllabus) on Moodle
lecture recordings are available online

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 Course Material and Prerequisites

Required material:

book “Corporate Finance” by J. Berk and P. DeMarzo (Pearson)

class material (slides, notes, practice problems, articles, syllabus) on Moodle
lecture recordings are available online

Prerequisites:

you need to be familiar with basic concepts in probability, statistics and

elementary algebra

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 Performance Evaluation

Final exam (5 June 2023)

(based on the required material covered during the whole course)

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 Performance Evaluation

Final exam (5 June 2023)

(based on the required material covered during the whole course)

Class participation:
(you are expected to attend all the classes and participate actively)

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 A Few Tips

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 A Few Tips

Be on time

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 A Few Tips

Be on time
Read both the slides and the relevant book chapters soon after each class

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 A Few Tips

Be on time
Read both the slides and the relevant book chapters soon after each class
Beyond the homework assignments, try to solve as many problems as possible

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 A Few Tips

Be on time
Read both the slides and the relevant book chapters soon after each class
Beyond the homework assignments, try to solve as many problems as possible
Remember: “Practice makes perfect”

Financial Management (363-0560) Course Information & Overview 6 / 18

 A Few Tips

Be on time
Read both the slides and the relevant book chapters soon after each class
Beyond the homework assignments, try to solve as many problems as possible
Remember: “Practice makes perfect”
Practice more!

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 A Few Tips

Be on time
Read both the slides and the relevant book chapters soon after each class
Beyond the homework assignments, try to solve as many problems as possible
Remember: “Practice makes perfect”
Practice more!
If you get stuck, please do not stay stuck: come to the office hours

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 A Few Tips

Be on time
Read both the slides and the relevant book chapters soon after each class
Beyond the homework assignments, try to solve as many problems as possible
Remember: “Practice makes perfect”
Practice more!
If you get stuck, please do not stay stuck: come to the office hours
Hard work will be rewarded

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 Objectives of The Course

Introduce you to the theory of corporate finance

Learn and practice the quantitative tools

Discuss practical applications of what we learn

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 Who Am I?

Undergrad in Econ, University of Zurich

PhD in Econ at University of Lugano

I have taught undergrad, grad, PhD, MBAs at LSE, Duke, Yale, MIT, and
Boston University.

Research mainly in asset pricing, not corporate finance :)

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 What is (Corporate) Financial Management?

Investment Decisions (Part I):

Investment criteria (NPV vs IRR)

Capital budgeting (Assessing cash flows and profitability of projects)
Real options (Importance of the timing of investments)
Risk Management (Hedging different risks using derivatives)

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 What is (Corporate) Financial Management?

Investment Decisions (Part I):

Investment criteria (NPV vs IRR)

Capital budgeting (Assessing cash flows and profitability of projects)
Real options (Importance of the timing of investments)
Risk Management (Hedging different risks using derivatives)

Financing Decisions (Part II):

Capital Structure (Determinants of Debt and Equity mix)

Interaction between Capital Structure and Capital Budgeting
Changes in Capital Structure (Levered Recaps & LBOs)
Payout Policy (Dividends vs Share Repurchases)

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 The Finance Function

Broadly stated, the finance function is concerned with the flow of funds
between the capital markets and the firm’s operations.

(2) (1)

Firm's Financial Capital

(4a)
Operations Manager Markets

(3) (4b)

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 The Finance Function

Broadly stated, the finance function is concerned with the flow of funds
between the capital markets and the firm’s operations.

(2) (1)

Firm's Financial Capital

(4a)
Operations Manager Markets

(3) (4b)

These flows include: (1) issues of securities to raise cash; (2) purchases of
real assets used in the firm’s operations; (3) cash inflows generated by the
real assets; this cash is either (4a) reinvested in the firm or (4b) returned to
the firm’s security holders.

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 The Finance Function (cont’d)

The financial manager, who serves as the intermediary between the firm’s
operations and capital markets, is faced with two main tasks:
I Investment decisions or capital budgeting (allocating funds to investments).
I Financing decisions (choosing what instruments to issue to raise funds).

Firm's Financial Capital

Operations Manager Markets

Investment Financing
Decisions Decisions

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 The Finance Function (cont’d)

As we will see, these tasks tend to be closely related.

I It is often unreasonable to make a capital budgeting decision without knowing
how the assets will be financed.
I Investment decisions interact with financing decisions.

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 The Finance Function (cont’d)

As we will see, these tasks tend to be closely related.

I It is often unreasonable to make a capital budgeting decision without knowing
how the assets will be financed.
I Investment decisions interact with financing decisions.

In making these decisions, the financial manager has to deal with many
different types of assets.
I Real assets:
F tangible: machinery, factories, real estate, products, offices, etc.
F intangible: technical expertise, trademarks, patents, reputation, etc.
I Financial assets:
F stocks, bonds, bank loans, leases, etc.
F hedging risks could involve options, etc.

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 Forms of Organization

There are different kinds of business organizations:

I Sole proprietorship: one-person business.
I Partnership: business run by two or more people.
I Corporation: business owned by many stockholders and run by professional
managers.
F legally distinct from its owners;
F limited liability;
F stockholders represented by the board of directors, who appoints the top
managers (including the financial manager) and ensures that they act in the
stockholders’ best interests;
F distinctive feature: separation of ownership and management.
In this corporate finance course, our focus will be on corporations.

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 Features of a Corporation

Legally distinct from its owners (i.e., legal entity): it can borrow or lend
money, it can sue or be sued, it pays its own taxes (but cannot vote!).

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 Features of a Corporation

Legally distinct from its owners (i.e., legal entity): it can borrow or lend
money, it can sue or be sued, it pays its own taxes (but cannot vote!).

Stockholders have limited liability.

I Example: If you buy shares of Enron, and the firm then goes bankrupt,
nobody will come and take your house and car away.

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 Features of a Corporation

Legally distinct from its owners (i.e., legal entity): it can borrow or lend
money, it can sue or be sued, it pays its own taxes (but cannot vote!).

Stockholders have limited liability.

I Example: If you buy shares of Enron, and the firm then goes bankrupt,
nobody will come and take your house and car away.

The stockholders own the firm but do not manage it. Instead, they elect a
board of directors to represent them by hiring and overseeing professional
managers.

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 Features of a Corporation (cont’d)

This separation of ownership and control is a distinctive feature of

corporations.

An advantage of this feature is that share ownership can change without

interfering with the operations of the business, and thus the size of the
business is not constrained by the manager’s wealth or risk tolerance.

However, it also implies a whole array of problems (some of which will be

discussed in this course), e.g.,
I incentives: stocks, stock options,...
I agency costs arising from conflicts between different constituents.

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 The Financial Manager

Who is the financial manager?

I Anyone responsible for a significant financial decision of a company.
I The main financial managers are usually the treasurer and, for larger
companies the controller; in the largest companies, they may report to the
chief financial officer.

There are different aspects to the financial manager’s job:

I Understanding capital markets (risk sharing).

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 The Financial Manager

Who is the financial manager?

I Anyone responsible for a significant financial decision of a company.
I The main financial managers are usually the treasurer and, for larger
companies the controller; in the largest companies, they may report to the
chief financial officer.

There are different aspects to the financial manager’s job:

I Understanding capital markets (risk sharing).
I Understanding value creation from outsiders view.

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 The Financial Manager

Who is the financial manager?

I Anyone responsible for a significant financial decision of a company.
I The main financial managers are usually the treasurer and, for larger
companies the controller; in the largest companies, they may report to the
chief financial officer.

There are different aspects to the financial manager’s job:

I Understanding capital markets (risk sharing).
I Understanding value creation from outsiders view.
I Understanding the effects of time and uncertainty.

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 Financial Managers...

Allocate Capital
I Capital Budgeting Policy

Raise Capital
I Capital Structure Policy

Disperse Excess Capital

I Dividend Policy

... to maximize shareholder value

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 Next Class...

We will start with “Investment criteria” (Chapter 7)

Check out Chapters 4 and 6 of the book if you like

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