FIN10670 Introduction to Finance Lecture 1 PDF

FIN10670 Introduction to Finance Topic 1 Introduction to Corporate Finance Dr. Haoran Wu [email protected] What does Finance mean to you? 5-minute discussion An Overview of Finance Finance is simply how individuals, bus...

FIN10670 Introduction to Finance Topic 1 Introduction to Corporate Finance Dr. Haoran Wu [email protected] What does Finance mean to you? 5-minute discussion An Overview of Finance Finance is simply how individuals, businesses, and organisations manage their financial resources, under conditions of uncertainty and risk, such as borrowing, investing, lending, budgeting, saving, and spending. It encompasses two primary areas: Corporate Finance Corporate finance focuses on how companies make decisions to maximise their value. It covers all the financial activities related to running a business. It involves managing a firm's capital structure, raising funds through equity or debt, investing in projects, and optimising financial performance. Key topics include capital budgeting, financial analysis, and risk management, which help corporations make informed decisions to achieve their strategic objectives. An Overview of Finance Asset Pricing Asset pricing deals with the valuation of financial assets like stocks, bonds, and derivatives. It examines how market participants determine the prices of these assets based on expected returns, risk, and the time value of money. Asset pricing theories and models, such as the Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT), are fundamental to understanding how financial markets function and how investors make decisions. An Overview of Finance An Overview of Finance An Overview of Finance An Overview of Finance More Finance News… 2022: ❖ Stocks and government bond prices fell as more of the world’s central banks joined the US Fed in raising interest rates. ❖ Pound hits 37-year low against Dollar on UK tax cut ‘gamble’. 2020: Stock markets across the world crashed due to the Covid-19 pandemic between 20 Feb to 7 April 2020. An Overview of Finance Things to Remember ▪ Everyone wants to be as well off as we can be ▪ We do not like risk ▪ Information is valuable Introduction to Finance – Market Capitalization Top Companies by Market Capitalization Source: https://www.pwc.co.uk/audit/assets/pdf/global-100/global-top-100-companies-2024.pdf (March 2022) Why mostly tech firms? 1. Apple [$2,850bn] 2. Microsoft [$2,311bn] 3. Saudi Aramco [$2,298bn] 4. Alphabet [$1,842bn] 5. Amazon [$1,659bn] Source: https://www.pwc.com/gx/en/audit-services/publications/top100/pwc-global-top-100-companies-by-market-capitalisation-2022.pdf Introduction to Finance – Market Capitalization Forbes Most Valuable Brands Rank Company Industry 1 Apple Technology 2 Alphabet (Google) Technology 3 Microsoft Technology 4 Amazon Technology 5 Facebook Technology 6 Coca Cola Beverage 7 Disney Leisure 8 Samsung Technology 9 Louis Vuitton Luxury 10 McDonald’s Restaurants Source: https://www.forbes.com/powerful-brands/list/ Introduction to Finance – Market Capitalization For many companies build brick-and-mortar stores, expand complex supply chains, and hire new employees Capital and manpower intensive for each new expansion Tech companies Bring in more revenue with less capital and risks Able to gain competitive advantage Key businesses that are unique Introduction to Finance – Resources… Financial Times The Economists Podcasts: Freakonomics (Stephen Dubner); EconTalk (Russ Roberts) Introduction to Finance – My three cents… What you learn from the textbook does not always work in reality. People have bounded rationality (e.g. cognitive ability, time constraint, and imperfect information). Distinguish between correlation and causation. Topic 1 Overview ❖ Corporate Finance and the Financial Manager ❖ The Goal of Financial Management ❖ Financial Markets and the Corporation ❖ Corporate Finance in Action: The Case of Alphabet Inc. ❖ Forms of Business Organization  Corporate Finance & the Financial Manager Corporate Finance and the Financial Manager Three Pillars of Corporate Finance Corporate Finance How will you manage your daily activities? What long term investments will you make? Investment Financing Liquidity Where will you get long term finance for your long term projects? Corporate Finance and the Financial Manager Three Pillars of Corporate Finance – Investment ▪ What do you need to start a firm? Investment Inventory Machinery Land Labour Corporate Finance and the Financial Manager Three Pillars of Corporate Finance – Investment & Financing ▪ Cash invested in assets must be matched by an equal amount of cash raised by financing Investment Financing Cash Cash Corporate Finance and the Financial Manager Three Pillars of Corporate Finance – Why are you starting a firm? = Value Creation Financing Who makes these decisions? Investment The Financial Manager Liquidity Corporate Finance and the Financial Manager Capital Budgeting ▪ Identify investment opportunities that are worth more to the firm than they cost to acquire. Capital Structure How much should Long-term Debt the firm borrow? Financing (Borrowing) + What are the least Equity (Owners’ Investment) expensive sources of funds for the firm? The Financial Manager has to decide how and here to raise funds Corporate Finance and the Financial Manager Working