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OBJECTIVES
• UNDERSTANDING OF THE NATURE AND ROLE OF FINANCIAL MANAGEMENT.
• UNDERSTANDING OF THE GENERAL FINANCIAL ENVIRONMENT AND THE OPERATION OF FINANCIAL SYSTEMS
• TO DEVELOP THE STUDENT’S ABILITY TO APPLY THE TOOLS OF FINANCIAL ANALYSIS AND INTERPRET RESULTS.
• TO DEVELOP A WORKING KNOWLEDGE AND UNDERSTANDING OF THE THEORETICAL FRAMEWORK AND ANALYTICAL TECHNIQUES INVOLVED IN:
• INVESTMENT AND FINANCING DECISIONS
• WORKING CAPITAL MANAGEMENT
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ASSESSMENT CRITERIA
• ASSIGNMENT 10%
• CLASS TEST 10%
• MID-TERM EXAM 20%
• FINAL EXAM 60%
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SYLLABUS1. AN OVERVIEW OF CORPORATE
FINANCE AND FINANCIAL MODELLING
2. FINANCIAL ENVIRONMENT
3. SOURCES OF FINANCE
4. THE TIME VALUE OF MONEY
5. BOND VALUATION
6. STOCK VALUATION
7. COST OF CAPITAL
8. CAPITAL BUDGETTING
9. RISK AND RETURN
10. DIVIDEND POLICY
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• PREPARE FOR THE WORKPLACE OF TOMORROW.
• BROADENING EXPECTATIONS OF FINANCIAL KNOWLEDGE AND SKILLS.
• USE AND UNDERSTAND FINANCIAL TERMINOLOGY AND CONCEPTS IN TEAM COMMUNICATION.
• DEVELOPING CROSS-FUNCTIONAL CAPABILITIES.
• CRITICAL THINKING.
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WHY ARE YOU TAKING CORPORATE FINANCE?
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“IF YOU DON’T KNOW WHERE YOU ARE GOING, IT DOESN’T
MATTER HOW YOU GET THERE”
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CHAPTER 1 WILL TEACH YOU TO EXPLAIN THE FOLLOWING:
• WHAT IS CORPORATE FINANCE
• THE GOAL OF THE FIRM
• CORPORATE GOVERNANCE
• ORGANIZATION OF THE FINANCIAL MANAGEMENT FUNCTION
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WHAT IS CORPORATE FINANCE?
GENERALLY DEFINED AS THE ACTIVITIES INVOLVED IN MANAGING CASH FLOWS
(MONEY) IN A BUSINESS ENVIRONMENT
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THE 5 BASIC CORPORATE FINANCE FUNCTIONS
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Financial Management
Capital Budgeting
Financing (Raising Capital)
Risk Management
Corporate Governance
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Financing(Raising Capital)Raising capital to support companies’ operations and investment programs.
Financial ManagementManaging firms’ internal cash flows and its mix of debt and equity financing, both to maximize the value of the debt and equity claims on firms’ and to ensure that companies can pay off their obligations when they come due.
Capital Budgeting Selecting the best projects in which to invest the resources of the firm, based on each project’s perceived risk and expected return.
Risk ManagementManaging firms ’exposures to all types of risk, both insurable and uninsurable, in order to maintain optimum risk return trade-off s and thereby maximize shareholder value.
Corporate Governance Developing ownership and corporate governance structures for companies that ensure that managers behave ethically and make decisions that benefit shareholders.
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The three decisions in Financial Management
Investment
Decisions
Financing
Decisions
Dividend
Decisions
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INVESTMENT DECISIONS
• WHAT IS THE OPTIMAL FIRM SIZE?
• WHAT SPECIFIC ASSETS SHOULD BE ACQUIRED?
• WHAT ASSETS (IF ANY) SHOULD BE REDUCED OR ELIMINATED?
These are decisions that have to do with the firm deciding on what investments it wishes to make. It also includes determining what assets to invest in. The decision making process involves selecting viable projects by applying investment appraisal techniques depending on the nature of business the firm is involved in
(E.g. Mining, retail, manufacturing or tourism.
