ch01 business finance

8/9/2019 ch01 business finance

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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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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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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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!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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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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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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&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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&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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&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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&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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&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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&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.

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ch01 business finance