Capital Management Liquidity ▪ The management of a firm’s short-term assets and liabilities Should we sell on credit? How much cash and If yes, what terms will we inventory to keep? offer, and to whom will we extend them to? How will we obtain any needed short term financing? Corporate Finance and the Financial Manager Showing Value – The Balance Sheet Liabilities Assets Equity Corporate Finance and the Financial Manager Responsibilities of a Financial Manager Buy assets that Choose long-term earn more cash investments that than they cost increase firm value Maximize Value from Cash Raise cheap Ensure efficient tax external financing policy Corporate Finance and the Financial Manager Cash is the centre of all financial decisions Figure 1.2: Cash flows between the firm, the financial markets and the economy Corporate Finance and the Financial Manager Identification Cash Flows or Accounting Figures? Timing When Do Cash Flows Occur? Risk Are Cash Flows Risky or Certain? The Goal of Financial Management The Goal of Financial Management Different Goals in Practice Maximize Avoid Profits Distress Maximize Survive Be the Best Maximize Firm Value Earnings Sales Growth Financial Markets and the Corporation Financial Markets and the Corporation Different Sources of Financing Private Bank Equity Investors Loans Short-term Bonds Financing Financial Markets and the Corporation Types of Financial Markets Primary Secondary The original sale of securities by Secondary: Securities bought/sold governments and corporations. after the original sale. Auction Sell to dealer Agency Hire agent to sell e.g. car dealership for £100 e.g. real estate Hire for you Trade Dealer sells for Agent sells for £110 Trade £110 Trade Profit to Dealer Agent charges = £10 Profit commission of £10 Profit Corporate Finance in Action: The Case of Alphabet Inc. Corporate Finance in Action - Alphabet Background ▪ Started in 1996 by two Stanford PhD students, Sergey Brin and Larry Page ▪ Idea: more efficient ways to search through Internet Pages ▪ Funding: ✓ Approached potential investors with the idea and a few algorithms ✓ Attracted a $100,000 funding from one of the founders of Sun Microsystems Within 1 year, they attracted another $25million from venture capitalists Corporate Finance in Action - Alphabet Funding ▪ Founders created a business plan and cashflow forecast using accounting and financial information ✓ Allow investors to arrive at the firm’s future valuation ▪ By 2004, Google was so successful that it required further capital to grow Should they choose to borrow (debt) or raise capital through issuing shares (equity). Why? Chose 100% equity as its capital structure. Why? Corporate Finance in Action - Alphabet Initial IPO share price $85 (19 August 2004) Price (September 4th, 2018): $1,214.75 Market cap (September 4th, 2018): $840.6bn Google share price today? Google market cap today? If you bought one share of Google in 2004 at its initial public offering price of $85, then it would be two shares worth $18,522 by 2019, taking into account Google's stock split. That's a 21,691% increase! Corporate Finance in Action - Alphabet Forms of Business Organization Forms of Business Organization Sole Proprietorship Partnership Limited Corporation Owned and managed by Requires a partnership Articles and one person agreement, easy to form Memorandum of Incorporation required Very easy to form Limited & unlimited partners Limited liability Profits taxed as personal Ceased when a partner dies or leaves the firm Profits taxed at corporate income tax rate Difficult to raise cash Unlimited liability Board of directors Profits taxed as personal Life of company linked to income Life of company life of owner hypothetically unlimited Controlled by general Amount of funding is partners – sometimes votes limited by owner’s are required on major personal wealth business decisions Forms of Business Organization Articles of Incorporation ▪ Name of the firm ▪ Intended life of the corporation (it may be forever) ▪ Business purpose ▪ Number of shares authorized to issue, with a statement of limited, and rights of different classes of shares ▪ Nature of the rights granted to shareholders ▪ Number of members of the initial board of directors Memorandum of Association ▪ The rules by which the corporation is organised Forms of Business Organization Partnership Corporation Liquidity and Restricted trading Traded easily, sometimes on Marketability an exchange Voting Rights Partners have control Each share (usually) gives a voting right Taxation Profits taxed at personal tax Profits taxed at corporate tax rate rate Reinvestment & All profits allocated to Total freedom in dividend Dividend Payout partners decisions Liability General Partners have Shareholders have limited unlimited liability liability Continuity of Limited life Unlimited life Existence Forms of Business Organization Unitary Board of Directors ▪ Board reports to shareholders ▪ Shareholders elect directors at the Annual General Meeting Chairman/ Chief Executive Non-executive Directors Directors Forms of Business Organization Two-Tier Board of Directors ▪ Board reports to supervisory board ▪ Supervisory board ▪ Elects directors Supervisory Board ▪ Consists of representatives from banks, government, trade unions, other stakeholders Chairman/Chief Executive Directors