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Most important of the three decisions
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The Hurdle Rate – reflects the riskiness of the investment and the mix od debt and equity used to fund it.
The Return – reflects the magnitude and timing of the cashflows as well as all side effects
FINANCING DECISIONS• WHAT IS THE BEST TYPE OF
FINANCING?
• WHAT IS THE BEST FINANCING MIX?
• WHAT IS THE BEST DIVIDEND POLICY (E.G., DIVIDEND-PAYOUT RATIO)?
• HOW WILL THE FUNDS BE PHYSICALLY ACQUIRED?
• These are decisions regarding, how the investment(s) selected will be financed. Firms have three options regarding where they source finances. They can source them internally by using retained earnings, borrowing from the debt capital market or issuing stocks (ordinary shares).
• The decision to use a specific source of finance is determined by the period of investment (long-term of short-term),use of funds for either capital investment or working capital requirements and desired capital structure for a given firm. That is, the balance between equity and debt used in financing the assets of the firm.
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The Optimal mix of debt and equity maximizes firm value
The Right Kind of debt matches the tenor of your assets
DIVIDEND DECISIONS
• These decisions involve determining a dividend policy for the firm which describes how the returns from the investment are distributed to shareholders as dividends. The policy describes when and how much of the profits are distributed as dividends including the mode of payment.
• As the finance manager performs these functions the overriding goal is to ensure that the firm’s value is maximized.
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How much cash you can return depends upon current & potential investment opportunities
How you chose to return cash to the owners will depend whether they prefer dividends or buybacks
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WHAT IS THE GOAL OF THE FIRM?
• POSSIBLE GOALS:
• AVOID BANKRUPTCY AND FINANCIAL DISTRESS
• MINIMIZE COSTS
• MAXIMIZE SALES
• MAXIMIZE PROFITS
• THE BEST GOAL OF A PUBLICLY TRADED FIRM:• MAXIMIZE SHARE PRICE (MAXIMIZATION OF SHAREHOLDER WEALTH)
• VALUE CREATION OCCURS WHEN WE MAXIMIZE THE SHARE PRICE FOR CURRENT SHAREHOLDERS.
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WHY TRADITIONAL CORPORATE FINANCIAL THEORY FOCUSES ON MAXIMIZING STOCKHOLDER WEALTH
• Stock prices are easily observable and constantly updated (unlike other performance measures)
• Stock prices reflect the wisdom of decisions, short and long term and instantaneously
• The objective of stock price performance provides theory on:
• Allocation of resources across scarce uses
• How to finance these investments
• How much to pay in dividends
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STRENGTHS OF SHAREHOLDER WEALTH MAXIMIZATION
• Takes account of:
• Current and future profits
• The timing, duration, and risk of profits
• Dividend policy and
• All other relevant factors.
• Share price serves as a barometer for business performance.
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SHORTCOMINGS OF PROFIT MAXIMIZATION
( MAXIMIZING EARNINGS AFTER TAXES )
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Problems• Could increase current profits
while harming firm (e.g., defer maintenance)
• Ignores changes in the risk level of the firm(Ignores risk)
• Does not fully consider cash flow timing
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THE MODERN CORPORATION
THERE EXISTS A SEPARATION BETWEEN OWNERS AND MANAGERS.
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Modern Corporation
Shareholders Management
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ROLE OF MANAGEMENT
• AN AGENT IS AN INDIVIDUAL AUTHORIZED BY ANOTHER PERSON, CALLED THE PRINCIPAL, TO ACT IN THE LATTER’S BEHALF.
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Management acts as an agent for the owners
(shareholders) of the firm.
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THE AGENCY PROBLEM
• This is defined as a potential conflict of interest between the principals (shareholders) and the agents (managers).This is created when managers act in contrast to the expectations of the shareholders regarding the objective of wealth maximization. It is necessary for shareholders to put in place incentives to ensure that managers maximize shareholder wealth.
•One agency problem is that managers can use corporate funds for non-value maximizing purposes.
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MANAGERIAL INCENTIVES TO MAXIMIZE SHAREHOLDER WEALTH
To ensure that managers act in line with shareholder expectation agency costs are incurred by firms. These costs take several forms:
• Expenditure to monitor managerial actions. E.G external audits
• Expenditure to structure the organization so that the possibility of undesirable managerial behavior will be limited.
