ch01 ppt brighamfm1ce

8/3/2019 Ch01 Ppt Brighamfm1ce

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PowerPoint Presentationprepared by

Traven ReedCanadore College


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Chapter1An Overview of Financial

Management and theFinancial Environment


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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-3

Topics in Chapter

Attributes of successful companies

Forms of business organization

Objective of the firm: maximizewealth

Determinants of fundamental value

Financial securities, financialinstitutions, and financial markets


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Attributes of SuccessfulCompanies

Like a stool needs all three legs tostand, a successful business relieson:

Skilled people

Strong external relationship

Sufficient capital


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The Corporate Life Cycle

No two companies will develop in exactlythe same way

A business usually begins as a smallpotato and hopefully finishes up as amajor giant

Structures of business organizations: Sole proprietorship

Partnership

Corporation

Income trust


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Starting as a Proprietorship

Advantages: Ease of formation

Subject to few regulations No corporate income taxes

Disadvantages:

Difficult to raise capital to supportgrowth

Unlimited liability

Limited life span


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Starting as or Growing into aPartnership

A partnership involves two or moreentities with various privileges and

responsibilities General vs. limited partner

Limited liability partnership

A partnership has roughly the sameadvantages and disadvantages asa sole proprietorship.


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Becoming a Corporation

A corporation is a legal entityseparate from its owners and

managers.

File papers and prepare reportswith Corporation Canada.

Articles of incorporation Bylaws


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Advantages and Disadvantagesof a Corporation

Advantages: Unlimited life

Easy transfer of ownership Limited liability

Ease of raising capital

Disadvantages: Double taxation Higher setup cost

Endless report filing


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A Unique Twist: Income Trusts

Expand 100 times to a market capitalization of$192 billion from 1994 to 2007

Growth ends as government has announcedplans in 2006 to tax trusts at the same rate ascorporations

In the past, income trust cash distributions areonly taxed in the hands of investors, not at thefirm level

Investors see trusts as tax-efficient and arewilling to pay more for a company converted toa trust


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What should be managementsprimary objective?

The primary objective should beshareholder wealth maximization, which

translates to maximizing the fundamentalshare price, not just the current marketprice.

Should firms behave ethically? YES!

Business ethics are a companys attitudeand conduct toward its employees,customers, community and shareholders


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Stock Price Maximization and

Social Welfare Do firms have any responsibilities

to society at large? Yes!

Unethical behavior destroys publictrust and confidence.

Maximizing share price is good for

society. Why?

Shareholders are also members ofsociety.



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Is Maximizing stock price

good for consumers? Consumer welfare is higher in

capitalist free market economies

than in communist or socialisteconomies due to competition

Consumers can improve quality of

life by the direct or the indirectinvestments in the stock market



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Is maximizing stock price good foremployees?

Employment growth is higher infirms that try to maximize stock

price. On average, employmentgoes up in:

firms that make managers into owners

(such as LBO firms) firms that were owned by the

government but that have been sold toprivate investors


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Free Cash Flows (FCF)

There are many ways firms canincrease free cash flows

FCF are cash flows available (orfree) for distribution to all investors(stockholders and creditors).

FCF = sales revenues - operatingcosts - operating taxes - requiredinvestments in operating capital.


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What is the weighted averagecost of capital (WACC)?

WACC is the average rate of returnrequired by all of the companys

investors. WACC is affected by:

Capital structure (the firms relative amountsof debt and equity)

Interest rates

Risk of the firm

Investors overall attitude toward risk


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Determinants of a Firms Value


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Who are the providers (savers) andusers (borrowers) of capital?

Households: Net savers

Non-financial corporations: Netusers (borrowers)

Governments: Net borrowers

Financial corporations: Slightly netborrowers, but almost breakeven


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Capital Allocation Process


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Transfer of Capital fromSavers to Borrowers

Direct transfer (e.g., corporation issuescommercial paper to insurance

company) Indirect transfer through an investment

banker (e.g., IPO, seasoned equityoffering, or debt placement)

Indirect transfer through a financialintermediary (e.g., individual depositsmoney in bank, bank loans to a firm)


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Cost of Money

Supply and demand of fundsdetermine the price of money.

What do we call the price (or cost)of debt capital? Of equity capital? Interest rate

Cost of equity = required return = dividendyield + capital gain

Both are the rate fund users pay tofund providers


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What four fundamental factorsaffect the cost of money?

Production opportunities

Time preferences for consumption

Risk

Expected inflation


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What economic conditions affectthe cost of money?

Bank of Canada policies

Budget deficits/surpluses

Level of business activity (recession orboom)

International trade deficits/surpluses

Country risk depending on its economic,political, and social environment

Exchange rate risk



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Financial Securities

Financial securities are contractsgranting owners specific rights and

claims on specific values

Vary in risk and maturity

Nature of claims: debt, equity, and

derivatives Money market instrument (T


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Financial Securities

Debt Equity Derivatives

MoneyMarket

T-BillsBankers AcceptancesCommercial papersMMMFsEuroCanadian dollars

OptionsFuturesForwardcontract

CapitalMarket

CanadianGovernment-BondsMortgagesCorporate bonds

Common stockPreferred stock

LEAPSSwaps


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Typical Rates of Return

Instrument Rate (April 2009)

Govt of Canada T-bills 2.05%

Bankers acceptances 3.57

Commercial paper 5.39

Money Market mutual funds 3.50

EuroCanadian market time 3.45

Commercial loans:

Tied to prime 5.25 +

or LIBOR 3.05 +


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Typical Rates (contd)

Instrument Rate (April 2009)

Govt of Canada bonds 3.56%

Mortgages 6.50

Corporate bonds 5.11

Leases 5.11

Common Stock 10.9


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What are some financialinstitutions?

Investment banks

Commercial banks

Trust companies Credit unions

Life insurance companies

Mutual funds Money Market Funds (MMMFs)

Exchanged Traded Funds (ETFs)

Pension funds

Hedge funds


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Types of Financial Markets

A financial market brings togethersavers and borrowers.

Physical asset vs. financial assetmarkets

Spot versus future markets

Money versus capital markets

Primary versus secondary markets

Private versus public markets


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Physical- vs. Financial-asset

Markets Physical (a.k.a. tangible or real)

asset markets

Products as wheat, autos and realestates

Financial asset markets

Primitive securities and derivativesecurities



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Spot vs. Futures Markets

Spot (a.k.a. cash) markets

Assets are bought or sold for on-the-

spot delivery

Futures markets

Assets are bought or sold for delivery

at some future date



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Primary vs. SecondaryMarkets

Primary

New issue (IPO or seasoned)

Key factor: issuer receives theproceeds from the sale.

Secondary

Existing owner sells to another party. Issuing firm doesnt receive proceeds

and is not directly involved.


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Private vs. Public Markets

Private markets

Transactions are worked out directly

between two parties

Lack of liquidity

Public markets

Standardized contracts are traded onan organized

More liquid and transparent


ch01 ppt brighamfm1ce

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