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8/9/2019 ch01 business finance
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Copyright2002 McGraw-Hill Australia Pty Ltd. $-$
Chapter 1: IntroductionChapter 1: Introduction
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Learning ObjectivesLearning Objectives
Identify the major types of business entities.
Explain the role of the nancial manager.
Specify the objective that is necessary to
ensure the nancial manager makes rationalinvestment and nancing decisions.
Identify the major nancial decisions madeby the managers of business entities.
Identify and explain the basic concepts ofnance.
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Copyright2002 McGraw-Hill Australia Pty Ltd. $-%
The Nature of Business
FinanceBroad aspects of nance:
corporate nance the nancialmanagement of companies
nancial institutions and markets
investments
Focus is mainly on corporate fnance,
but also considers fnancialinstitutions and markets, andinvestments.
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Financial Decisions
ajor nancial decisions are: investment decisions ! decisions that
determine the asset prole of a business"amount and composition of investments#
nancing decisions ! ho$ the assets areto be funded "debt and e%uity#
nancing decisions also involve dividenddecisions
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Business tructuresSole proprietorship
business o$ned by one person
&artnership business o$ned by t$o or more people
acting as partners'ompany
separate legal entity formed under the'orporations (ct
)ocus is on nancial decision makingby managers of public companies.
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Copyright2002 McGraw-Hill Australia Pty Ltd. $-(
ole !roprietorship
(dvantages*. 'ontrol of the business rests $ith the o$ner
+. It is easy and inexpensive to form and todisolve
,. It is not treated as a separate entity for tax
purpose -isadvantages
*. nlimited liability to the o$ner for debts
+. /he si0e of the business is limited by the
$ealth of the o$ner,. 1$nership can be transferred only by
selling the business
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Copyright2002 McGraw-Hill Australia Pty Ltd. $-)
!artnership
(dvantages
*. It is easy and inexpensive to form
+. It can combine the $ealth and talents
-isadvantage
*. &artners are personally liable for thedebts
+. It is di2cult to $ithdra$ the investment
,. -isputes bet$een partners is damaging
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Co"pan#
(dvantages*. It is a separate legal entity
+. It has an indenite life
,. It can raised fund from public
-isadvantages
*. It is expensive to establish
+. It face a proliferation of regulations
,. anagers and sta3s are the employees"motivation#
4. -ouble tax on income and dividends paid
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Copyright2002 McGraw-Hill Australia Pty Ltd. $-*
The Finance Function:
$ajor %oles of Financial$anagers
&roject evaluation
Evaluating5 obtaining and servicing short6and long6term nancing
-ividend distributions
'ollection and custody of cash andpayment of bills
anagement of investments in currentassets
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The Finance Function: $ajor
%oles of Financial $anagers&cont'(
(ssessing the viability of gro$th
through ac%uisitions &lanning the future development of the
business
Interest rate and exchange rate risk
management -evelopment and implementation of
nancial policies
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) Co"pan#*s) Co"pan#*s FinancialFinancial
ObjectiveObjective
/he maximisation of market value of a
company7s shares is the overridingobjective.
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Copyright2002 McGraw-Hill Australia Pty Ltd. $-$2
Basic Concepts of Finance
8alue /he value of a company "V # on the
nancial markets may be expressed as :V 9 D E
$here D 9 the value of debt
E 9 the value of e%uity
)inancial markets $ill value debt ande%uity5 taking into account the risk and
expected return from investing in thesesecurities.
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Basic Concepts of Finance
&cont'(/ime and ncertainty
/he value of an investment $ill depend onthe amount and timing of the cash ;o$sgenerated by the investment.
/ime value of money: a dollar today is
$orth more than a dollar in the future.
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Copyright2002 McGraw-Hill Australia Pty Ltd. $-$&
Basic Concepts of Finance
&cont'(o$ever5 due to in;ation and de;ation5 thepurchasing po$er of money changes.
/herefore5 it is necessary to distinguishbet$een the nominal or face value ofmoney and the real or in;ation6adjustedvalue of money.
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Basic Concepts of Finance
&cont'(arket E2ciency and (sset &ricing
arket e2ciency means that $e should expectsecurities and other assets to be fairly priced5given their expected risks and returns.
/rade6o3 bet$een risk and expected return underthe capital asset pricing model "'(:
Systematic risk: market6$ide factors "non6diversiable or market risk#.
nsystematic risk: factors that are specic to a
particular company "diversiable or uni%ue risk#.
(ccording to the '(&5 investors can diversifytheir investments to eliminate unsystematic risk.
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Basic Concepts of Finance
&cont'((rbitrage
If t$o identical assets $ere to trade in thesame market at the same time at di3erentprices5 and if there $ere no transaction costs5
then an arbitrage opportunity $ould exist. ( risk6free prot could be made by
simultaneously purchasing at the lo$er priceand selling at the higher price.
>o$ever5 competition among traders $ill force
the t$o alternative prices to become thesame.
(rbitrage precludes perfect substitutes fromselling at di3erent prices in the same market.
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Basic Concepts &u""ar#(
/he company7s objective is tomaximise shareholders7 $ealth5
( dollar receive today is preferred to a
dollar received later? andInvestors prefer less risk to more risk5
other things being e%ual 6 that is5 theyare risk6averse.
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Copyright2002 McGraw-Hill Australia Pty Ltd. $-$"
Basic Concepts of Finance
&cont'((gency =elationships
1ne party5 theprincipal5 delegates
decision6making authority to anotherparty5 the agent.
In a company: managers 9 agents
shareholders 9 principals
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Basic Concepts of Finance
&cont'((gency =elationships "cont.#
(gency costs: con;ict of interest bet$eenparties creates costs
reduced value due to managers acting intheir o$n best interests
costs associated $ith monitoringmanagers7 behaviour
bonding costs
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u""ar#
Business entities include soleproprietorship5 partnership and company.@e focus on public companies.
@e study corporate nance along $ithinvestments and the structure ofnancial markets and institutions.
@e consider broad nance issues such
as valuations5 market e2ciency5 assetpricing and arbitrage5 along $ith agencyissues.