fund.finance lecture 1 introduction 2011
TRANSCRIPT
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FUND MENT LSOFFIN NCI L M N GEMENT
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COURSE CONTENT
Topic 1. Introduction to Finance. Overview of orporate
Financing Decisions. Capital Markets and FinancialInstruments.
Topic 2.Time Value of Money and Present ValueConcept.
Topic 3.Valuing Debt and Equity Securities: Bond vs.Stock
Topic 4.Investment Evaluation. Capital BudgetingDecisions.
Topic 5.Risk and Return. Introduction to Portfolio Theory.
Topic 6.Long-term Financial Decisions: Capital Structureand Cost of Capital.
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COURSE ASSESSMENT
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Element Weight
1. In-class tests (2) 30%
2. Mid-term Exam 30%
3. Final Exam 40%
TOTAL 100%
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RESOURCE
Required Textbook:Brealey, Myer & Allen, Fundamentals
of Corporate Finance, 6-th ed. McGraw Hill,2008
Selected web sites:TheStreet.com at www.thestreet.com
The CNNat www.money.cnn.com
Yahoo financeat www.finance.yahoo.com4
http://www.thestreet.com/http://www.money.cnn.com/http://www.finance.yahoo.com/http://www.finance.yahoo.com/http://www.money.cnn.com/http://www.thestreet.com/ -
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INTRODUCTION TOFIN NCI L M N GEMENT
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Lecture 1
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INTRODUCTION TO FINANCIAL MANAGEMENTTopic cover
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Forms of business organization
Goals of corporation
Major decisions of a firm
The role of financial manager in the organization
Agency problems
Some important trends
Business ethics
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FORMS OF BUSINESS ORGINIZATION
Proprietor-
ship/Sole Pro.
Partnership Corporation S Corporation
Who owns
the business
The manager
(only one)
Partners
(two or more)
Shareholders
(unlimited)
Shareholders
(at most 100)
Are owners
and
managersseparate?
No No Yes Sometimes
How is the
owners
liabilities
Unlimited
(big
disadvantage)
Unlimited
(big
disadvantage)
Limited Limited
Are the
owners and
the business
taxed
separately
No - Individual
income tax
No - Individual
income tax
Yes - Corporate
income tax &
individual
income tax
No - Individual
income tax
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PRIMARY GOAL OF A CORPORATION
Which one is the main goal of a corporation?
- Maximize the profit
- Maximize the market share
- Maximize EPS
- Maximize the value of shareholders wealth
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PRIMARY GOAL OF A CORPORATION (CONT.)
Maximize the profit- May resulting from improper actions, affected by
accounting methods, subject to manipulation. E.g.Erron, Worldcom etc.
Maximize the market share:a strategy rather than objective.
Maximize EPS:May follow too high leverage tactic, vulnerable tofinancial distress.
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PRIMARY GOAL OF A CORPORATION (CONT.)
Maximize shareholders wealth=> translate into maximizing the price of stocks.
=> Primary goal of a corporation Maximize shareholders wealth10
Prices of stock reflect expectation of investors about future
of a company.
Take into account riskiness of companies.
Focus on long-term value.
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WHICH ONE DETERMINES SHAREHOLDERS
WEALTH?
Intrinsic values & Stock prices
- Intrinsic values: estimate of a stocks true value
based on accurate risk and return data.
- Stock price: market price of a stock trading in the
market, may based on improper information.
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WHICH ONE DETERMINES SHAREHOLDERS
WEALTH? (CONT.)
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Managerial actions, the economic
environment, and the political climate
True
investorreturns
true
risk
Perceived
investor returns
Perceived risk
Stocks intrinsic
value
Stocks market price
Market equilibrium:
Intrinsic value = stock price
O O
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WHICH ONE DETERMINES SHAREHOLDERS
WEALTH? (CONT.)
