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8/4/2019 01 Finance and the Financial Manager
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Chapter 1Principlesof
CorporateFinance
Finance and The
Financial Manager
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Topics Covered
What Is A Corporation?The Role of The Financial Manager
Who Is The Financial Manager?Separation ofOwnership and
Management
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Corporate Structure
Sole Proprietorships
Corporations
Partnerships
Limited Liability
Corporate tax on profits +
Personal tax on dividends
Unlimited Liability
Personal tax on profits
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SoleProprietorship
Partnership Corporation
Who owns the
business?
The manager Partners Shareholders
Are managersand owners
separate?
No No Usually
What is the
owners
liability?
Unlimited Unlimited Limited
Are the owner
& business
taxed
separately?
No No Yes
Organizing a Business
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Financial Market Functions
Source of funding
Investor liquidity
Risk management
Source of information
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Role of The Financial Manager
Financial manager refer to anyone responsible for a
significant investment or financing decision.
Treasureris responsible for looking after the firms cash,
raising new capital, and maintaining relationships with
banks, stockholders, and other investors who hold the firms
securities.
Controlleris one who prepares the financial statements,
managesthe firms internal accounting, and looks after its
tax obligations. The treasurers main responsibility is to obtain and manage
the firms capital, whereas the controller ensures that the
money is used efficiently.
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Role of The Financial Manager
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Role of The Financial Manager
Financial
manager
Firm's
operations
Financial
markets
(1) Cash raised from investors
(1)
(2) Cash invested in firm
(2)
(3) Cash generated by operations
(3)
(4a) Cash reinvested
(4a)
(4b) Cash returned to investors
(4b)
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Role of The Financial Manager
Common Finance Terminology
Real assets
Financial assets / Securities
Capital markets and financialmarkets
Investment / capital budgeting
Financing
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Who is The Financial Manager?
Chief Financial Officer
ControllerTreasurer
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Ownership vs. Management
Difference in Information
Stock prices and returns
Issues of shares and
other securities
Dividends
Financing
Different Objectives
Managers vs.
stockholders
Top mgmt vs.
operating mgmt
Stockholders vs. banks
and lenders
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CORPORATE FINANCE
TIME VALUE OF MONEY
A dollar on hand today is worth more than a
dollar to be received in the future because the dollar
on hand today can be invested to earn interest to
yield more than a dollar in the future.
The Time Value of Money mathematics quantify
the value of a dollar through time. This, of course,
depends upon the rate of return or interest ratewhich can be earned on the investment.
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TIME VALUE OF MONEY
The Time Value of Money has applications in
many areas of Corporate Finance including CapitalBudgeting, Bond Valuation, and Stock Valuation.
The Time Value of Money concepts will be
grouped into two areas: Future Value and PresentValue.
Future Value describes the process of finding what
an investment today will grow to in future. Present Value describes the process of determining
what a cash flow to be received in the future is
worth in today's dollars.
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TIME VALUE OF MONEY
Concepts
Future Value of a Single Cash Flow
Present Value of a Single Cash Flow
Cash Flow Streams
Annuities
Other Compounding Periods
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1.1 FUTURE VALUE
The Future Value of a cash flow represents the amount,at some time in the future, that an investment made
today will grow to if it is invested to earn a specific
interest rate. For example, if you were to deposit $100
today in a bank account to earn an interest rate of 10%compounded annually, this investment will grow to
$110 in one year. This can be shown as follows:
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1.1 FUTURE VALUE
At the end of two years, the initial investmentwill have grown to $121. Notice that the
investment earned $11 in interest during the
second year, whereas, it only earned $10 in
interest during the first year. Thus, in the second
year, interest was earned not only on the initial
investment of $100 but also on the $10 in
interest that was paid at the end of the first year.This occurs because the interest rate in the
example is a compound interest rate.
