Chapter 1 PDF - Finance

1-2 1-2 Today What is Finance? Why do you study Finance? Explain the primary goal of financial managers. Different forms of organization. Goal of the firm Agency problem Role of the Financial Markets financial manager role : 1) manage cash flow 2) make...

1-2 1-2 Today What is Finance? Why do you study Finance? Explain the primary goal of financial managers. Different forms of organization. Goal of the firm Agency problem Role of the Financial Markets financial manager role : 1) manage cash flow 2) make activities decisions on how to grow company 3) select long-term investment 1-3 1-3 (day to day What is Finance? use Personal ( spend, save and invest) main sources use of capital X Business (raise money, Debt Equity spend, invest, reinvest (bond) (stock) /distribute) ↳ shareholder A 4D - I have to give it back) E ↳ stock holder © McGraw Hill LLC. All rights reserved Heba Ali  finance-> analyze data for future (looking forward 1-4 1-4 The Field of Finance statements theories is concepts by analyzing infinance (which finance needs) from N Finance is closely related to &economics and accounting Grelated to book keeping , reporting (backward) Economics provides picture of business environment – Consider consumers and producers Accounting provides financial data – Income statements, balance sheets, cashflow statements © McGraw Hill LLC. All rights reserved Heba Ali  1-5 1-5 The Field of Finance- Cont’d Finance is closely tied to accounting – CFO often in charge of financial planning, accounting, and tax systems – Financial manager needs to know how to understand and interpret financial statements Finance is forward thinking vs accounting which measures business activity results © McGraw Hill LLC. All rights reserved Heba Ali  1-6 1-6 Investments vs. Corporate Finance Investments – Investors use investment principles to value stocks and bonds of companies – Investors choose which to purchase – Portfolio includes securities by multiple companies Corporate finance – Principles used to determine which assets the firm should develop or buy Financial management: – Term can be used interchangeable with corporate finance © McGraw Hill LLC. All rights reserved Heba Ali  1-7 1-7 Activities of Financial Management Financial managers perform numerous activities – Daily activities include monitor cash balances, manage credit decisions, monitor inventory levels, collect and distribute cash. – Less routine activities include negotiations with banks for loans, sale of stocks and bonds, establishment of capital budgeting and dividend plans financial management operational finance debt fixed asset vs Current assets equity vs. > -. Risk-return trade-off determined to maximize the market value – Influences operational side (capital vs. labor or Product A vs. Product B) – Influences financial mix (stock vs. bonds vs. retained earnings) © McGraw Hill LLC. All rights reserved Heba Ali  1-8 1-8 Figure 1: Functions of the Financial Manager © McGraw Hill LLC. All rights reserved Heba Ali  1-9 1-9 Why Do You Study Finance?  Career opportunities include: - Corporate financial officer, banker, stockbroker, financial analysist, portfolio manager, investment banker, financial consultant, & personal financial planner. Finance is relevant to all business decisions. E.g., marketing managers interested in return on investment of marketing initiatives Many personal decisions have financial implications (buying car, getting married ☺) © McGraw Hill LLC. All rights reserved Heba Ali  1-101-10 Forms of Organization double adv action fees ladu ) Slow. no pat 1 person business ↑ (Unlimited d. - Forms of organization include sole proprietorship, liability) partners, and corporation G2ormore ↳ a separate legal entity ↳ no double taxation (adv. ) ↳ limited liability (adv.) – Number of people in organization – Liability of owners – Complexity of state and federal regulations © McGraw Hill LLC. All rights reserved Heba Ali  1-11 1-11 Forms of Organization- Cont’d Sole Proprietorship – Represents single-person ownership – Advantages Simplicity of decision making Low organizational and operational costs – Drawback Unlimited liability to owner – Profits and losses taxed as though they belong to individual owner Did you know companies like Coca-Cola, Apple, Amazon, Google, Mattel and Walt Disney, etc, all started their company as Sole Proprietorship? © McGraw Hill LLC. All rights reserved Heba Ali  1-121-12 Forms of Organization- Cont’d Partnership –Similar to sole proprietorship except with two or more owners – Articles of partnership specify: Ownership interest, Methods for distributing profits, Means of withdrawing from the partnership – Carries unlimited liability for the owners (This might be worse! Why?) = you might find yourself paying for your partner (so could be double © McGraw Hill LLC. All rights reserved Heba Ali  1-131-13 Forms of Organization- Cont’d – Partnership: Limited liability partnership One or more partners designated general partners and have unlimited liability for debts of firm Other partners designated limited partners and liable only for initial contribution – Not all financial institutions extend funds to limited partnership firms © McGraw Hill LLC. All rights reserved Heba Ali  1-141-14 Forms of Organization- Cont’d Corporation – Unique; legal entity unto itself May sue or be sued, engage in contracts, and acquire property – Owned by shareholders who enjoy limited liability – Has continual life – Key feature—easy divisibility of ownership interest by issuing shares of stock © McGraw Hill LLC. All rights reserved Heba Ali  1-151-15 Forms of Organization- Cont’d Corporation – Disadvantage Potential of double taxation of earnings – S corporation Income taxed as direct income to stockholders, thus taxed only once as normal income – Limited liability company (LLC) Provides limited liability for the owners Can be taxed as sole proprietorship, partnership, corporation, or S corporation, depending upon elections made by owners © McGraw Hill LLC. All rights reserved Heba Ali  & not asked aboutA 1-161-16 What about Types of Business in Bahrain? According to Commercial Companies Law 2001, a commercial company incorporated in the State of Bahrain shall take one of the