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8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 1/18
An Overview of Financial
Management
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 2/18
The Balance-Sheet Model
of the Firm
Current
Assets
Fixed Assets
1 Tangible
2 Intangible
Total Value of Assets:
Shareholders
’ Equity
Current
Liabilities
Long-TermDebt
Total Firm Value to Investors:
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 3/18
The Balance-Sheet Model
of the Firm
Current
Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders
’ Equity
Current
Liabilities
Long-Term
Debt
What long-
terminvestmentsshould thefirm engagein?
The Capital Budgeting Decision
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 4/18
The Balance-Sheet Model
of the Firm
How can the
firm raise the
money for the
requiredinvestments?
The Capital Structure Decision
Current
Assets
Fixed Assets
1 Tangible
2 Intangible
Shareholders
’ Equity
Current
Liabilities
Long-Term
Debt
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 5/18
The Balance-Sheet Model
of the Firm
How much
short-term cashflow does acompany needto pay its bills?
The Net Working Capital Investment Decision
Net
WorkingCapital
Shareholders
’ Equity
Current
LiabilitiesCurrent
Assets
Fixed Assets
1 Tangible
2 Intangible
Long-Term
Debt
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 6/18
Corporate Finance Functions
Financial Management
Capital-Raising(Financing)
Capital Budgeting
Risk Management
Corporate Governance
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 7/18
Relationship with Accounting
• The firm’s finance (treasurer) and accounting (controller)
functions are closely-related and overlapping. In smallerfirms, the financial manager generally performs bothfunctions
• One major difference in perspective and emphasis between
finance and accounting is that accountants generally use theaccrual method while in finance, the focus is on cash flows .
• Finance and accounting also differ with respect to decision- making . While accounting is primarily concerned with the
presentation of financial data, the financial manager isprimarily concerned with analyzing and interpreting thisinformation for decision-making purposes
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 8/18
TEN PRINCIPLES OF FM1. Risk Return Trade off: We wont take any additional risk
unless we expect to be compensated with additional return.2. Time Value of Money: A dollar received today is worth
more than a dollar received in the future
3. Cash-Not Profits-Is King
4. Incremental Cash Flows-It’s only what changes thatcounts
5. The curse of competitive markets- Why its hard to findexceptionally profitable projects
6. Efficient Capital Markets- The markets are quick and theprices are right; there fore wealth maximization is a goodobjective of FM
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 9/18
7. The Agency Problem- Managers wont work for owners
unless it’s in their best interest. 8. Taxes bias business decisions
9. All risks are not equal, some risks can be diversified away,and some cannot
10. Ethical behavior is doing the right thing, and ethicaldilemmas are everywhere in Finance
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 10/18
DECISIONS, RETURN, RISK,
AND MARKET VALUE
Capital Budgeting
Decisions
Capital StructureDecisions
Dividend
Decisions
Working Capital
Decisions
Return
Risk
Market Value of
the Firm
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 11/18
THE OBJECTIVE OF
CORPORATE FINANCE
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 12/18
Characteristics of a Good Objective Function
• It is clear and unambiguous
• It comes with a clear and timely measure that can be used toevaluate the success or failure of decisions.
• It does not create costs for other entities or groups that erase firm-specific benefits and leave society worse off overall. As an
example, assume that a tobacco company defines its objectiveto be revenue growth.
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 13/18
First Principles
• Invest in projects that yield a return greater than the minimum
acceptable hurdle rate.
– The hurdle rate should be higher for riskier projects and reflectthe financing mix used - owners’ funds (equity) or borrowed
money (debt)
– Returns on projects should be measured based on cash flows
generated and the timing of these cash flows; they should also
consider both positive and negative side effects of these projects.• Choose a financing mix that minimizes the hurdle rate and matches
the assets being financed.
• If there are not enough investments that earn the hurdle rate, return
the cash to stockholders.
– The form of returns - dividends and stock buybacks - will
depend upon the stockholders’ characteristics.
Objective: Maximize the Value of the Firm
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 14/18
The Classical Objective Function
STOCKHOLDERS
Maximizestockholderwealth
Hire & firemanagers- Board- Annual Meeting
BONDHOLDERSLend Money
ProtectbondholderInterests
FINANCIAL MARKETS
SOCIETYManagers
Reveal
informationhonestly andon time
Markets are
efficient andassess effect onvalue
No Social Costs
Costs can betraced to firm
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 15/18
Another Way of Presenting this is...
Stockholders hire managers to run their firms for them
Managers set aside their interests and maximize stock prices
Stockholder wealth is maximized
Firm Value is maximized
Societal wealth is maximized
Because stockholders have absolute power to hire and fire managers
Because markets are efficient
Because lenders are fully protected from stockholder actions
Because there are no costs created for society
Why Stock Price Maximization Works
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 16/18
Maximizing stock prices as opposed to
firm value
• Stock price is easily observable and constantly updated(unlike other measures of performance, which may not be aseasily observable, and certainly not updated as frequently).
• If investors are rational (are they?), stock prices reflect thewisdom of decisions, short term and long term,instantaneously.
• The stock price is a real measure of stockholder wealth, sincestockholders can sell their stock and receive the price now .
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 17/18
What can go wrong?
STOCKHOLDERS
Managers puttheir interestsabove stockholders
Have little controlover managers
BONDHOLDERSLend Money
Bondholders canget ripped off
FINANCIAL MARKETS
SOCIETYManagers
Delay badnews or
providemisleadinginformation
Markets make
mistakes andcan over react
Significant Social Costs
Some costs cannot betraced to firm
8/2/2019 Introduction - FM
http://slidepdf.com/reader/full/introduction-fm 18/18
The Counter Reaction
STOCKHOLDERS
Managers of poorlyrun firms are puton notice.
1. More activistinvestors2. Hostile takeovers
BONDHOLDERS
Protect themselves
1. Covenants2. New Types
FINANCIAL MARKETS
SOCIETYManagers
Firms are
punishedfor misleadingmarkets
Investors and
analysts becomemore skeptical
Corporate Good Citizen Constraints
1. More laws2. Investor/Customer Backlash