More Related Content
Similar to 1. chapter 1 introduction of Finance
Similar to 1. chapter 1 introduction of Finance (20)
More from AfiqEfendy Zaen
More from AfiqEfendy Zaen (14)
1. chapter 1 introduction of Finance
- 1. Chapter 1
An Introduction
to the
Foundations
of Financial
Management
Copyright © 2011 Pearson Prentice Hall.
All rights reserved.
- 2. Learning Objectives
Identify the goal of the firm.
Understand the five basic principles of finance and
business, the consequences of forgetting those
basic principles of finance, and the importance of
ethics and trust in business.
Describe the role of finance in business.
Distinguish between the different legal forms of
business.
Explain what has led to the era of the multinational
corporation.
© 2011 Pearson Prentice Hall. All rights reserved. 1-2
- 3. Slide Contents
1. What is Finance?
2. The Goal of the Firm
3. Legal Forms of Business Organization
4. Role of Financial Manager in a
Corporation
5. Income Taxation
6. Ten Principles of Finance
7. Finance and Multinational Firm
© 2011 Pearson Prentice Hall. All rights reserved. 1-3
- 4. What is Finance?
Finance applies specific value to
things owned
services used
decisions made
Financial management
organization’s approach to
valuation
© 2011 Pearson Prentice Hall. All rights reserved. 1-4
- 5. 1. The Goal of the Firm
The goal of the firm is to create value for the
firm’s legal owners (that is, its shareholders).
Thus the goal of the firm is to “maximize
shareholder wealth” by maximizing the price
of the existing common stock.
© 2011 Pearson Prentice Hall. All rights reserved. 1-5
- 6. 2. Five Foundational
Principles of Finance
Cash flow is what matters
Money has a time value
Risk requires a reward
Market prices are generally right
Conflicts of interest cause agency
problems
© 2011 Pearson Prentice Hall. All rights reserved. 1-6
- 7. Five Principles
“…while it is not necessary to understand
finance in order to understand these principles,
it is necessary to understand these principles in
order to understand finance.”
© 2011 Pearson Prentice Hall. All rights reserved. 1-7
- 8. Principle 1:
Cash flow is what matters
Accounting profits are not equal to cash flows. It is
possible for a firm to generate accounting profits but
not have cash or to generate cash flows but not
report accounting profits in the books.
Cash flow, and not profits, drive the value of a
business.
We must determine incremental cash flows when
making financial decisions.
Incremental cash flow is the difference between the
projected cash flows if the project is selected, versus what
they will be, if the project is not selected.
© 2011 Pearson Prentice Hall. All rights reserved. 1-8
- 9. Principle 2:
Money has a time value
A dollar received today is worth more than a
dollar received in the future.
Since we can earn interest on money received
today, it is better to receive money earlier rather
than later.
© 2011 Pearson Prentice Hall. All rights reserved. 1-9
- 10. Principle 3:
Risk requires a Reward
We won’t take on additional risk unless we
expect to be compensated with additional
reward or return.
Investors expect to be compensated for
“delaying consumption” and “taking on risk”.
Thus investors expect a return when they put their
savings in a bank (i.e. delay consumption) and
they expect to earn a higher rate of return on
stocks relative to bank savings account (i.e. taking
on risk)
© 2011 Pearson Prentice Hall. All rights reserved. 1-10
- 12. Principle 4: Market Prices
are generally Right
In an efficient market, the prices of all traded assets
(such as stocks and bonds) at any instant in time fully
reflect all available information.
Thus stock prices are a useful indicator of the value
of the firm. Prices changes reflect changes in
expected future cash flows. Good decisions will tend
to increase the stock prices and vice versa.
Note there are inefficiencies in the market that may
distort the prices.
© 2011 Pearson Prentice Hall. All rights reserved. 1-12
- 13. Principle 5: Conflicts of interest
cause agency problems
The separation of management and the
ownership of the firm creates an agency
problem. Managers may make decisions that
are not consistent with the goal of maximizing
shareholder wealth.
Agency conflict is reduced through monitoring
(ex. Annual reports), compensation schemes
(ex. stock options), and market mechanisms
(ex. Takeovers)
© 2011 Pearson Prentice Hall. All rights reserved. 1-13
- 14. Ethics and business
Ethical behavior is doing the right thing! …
but what is the right thing?
Ethical dilemma - Each person has his or her
own set of values, which forms the basis for
personal judgments about what is the right
thing.
Sound ethical standards are important for
business and personal success. Unethical
decisions can destroy shareholder wealth
(ex. Enron Scandal)
© 2011 Pearson Prentice Hall. All rights reserved. 1-14
- 15. 3. The Role of Finance
in Business
Three broad issues addressed by the study of
finance:
Where to Invest? (Capital budgeting
decision)
How to raise money to fund the investment?
(Capital structure decision)
How to manage cash flows from daily
operations? (Working capital decision)
© 2011 Pearson Prentice Hall. All rights reserved. 1-15
- 16. The Role of Business in
Finance (cont.)
