Ayesha Saimoon1

Ayesha Saimoon2

Email:Ayeshasaimoon@yahoo.co.uk

Counseling: Before starting or after finishing every class.

For your Emergency:

01726427878 (Please don’t make a call after 10:00 pm)

Required Text Book

Besley and Brigham, Essentials of Managerial Finance

Additional Readings

1. Brigham and Houston, “Fundamentals of Financial Management”

2. L J Gitman, “Principles of Managerial Finance”

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Required Computer Knowledge

1. MS-Excel Spread Sheet 2. MS-Word3. PowerPoint Presentation

Course Websites

www.teachmefinance.com www.studyfinance.comwww.investorwords.com www.islamicfinance.com

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Required Instrument

A good Financial Calculator or a Good Scientific Calculator.

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Evaluation Process

Mid-Term (Week 07) 30

Final Exam (Week 14) 40

Class Test

a. Closed bookb. Open book c. Surprised Testd. Take Home exam

10

Assignment and Presentation/case study 10

Class Attendance and Performance 10

Total 100

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Points To Be Noted

• For Closed book class test, student will get one week prior notice.

• For open book class test, student will get 7 days prior notice.

• For Assignment/presentation/case study, student will get maximum 2 months to submit it.

• For take home exam, student will get 7 days to submit the (hand written) answer scripts.

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Contents

Definitions of Finance, Basic Principles of Finance, Functions of Finance, Sectors of Finance, Responsibility of Financial Manager, Financial Management Issue of The New Millennium, Forms of Business Organizations, Financial Goals of The Corporations, Profit Maximization Vs. Wealth Maximization and The Agency Problems.

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What is Finance?• Finance is the relationship between deficit sector and surplus

sector of the society.• Finance is the process of transferring fund from one sector to

another sector.– Individual to individual– Individual to organization– Organization to individual– Organization to organization– One place to another place– One government to another government– One country to another country etc.

• The commercial activity of providing funds and capital for the business is called Finance.

• Finance is the branch of economics that studies the management of money and other assets

• The management of money and credit and banking and investments is known as finance.

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Types of Finance

1. Public Finance

2. Private Finance

a. Personal Finance

b. Business Finance

i. Personal Business Finance

ii. State-Owned Business Finance

iii.Financing for Autonomous Organization

c. Non-Business Finance

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Importance of Studying Finance:

Every interested person should study finance to know the following principles related to any business:

– To know the Risk and Return associated with the business

– To know the application of Time Value of Money– To know the Cash Flow– To know the Profitability and Liquidity– To apply Hedging Principles in risk management– To Diversify the risk– To know the Business Cycle

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Functions of Finance(Responsibilities of Financial Manager)

1. Financial Planning: Future actions of Money related activities of an organization.

2. Identification of Sources of financing: From where the organization can collect its desired fund

3. Analyzing and Selecting of Sources

4. Raising of Funds5. Investment of

Funds/Utilization of Fund6. Protection of Funds7. Distributions of Profit

Sources of financing1. Individuals2. Organizations3. Government4. Foreign Agencies

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Sectors of Finance(Career Fields in Finance)

• Financial Markets & Institutions– Money and capital markets:

• Investments– Investment in Existing Business– Expansion of Existing Business– Investment in New Project– Research and Development

• Financial management

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Role of Finance in a Typical Business Organization (Career Opportunities in Finance)

Board of Directors

President

VP: Sales VP: Finance VP: Operations

Treasurer Controller

Credit Manager

Inventory Manager

Capital Budgeting Director

Cost Accounting

Financial Accounting

Tax Department

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Common Functions of Treasurer & Controller

Functions of Treasurer Functions of Controller

Financial Planning Corporate Accounting

Fund Raising (Financing) Cost Accounting

Capital Expenditure Decisions Tax Management

Cash Management Financial Accounting

Credit Management

Pension Fund Management

Foreign Exchange Management

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Finance in The 20th CenturySome issues are observed and discussed in the 20th

century’s ----• Inflation and its effects on business decisions• Deregulation of financial institutions and the resulting

trend toward large, broadly diversified financial services companies------------------- Mergers and Acquisitions

• The dramatic increase in both the use of computers for analysis and the electronic transfer of information

• The increased importance of global markets and business operations

• Innovations in the financial products offered to investors• The effect of changing technology• The globalization of business

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Forms of Business Organization

• Sole proprietorship

• Partnership

• Corporation

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01. Sole Proprietorship

Advantages– Easiest to start– Least regulated– Single owner

keeps all the profits

– Taxed once as personal income

Sole Proprietorships: A business owned by a single individual

Disadvantages– Limited to life of

owner– Equity capital

limited to owner’s personal wealth

– Unlimited liability– Difficult to sell

ownership interest

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A partnership has roughly the same advantages and disadvantages as a sole proprietorship with two or more owners.

02. Partnership

Advantages1. Two or more

owners2. More capital

available3. Relatively easy to

start4. Income taxed once

as personal income

Disadvantages– Unlimited liability

– Partnership dissolves when one partner dies or wishes to sell

– Difficult to transfer ownership, but less difficult than sole proprietorship – add partners

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Advantages1. Limited liability2. Unlimited life3. Separation of ownership and

management4. Transfer of ownership is easy5. Easier to raise capital

Generally, any business organization which shares are traded in the share market is called Corporation.A business entity that legally functions separate and apart from its owners.

