Topic Introduction to FM

Introduction to Financial Management course

By Dr. Nguyen Thu Hien

Modified from slides by Ross, Westerfield, Jordan, Fundamentals of Corporate Finance, 7th ed., McGraw-Hill Irwin

What is Finance?
The Five Basic Areas of Finance
Corporate Finance Investments Financial Institutions International Finance Behavioral Finance

What is the focus of Corporate finance?

ASSETS
Current assets
Cash, Inventory, Account receivables. Marketable securities Repulation; Company image

LIABILITIES
Account payables, Notes payable; Short-term borrowings

Current liabilities

Working capital mgt.

Goodwills

Long-term loans; Bonds

Long-term debts

Capital Budgeting

Capital structuring
Fixed assets
Stocks; Retained earnings

Equity

Land; Plants; Equiptment;

What is the focus of Corporate finance?

Basic Issues:
What long-term investments should a firm take on?

The process of planning and managing a firms long-term investments is called:

What is the focus of Corporate finance?

Basic Issues:
Where will you get the long-term financing to pay for your investment?

The mixture of debt and equity maintained by a firm is called:

What is the focus of Corporate finance?

Basic Issues:
How will you manage your everyday financial activities such as collecting from customers and paying suppliers?

The process of managing a firms short-term assets and liabilities is called:

Who focuses on financial issues within a business/firm?

Legal Forms of Business Organization

Sole Proprietorship Partnership
General Partnership Limited Partnership

Corporation

(1) Sole Proprietorship:business owned by a single individual

Advantages
Easily Established Minimal Organizational Costs Keep all Generated Profits

Disadvantages
Unlimited Liability Losses absorbed by owner Limited Capital Limited Life

(2) Partnership: An association of two or more individuals

General Partnership
each partner is fully responsible for liabilities

Limited Partnership
one or more partners have limited liability limited partners do not participate in the management limited partners are merely investors one general partner must exist

(2a) General Partnership:

Advantages Minimal Organizational Requirements Negligible Government Regulations Disadvantages All Partners have Unlimited Liability Losses absorbed by owners Difficulty of transferring ownership Limited Life-Terminates at Death or Decision of One Partner

(3) Corporation: Business form existing separate and apart from its owners
Advantages
Liability Limited to Invested capital Ease in Raising Capital Continues after death of owner(s)

Disadvantages
Tax Treatment of earnings (Double Taxation) Time and Cost of Incorporation Separation of ownership and management

What is the classical goal of the firm?

To Maximize Shareholder Wealth:
Price of common stock Value of the firm

Why Maximize stock price the goal?

Future performance Riskiness

Why not profit maximization?

Maximize Profits
Not Specific Enough in Practice
Timing Risk Not reflecting growth opportunities Accounting data

Example:Timing of Profits
Film Producer can produce one of two movies: 1. Quick Movie for Video Release 2. Epic Film for Theaters Profits: $10 , same for each movie Movie 1 Year 1 $ 10 Year 2 $ 0

Movie 2 $ 0 $ 10

Which movie should be produced? Why (based on cash vs. profit)?

Example: Riskiness of Profits

Film Producer can produce one of two movies: 1. Quick Movie for Video Release 2. Epic Film for Theaters Profits: $10 , same for each movie Review Movie 1 $ 10 $ 10 $ 10

Movie 2 ($ 10) $ 10 $ 30

Which movie should be produced? Why (based on cash vs. profit)?

Agency Problem:
Will managers work in the shareholders best interests?

Managerial compensation
Incentives can be used to align management and stockholder interests The incentives need to be structured carefully to make sure that managers achieve their goal (eg.: stock bonus)

Corporate control market

The threat of a takeover may result in better management

Role of financial markets in Corporate finance?

Primary vs. Secondary

Role of financial markets in Corporate finance?

Money vs. Capital

The Basics of Topic

What are the three types of financial management decisions and what questions are they designed to answer? What are the three major forms of business organization? What is the goal of financial management? What are agency problems and why do they exist within a corporation? What is the difference between a primary market and a secondary market? Between a money market and a capital market?