Knowledge of financial tools is relevant for
decision making in all areas of business
(be it marketing, production etc.).
Decisions involve an element of time and
uncertainty … financial tools help adjust for
time and risk.
Decisions taken in business should be
financially feasible … financial tools help
determine the financial viability of decisions.
© 2011 Pearson Prentice Hall. All rights reserved. 1-16
- 17. The Role of a Financial
Manager in a Firm
© 2011 Pearson Prentice Hall. All rights reserved. 1-17
- 18. 4. The Legal Forms of
Business Organization
Business Forms
Sole
Partnership Corporation Hybrid
Proprietorship
S-Type LLC
© 2011 Pearson Prentice Hall. All rights reserved. 1-18
- 19. Sole Proprietorship
Business owned by an individual
Owner maintains title to assets and
profits
Unlimited liability
Termination occurs on owner’s death or
by owner’s choice
© 2011 Pearson Prentice Hall. All rights reserved. 1-19
- 20. Partnerships
Two or more persons come together as co-owners
General Partnership: All partners are fully responsible
for liabilities incurred by the partnership.
Limited Partnerships: One or more partners can have
limited liability, restricted to the amount of capital
invested in the partnership. There must be at least one
general partner with unlimited liability. Limited partners
cannot participate in the management of the business
and their names cannot appear in the name of the firm.
© 2011 Pearson Prentice Hall. All rights reserved. 1-20
- 21. Corporation
Legally functions separate and apart from its owners
Corporation can sue, be sued, purchase, sell, and own property
Owners (shareholders) dictate direction and policies of
the corporation, oftentimes through elected board of
directors.
Shareholder’s liability is restricted to amount of
investment in company
Life of corporation does not depend on the owners …
corporation continues to exist through easy transfer of
ownership
Taxed separately
© 2011 Pearson Prentice Hall. All rights reserved. 1-21
- 22. The trade-offs:
Corporate Form
Benefits: Limited liability, Easy to transfer
ownership, Easier to raise capital, Unlimited
life (unless the firm goes through corporate
restructuring such as mergers and
bankruptcies)
Drawbacks: No secrecy of information,
maybe delays in decision making, Greater
regulation, double taxation.
© 2011 Pearson Prentice Hall. All rights reserved. 1-22
- 23. Double Taxation example
Assume earnings before tax = $1,000
Federal Tax @25% = $250
After tax Income available for distribution to
shareholders= $750
Examine the tax effects, if the company
chooses to distribute the after-tax profits to
shareholders as dividends.
© 2011 Pearson Prentice Hall. All rights reserved. 1-23
- 24. Double Taxation example
If corporation distributes all the profits as
dividends to shareholders ==> Shareholders
will be taxed again.
Assume dividends are taxed @15%
= 15% of $750 = $112.50
==>Total tax = 250 + 112.5 = $362.5 or 36.25%
© 2011 Pearson Prentice Hall. All rights reserved. 1-24
- 25. Hybrid Organizations:
S-Type Corporation and
Limited liability Companies (LLC)
S-Type Corporations
Benefits
Limited liability
Taxed as partnership (no double taxation like
corporations)
Limitations
Owners must be people so cannot be used for
joint ventures between two corporations
© 2011 Pearson Prentice Hall. All rights reserved. 1-25
- 26. Hybrid Organizations:
S-Type Corporation and
Limited liability Companies (LLC) (cont.)
Limited Liability Companies (LLC)
Benefits
Limited liability
Taxed like a partnership
Limitations
Qualifications vary from state to state
Cannot appear like a corporation otherwise it
will be taxed like one
© 2011 Pearson Prentice Hall. All rights reserved. 1-26
- 27. 5. Finance and the Multinational
Firm: The New Role
U.S. corporations are looking to international
expansion to discover profits
For example, Coca-Cola earns over 80% of its profits from
overseas sales
In addition to US firms going abroad, we have also
witnessed many foreign firms making their mark in
the United States (ex. Domination of auto industry by
Honda, Toyota, and Nissan)
Internationalization of business has been spurred by:
Collapse of communism
Acceptance of free market system
Technology
Improved transportation
© 2011 Pearson Prentice Hall. All rights reserved. 1-27
- 28. Why do companies
go abroad?
To increase revenues
To reduce expenses (land, labor, capital, raw
material, taxes)
To lower governmental regulation standards
(ex. Environmental, labor)
To increase global exposure
© 2011 Pearson Prentice Hall. All rights reserved. 1-28
- 29. Risks/challenges
Country risk (changes in government
regulations, unstable government, economic
changes in foreign country)
Currency risk (fluctuations in exchange rates)
Cultural risk (differences in language,
traditions, ethical standards etc.)
© 2011 Pearson Prentice Hall. All rights reserved. 1-29
- 30. Review: Key Terms
Agency problem LLC
Corporation Limited Partnership
Efficient market Partnership
General partnership Sole proprietorship
Incremental cash S-type corporation
flow
© 2011 Pearson Prentice Hall. All rights reserved. 1-30