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1.1 FUTURE VALUE
The interest rate in the example is 10% compounded
annually. This implies that interest is paid annually.Thus the balance in the account was $110 at the end of
the first year. Thus, in the second year the account pays
10% on the initial principal of $100 and the $10 of
interest earned in the first year. Thus, the $121 balance
in the account after two years can be computed as
follows:
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1.1 FUTURE VALUE
If the money was left in the account for one more year,interest would be earned on $121, i.e., the initial
principal of $100, the $10 in interest paid at the end of
year 1, and the $11 in interest paid at the end of year 2.
Thus the balance in the account at the end of year threeis $133.10. This can be computed as follows:
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1.1 FUTURE VALUE
The Future Value of an initial investment at a giveninterest rate compounded annually at any point in the
future can be found using the following equation:
Solve Problem
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1.2 PRESENT VALUE
Present Value describes the process ofdetermining what a cash flow to be received in
the future is worth in today's dollars.
The process of finding present values is called
Discounting and the interest rate used to
calculate present values is called the discountrate.
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1.2 PRESENT VALUE
For example, the Present Value of $100 to bereceived one year from now is $90.91 if the
discount rate is 10% compounded annually.
This can be demonstrated as follows:
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1.2 PRESENT VALUE
Notice that the Future Value Equation is used
to describe the relationship between the present
value and the future value. Thus, the Present
Value of $100 to be received in two years can
be shown to be $82.64 if the discount rate is10%.
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1.2 PRESENT VALUE The following equation can be used to calculate the
Present Value of a future cash flow given the discount rateand number of years in the future that the cash flow occurs.
Solve Problem
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1.3 CASH FLOW STREAMSPRESENT VALUE
The Present Value of a Cash Flow Stream is equal to thesum of the Present Values of the individual cash flows.
To see this, consider an investment which promises to pay
$100 one year from now and $200 two years from now.
If an investor were given a choice of this investment or
two alternative investments, one promising to pay $100
one year from now and the other promising to pay $200
two years from now, clearly, he would be indifferentbetween the two choices. (Assuming that the
investments were all of equal risk, i.e., the discount rate
is the same.)
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1.3 CASH FLOW STREAMS
This is because the cash flows that the investor would
receive at each point in time in the future are the sameunder either alternative. Thus, if the discount rate is
10%, the Present Value of the investment can be found
as follows:
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1.3 CASH FLOW STREAMS
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1.3 CASH FLOW STREAMS
The Future Value of a Cash Flow Stream is equal to the
sum of the Future Values of the individual cash flows.For example, consider an investment which promises to
pay $100 one year from now and $200 two years from
now. Given that the discount rate is 10%, the Future
Value at the end of year 2 of the investment can be found
as follows:
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1.3 CASH FLOW STREAMS
As of year 2, the $100 received at the endof year 1 would have earned interest for one
year while the $200 received at the end of
year 2 would not yet have earned any
interest. Thus, the Future Value at the end
of year 2, i.e., immediately after the $200
cash flow was received, is $310.00.
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1.3 CASH FLOW STREAMS
The following equation can be used to find the Future Value of a CashFlow Stream at the end of year t.
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1.4 AnnuitiesAn Annuity is a cash flow stream which adheres to a
specific pattern. Namely, an Annuity is a cash flowstream in which the cash flows are level (i.e., all of the
cash flows are equal) and the cash flows occur at a
regular interval. The annuity cash flows are called
annuity payments orsimplypayments.
Thus, the following cash flow stream is an annuity.
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1.4 Present Value of an Annuity
The Present Value of an Annuity is equal to thesum of the present values of the annuity
payments. This can be found in one step through
the use of the following equation:
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1.4 Present Value of an Annuity
Consider the annuity of $100 per year for fiveyears given in the Figure. If the discount rate
is equal to 10%, then the Present Value of the
Annuity can be found as follows:
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1.4 Future Value of an Annuity
The FV of an Annuity is calculated at the end ofthe period in which the last annuity payment
occurs. The FV of the Annuity is equal to the sum
of the future values of the individual annuity
payments at that time. This can be found in onestep through the use of the following equation:
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1.4 Future Value of an Annuity
Consider the annuity of $100 per year forfive years given in Figure. If the discount
rate is equal to 10%, then the Future Value
of this Annuity at the end of period five can
be found as follows: