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Chapter 1 - Introduction To Finance: FIN2102 - Financial Management

This document provides an introduction to finance, covering key topics such as the goal of the firm, the five principles of finance, legal forms of business organization, and the rise of multinational corporations. Specifically, it discusses how the goal of the firm is to maximize shareholder wealth, identifies the five principles of finance as cash flow, time value of money, risk and return, market efficiency, and agency problems. It also outlines the main business forms of sole proprietorship, partnership and corporation. Finally, it addresses why companies expand abroad and the associated risks.

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© © All Rights Reserved
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129 views

Chapter 1 - Introduction To Finance: FIN2102 - Financial Management

This document provides an introduction to finance, covering key topics such as the goal of the firm, the five principles of finance, legal forms of business organization, and the rise of multinational corporations. Specifically, it discusses how the goal of the firm is to maximize shareholder wealth, identifies the five principles of finance as cash flow, time value of money, risk and return, market efficiency, and agency problems. It also outlines the main business forms of sole proprietorship, partnership and corporation. Finally, it addresses why companies expand abroad and the associated risks.

Uploaded by

sating
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 21

Chapter 1 – Introduction to Finance

FIN2102 –
Financial
Management
Learning Objectives
 Identify the goal of the firm.
 Understand the five basic principles of finance
and business.
 Distinguish between the different legal forms of
business.
 Explain what has led to the era of the
multinational corporation.

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Slide Contents

1. What is Finance?
2. The Goal of the Firm
3. Five Principles of Finance
4. Legal Forms of Business Organization
5. Finance and Multinational Firm

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1. What is Finance?

• Finance
Study of how people and businesses evaluate
investments and raise capital to fund them.
(How to get and use money)

• Financial management
Efficient and effective management of money to
accomplish the objective of the organization.

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2. The Goal of the Firm

 The goal of the firm is to create value for the


firm’s legal owners (that is, its shareholders). Thus
the goal of the firm is to “maximize shareholder
wealth” by maximizing the price of the existing
common stock.

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3. Five Foundational
Principles of Finance

 Cash flow is what matters


 Money has a time value
 Risk requires a reward
 Market prices are generally right
 Conflicts of interest cause agency
problems

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Five Principles

“…while it is not necessary to understand finance in


order to understand these principles, it is necessary
to understand these principles in order to
understand finance.”

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Principle 1:
Cash flow is what matters

 Accounting profits are not equal to cash flows. It is


possible for a firm to generate accounting profits but not
have cash or to generate cash flows but not report
accounting profits in the books.
 Cash flow, and not profits, drive the value of a business.
 We must determine incremental cash flows when making
financial decisions.
 Incremental cash flow is the difference between the projected
cash flows if the project is selected, versus what they will be, if
the project is not selected.

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Principle 2:
Money has a time value

 A dollar received today is worth more than a


dollar received in the future.
 Since we can earn interest on money received today, it
is better to receive money earlier rather than later.

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Principle 3:
Risk requires a Reward

 We won’t take on additional risk unless we expect


to be compensated with additional reward or
return.
 Investors expect to be compensated for “delaying
consumption” and “taking on risk”.
 Thus investors expect a return when they put their
savings in a bank (i.e. delay consumption) and they
expect to earn a higher rate of return on stocks relative
to bank savings account (i.e. taking on risk)

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Principle 4: Market Prices
are generally Right

 In an efficient market, the prices of all traded assets (such


as stocks and bonds) at any instant in time fully reflect all
available information.
 Thus stock prices are a useful indicator of the value of the
firm. Prices changes reflect changes in expected future
cash flows. Good decisions will tend to increase the stock
prices and vice versa.
 Note there are inefficiencies in the market that may
distort the prices.

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Principle 5: Conflicts of interest cause
agency problems

 The separation of management and the


ownership of the firm creates an agency problem.
Managers may make decisions that are not
consistent with the goal of maximizing
shareholder wealth.
 Agency conflict is reduced through monitoring
(ex. Annual reports), compensation schemes
(ex. stock options), and market mechanisms
(ex. Takeovers)

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Ethics and business
 Ethical behavior is doing the right thing! … but what is
the right thing?
 Ethical dilemma - Each person has his or her own set
of values, which forms the basis for personal
judgments about what is the right thing.
 Sound ethical standards are important for business
and personal success. Unethical decisions can destroy
shareholder wealth
(ex. Enron Scandal)

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4. The Legal Forms of
Business Organization

Business
Forms

Sole Corporation
Partnership
Proprietorship

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Sole Proprietorship

 Business owned by an individual


 Owner maintains title to assets and profits
 Unlimited liability
 Termination occurs on owner’s death or by
owner’s choice

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Partnerships

 Two or more persons come together as co-owners


 General Partnership: All partners are fully responsible for
liabilities incurred by the partnership.
 Limited Partnerships: One or more partners can have limited
liability, restricted to the amount of capital invested in the
partnership. There must be at least one general partner with
unlimited liability. Limited partners cannot participate in the
management of the business and their names cannot appear
in the name of the firm.

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Corporation
 Legally functions separate and apart from its owners
 Corporation can sue, be sued, purchase, sell, and own property
 Owners (shareholders) dictate direction and policies of the
corporation, oftentimes through elected board of directors.
 Shareholder’s liability is restricted to amount of investment in
company
 Life of corporation does not depend on the owners …
corporation continues to exist through easy transfer of
ownership
 Taxed separately

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5. Finance and the Multinational Firm:
The New Role

 Internationalization of business has been


spurred by:
 Collapse of communism
 Acceptance of free market system
 Technology
 Improved transportation

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Why do companies
go abroad?

 To increase revenues
 To reduce expenses (land, labor, capital, raw
material, taxes)
 To lower governmental regulation standards (ex.
Environmental, labor)
 To increase global exposure

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Risks/challenges
 Country risk (changes in government regulations,
unstable government, economic changes in
foreign country)
 Currency risk (fluctuations in exchange rates)
 Cultural risk (differences in language, traditions,
ethical standards etc.)

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