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Market price
Intrinsic value
Stock
undervalued
Stock
overvalued
Time
Stock
price
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WHICH ONE DETERMINES SHAREHOLDERS WEALTH?
(CONT.)
Shareholdersconcern about market pricesof stocks,
sometimes they do not have enough information to identify
intrinsic values of stocks.
Stocks market price are fluctuated. Stock prices change every
minutes. Do they concern every m inutes?
Managersfocus on intrinsic valuesof stocks. They have inside
information => estimate intrinsic values more accurate than
investors.
Do shareholders and managers conflict?
How can their target meet together?
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WHICH ONE DETERMINES SHAREHOLDERS WEALTH? (CONT.)
What happens if:
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Market pricesof stock islowerthanintrinsic valuesof it (undervalued)?
This happens for a long time, a
company will be taken over byothers. Some investors perceive,they increasingly buy stocks.
Market pricesof stock ishigherthan
intrinsic valuesof it (overvalued)?Managers will sell their shares orissue more stock to raise fund,simultaneously some investors willsell their shares as well.
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WHICH ONE DETERMINES SHAREHOLDERS WEALTH?
(CONT.)
From an automatic mechanism, in long run, market
prices of stocks have tendency to convert to its
intrinsic values.
And shareholders concern market prices of stocks
on average in long term.
Thus, shareholders and managers target can meettogether.
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PRIMARY GOAL OF A CORPORATION
Therefore, managers should try to maximize
their stocks intrinsic value and then
communicate with shareholders
=> Result to intrinsic value high and actual stock
prices track close to the intrinsic value.
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MAJOR DECISIONS OF A CORPORATION
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Three maindecisions afirm deals
with:
Capitalbudgeting/invest-
ment decisionWhich
assets/projectsshould firm invest?
Financingdecision
Where and howthey can raisethe capital?
Dividend policy
How profitdistributed?
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ROLE OF FINANCIAL MANAGER
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ROLE OF FINANCIAL MANAGER (CONT.)
Chairman of the Board andChief Executive Officer (CEO)
Director and ChiefMarketing Officer (CMO)
Director andChief Financial Officer (CFO)
Treasurer Controller
Cash Manager
Capital Expenditures
Credit Manager
Financial Planning
Tax Manager
Financial Accounting
Cost Accounting
Data Processing
Board of Directors
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Director and ChiefOperating Officer (COO)
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AGENCY PROBLEMS
Agency problems between managers and
stockholders
E.g. luxury trips, cars, overstated profit, investing in
not promising projects etc.
Cause: the separation of ownership and
management.
Solutions: bind compensation plan with companys
performance.
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AGENCY PROBLEMS (CONT.)
Compensation package:Bonuses, stock options
etc.
How should compensation plan be? Reasonable
Direct intervention
Threat of a takeover
=> Should be rewarded on the basis of the stocks
performance over the long run.
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AGENCY PROBLEMS (CONT.)
Agency problems between creditors and stockholder
- Creditors: willing to take less risk
- Shareholders: willing to take more risk
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Creditors
Gains/losses
Companys performance
Shareholders
Gains/losses
Companys performance
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AGENCY PROBLEMS (CONT.)
Solutions: covenant, requirement of interest
coverage ratio etc.
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IMPORTANT TRENDS
Three important trends:
Requirement of higher standard for financial
disclosures.
Globalization
Ever-improving information technology (IT)
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BUSINESS ETHICS
Recent years, the increase in number of scandals
related to business ethics.
E.g. Enron, WorldCom, Madoff etc
Business ethics:standard of conduct ofbusiness.
Consequences of unethical behavior:
shareholders lose their wealth, firm may end upgoing to bankruptcy
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BUSINESS ETHICS
How should employees deal with unethical
behavior?
Losing a job or ending up in jai l?
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TUTORIAL QUESTIONS
Self-test 1.1, 2, 3
Quiz 1, 2, 3, 4 Problems 16, 18, 20
GOOD LUCK!
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