03. Corporation

Disadvantages– Agency Problem– Double taxation – Lacks of Secrecy

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Partnership vs. Corporation

EasyUneasyRaising of Fund

LargeMediumCapital Size

LimitedUnlimitedLiability

UnlimitedLimitedLife Duration

SeparateSameOwners and Mangers

DoubleSingleTaxation

EasyDifficultTransferability of ownership

HardEasyStarting

CorporationPartnershipIssues

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Financial Goals of the Corporation

• The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price.– Do firms have any responsibilities to society at large?– Is stock price maximization good or bad for society?– Should firms behave ethically?

Two opinion

1. Profit Maximization

2. Wealth Maximization

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Profit MaximizationUnder this approach, action that increase profit should be undertaken

and those that decrease profits are to be avoided.Profit maximization consists of the following important features.1. Profit maximization is also called as cashing per share

maximization. It leads to maximize the business operation for profit maximization.

2. Ultimate aim of the business concern is earning profit, hence, it considers all the possible ways to increase the profitability of the concern.

3. Profit is the parameter of measuring the efficiency of the business concern. So it shows the entire position of the business concern.

4. Profit maximization objectives help to reduce the risk of the business.

Measurement of Profit: For corporations profits are commonly measured in terms of

Earnings Per Share (EPS)Profitability also refers to a situation where output exceeds input.

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Favorable and Unfavorable argument for Profit Maximization

Favorable Arguments for Profit Maximization(i) Main aim is earning profit.(ii) Profit is the parameter of the business operation.(iii) Profit reduces risk of the business concern.(iv) Profit is the main source of finance.(v) Profitability meets the social needs also.

Unfavorable Arguments for Profit Maximization

(i) Profit maximization leads to exploiting workers and consumers.

(ii) Profit maximization creates immoral practices such as corrupt practice, unfair trade practice, etc.

(iii) Profit maximization objectives leads to inequalities among the sake holders such as customers, suppliers, public shareholders, etc.

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Drawbacks of Profit MaximizationProfit maximization objective consists of certain drawback

also:1. It is vague: In this objective, profit is not defined

precisely or correctly. It creates some unnecessary opinion regarding earning habits of the business concern.

2. It ignores the time value of money: Profit maximization does not consider the time value of money or the net present value of the cash inflow. It leads certain differences between the actual cash inflow and net present cash flow during a particular period.

3. (It ignores risk: Profit maximization does not consider risk of the business concern. Risks may be internal or external which will affect the overall operation of the business concern.

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Wealth Maximization• The financial goal of wealth maximization is also known

as value maximization. The term wealth means shareholder wealth or the wealth of the persons those who are involved in the business concern. Wealth maximization is also known as value maximization or net present worth maximization. This objective is universally accepted concept in the field of business.

• The wealth of a corporate owner is measured by the share price of the stock which in term based on the – Timing of returns– Cash flows and– Risk

Wealth = Price per share x No. of Shares

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Favorable Arguments for Wealth Maximization1. Wealth maximization is superior to the profit

maximization because the main aim of the business concern under this concept is to improve the value or wealth of the shareholders.

2. Wealth maximization considers the comparison of the value to cost associated with the business concern. Total value detected from the total cost incurred for the business operation. It provides extract value of the business concern.

3. Wealth maximization considers both time and risk of the business concern.

4. Wealth maximization provides efficient allocation of resources.

5. It ensures the economic interest of the society.

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Unfavorable and Unfavorable argument for Wealth Maximization

1. Wealth maximization leads to prescriptive idea of the business concern but it may not be suitable to present day business activities.

2. Wealth maximization is nothing, it is also profit maximization, it is the indirect name of the profit maximization.

3. Wealth maximization creates ownership-management controversy.

4. Management alone enjoy certain benefits.

5. The ultimate aim of the wealth maximization objectives is to maximize the profit.

6. Wealth maximization can be activated only with the help of the profitable position of the business concern.

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Is stock price maximization the same as profit maximization?

• No, despite a generally high correlation amongst stock price, EPS, and cash flow.

• Current stock price relies upon current earnings, as well as future earnings and cash flow.

• Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa).

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Home Task

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The Agency Problems & Relationships

• Agency problem– Conflict of interest between principal and agent

• Agency relationship

An agency relationship exists whenever a principal hires an agent to act on their behalf.– Stockholders (principals) hire managers (agents) to run

the company

• Within a corporation, agency relationships exist between:

– Shareholders and managers

– Shareholders and creditors

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Examples of Agency Problem• Common example of an agency relationship is a real

estate broker – in particular if you break it down between a buyers agent and a sellers agent. A classic conflict of interest is when the agent is paid on commission, so they may be less willing to let the buyer know that a lower price might be accepted or they may elect to only show the buyer homes that are listed at the high end of the buyers price range.

• Direct agency costs – the purchase of something for management that can’t be justified from a risk-return standpoint, monitoring costs.

• Indirect agency costs – management’s tendency to forgo risky or expensive projects that could be justified from a risk-return standpoint.

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Managers are naturally intended to act in their own best interests.

But the following factors affect managerial behavior:

1. Managerial compensation plans

2. Direct intervention by shareholders

3. The threat of firing

4. The threat of takeover

Tools for Mitigating the Agency Problems

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Preparation!!Following are the sample questions to take preparation!!

• Explain the Term “Finance”. Discuss the different principles of Finance.

• Discuss the main functions of Finance (or the responsibilities of a Financial manager).

• Define and discuss the Characteristics of Sole proprietorship, partnership and Corporation.

• Differentiate between partnership and Corporation.• What is agency problems and Agency

Relationships? What are the ways to reduce/mitigate the agency problem. Discuss in details.

• Discuss the goals of a business Organization. Why the profit maximization is criticized?