following forms: 1— General partnership company X 2— Limited Partnership company 3— Association in participation (Joint Venture) 4— Joint Stock Company 5— Limited Partnership By Shares 6— Limited Liability Company 7— Single person Company 8— Holding Company For more information: https://cbben.thomsonreuters.com/entiresection/1600005 © McGraw Hill LLC. All rights reserved Heba Ali  1-171-17 Goals of Financial Management Primary goal—maximization of profit – Drawbacks Change in profit may also represent change in risk Fails to consider timing of benefits Impossible task of accurately measuring key variable “profit” Problems with inflation and international currency transactions further complicate the issue © McGraw Hill LLC. All rights reserved Heba Ali  1-181-18 Goal of the firm? Shareholder wealth vs. profit Shareholders are the owners of the company, and they will only invest if they get something back Managers should act in the best interests of the firm’s owners. So, what goal should the managers purse? © McGraw Hill LLC. All rights reserved Heba Ali  1-191-19 Goal of the firm? Shareholder wealth vs. profit tomhenFair Maximize shareholder e wealth ? © McGraw Hill LLC. All rights reserved Heba Ali  1-201-20 Maximizing Shareholder Wealth Shareholder wealth maximization is the broad goal of the firm – Achieved through high value for the firm Residual claim – value of their claims is not fixed Financial manager cannot directly control firm’s stock price – Can act in consistent way with shareholder desires – Long-term wealth is more important that daily value © McGraw Hill LLC. All rights reserved Heba Ali  1-211-21 Corporate Governance: Principal-Agent Relation Agency theory – Examines relationship and potential conflict between owners and managers of firm – Management operates vs owners focused on shareholders Institutional investors – Have more to say about how publicly owned companies are managed – Able to vote large blocks of shares for election of board of directors © McGraw Hill LLC. All rights reserved Heba Ali  1-221-22 Agency Problem -G Manager (Agent) Owner (Principal) G ( Runs company different Owns company ~ Possible personal or short term - Long term objectives objectives? © McGraw Hill LLC. All rights reserved Heba Ali  1-231-23 Management and Stockholder Wealth Only way to retain power in long run is by becoming sensitive to shareholder concerns – Management maintains long run perspective – Board of Directors align management’s incentives and those of shareholders funds - represent > – Institutional investors often control enough shares in large companies that they are able to influence the board to unseat managers who are not responsive to shareholders’ interests © McGraw Hill LLC. All rights reserved Heba Ali  1-241-24 Social Responsibility and Ethical Behavior Adopting policies that maximize values in market – Attract capital – Provide employment – Offer benefits to society Socially desirable action like pollution control, equitable hiring practices, and fair pricing standards may be inconsistent with achieving maximum valuation in the market. © McGraw Hill LLC. All rights reserved Heba Ali  1-251-25 Role of the Financial Markets Financial markets—meeting place for people, corporations, and institutions – Have either a need to lend, borrow, or invest money Participants can be national, state, and local governments – Their markets are public financial markets Corporate participants raise funds in corporate financial markets © McGraw Hill LLC. All rights reserved Heba Ali  1-261-26 Structure and Functions of the Financial Markets Money markets financing – Deal with short-term securities with life of one year or less ↳ T-bills (note issued by government – Securities include Commercial paper sold by corporations to finance daily operations Certificates of deposit with maturities of less than one year sold by banks Represent Owners inthe firm Bond market borrowing - have to pay interest Stock market > © McGraw Hill LLC. All rights reserved Heba Ali  1-271-27 Structure and Functions of the Financial Markets- Cont’d Capital markets – Deal with securities that have life of more than one year – Long-term markets Defined as either 1 to 10 years (intermediate markets) or greater than 10 years (long-term markets) – Securities include Common stock Preferred stock Corporate and government bonds © McGraw Hill LLC. All rights reserved Heba Ali  1-281-28 Allocation of Capital Primary market – When corporation uses financial markets to raise new funds, sale of securities made through new issue is called initial public offering (IPO) Secondary market – Securities bought/sold amongst investors – Prices of securities keep changing continually – Financial managers given feedback about firms’ performance © McGraw Hill LLC. All rights reserved Heba Ali  Power of voting ; shareholders J 1-291-29 Apple Computer, Steven Jobs (1955-2011) Apple Computer began as a two-man partnership in a garage. It became a large en, publicly traded corporation with 60m shares of stock and a total market value in excess of $1 billion in 1985. The co-founder, 30-yea old Steven Jobs, owned 7m edity shares worth about $120m. A year later, when Apple’s financial performance turned wil keyit sour, Jobs was forced to resign. Jobs formed Pixar Animation Studios. In 1995, because iste Jobs’s 80 percent Pixar stake was valued at about $1.1 billion. In 1997, Apple’s future was still in doubt. So it hired a new chief executive officer (CEO): Steven Jobs! How successful was he at his new (old) job? In January 2000, Apple’s board of directors granted Jobs stock options worth $200m and threw in $90m for the purchase and care of a Gulfstream V jet. In 2004, following the introduction of iPod, Business Week named Jobs as a manager of the year. Apple released the iPad in April 2010, and sold 3 million of the devices in 80 days. © McGraw Hill LLC. All rights reserved Heba Ali  1-301-30 Apple Computer, Steven Jobs (1955-2011) cont’d Understanding Jobs’ journey from garage-based entrepreneur to corporate executive to ex-employee and, finally, to CEO takes us into issues involving the forms of organization, management goals, and management compensation/incentive. © McGraw Hill LLC. All rights reserved Heba Ali