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MECHANISM APPLIED TO FORCE MANAGERS TO ACT IN THE SHAREHOLDERS BEST INTEREST INCLUDE
• The threat of being fired.
• The threat of take over which takes the form a hostile takeover. When a new firm takeover another company managers are usually replaced by these appointed by the new board. Management would want to avoid a takeover for fear of losing their jobs to competition.
• Structured managerial incentives, which include executive share options, where executive, are given an opportunity to buy share in the future at some discounted price and performance shares awarded on the basis of performance using some criteria.
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CORPORATE SOCIAL RESPONSIBILITY
•Wealth maximization does not preclude the firm from being socially responsible at the corporate level.
•Assume we view the firm as producing both private and social goods.
•Then shareholder wealth maximization remains the appropriate goal in governing the firm.
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CORPORATE GOVERNANCE
•Corporate governance: represents the system by which corporations are managed and controlled.
•Includes shareholders, board of directors, and senior management.
•Then shareholder wealth maximization remains the appropriate goal in governing the firm.
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BOARD OF DIRECTORS• Typical responsibilities:
• Set company-wide policy;
• Advise the CEO (chief executive officer) and other senior executives;
• Hire, fire, and set the compensation of the CEO;
• Review and approve strategy, significant investments, and acquisitions; and
• Oversee operating plans, capital budgets, and financial reports to common shareholders.
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Forms of Business Organizations
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• SOLE PROPRIETORSHIPS
• PARTNERSHIPS (GENERAL AND LIMITED)
• CORPORATIONS
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THE THREE BASIC FORMS OF BUSINESS ORGANIZATION
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THE BUSINESS ENVIRONMENT
• OLDEST FORM OF BUSINESS ORGANIZATION.
• BUSINESS INCOME IS ACCOUNTED FOR ON YOUR PERSONAL INCOME TAX FORM.
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Sole Proprietorship – A business form for which there is one owner. This single owner has unlimited liability for all debts of the firm.
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SOLE PROPRIETORSHIP
ADVANTAGES• EASIEST TO START
• LEAST REGULATED
•SINGLE OWNER KEEPS ALL THE PROFITS
•SINGLE TAX FILING ON INDIVIDUAL FORM
DISADVANTAGES• UNLIMITED LIABILITY
• HARD TO RAISE ADDITIONAL CAPITAL
• TRANSFER OF OWNERSHIP DIFFICULTIES
• LIMITED TO LIFE OF OWNER
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• BUSINESS INCOME IS ACCOUNTED FOR ON EACH PARTNER’S PERSONAL INCOME TAX FORM.
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Partnership – A business form in which two or more individuals act as owners.
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PARTNERSHIP
TYPES OF PARTNERSHIPS
Limited partnership – limited partners have liability limited to their capital contribution (investors only). At least one general partner is required and all general partners have unlimited liability.
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General Partnership – all partners have unlimited liability and are liable for all obligations of the partnership.
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PARTNERSHIPADVANTAGES
• CAN BE SIMPLE
• LOW SETUP COST, HIGHER THAN SOLE PROPRIETORSHIP
• RELATIVELY QUICK SETUP
• LIMITED LIABILITY FOR LIMITED PARTNERS
DISADVANTAGES
• UNLIMITED LIABILITY FOR THE GENERAL PARTNER
• DIFFICULT TO RAISE ADDITIONAL CAPITAL, BUT EASIER THAN SOLE PROPRIETORSHIP
• TRANSFER OF OWNERSHIP DIFFICULTIES
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• An artificial entity that can own assets and incur liabilities.
• Business income is accounted for on the income tax form of the corporation.
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Corporation – A business form legally separate from its owners.
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CORPORATION
CORPORATIONADVANTAGES
• LIMITED LIABILITY
• EASY TRANSFER OF OWNERSHIP
• UNLIMITED LIFE
• EASIER TO RAISE LARGE QUANTITIES OF CAPITAL
DISADVANTAGES• DOUBLE TAXATION
• MORE DIFFICULT TO ESTABLISH
• MORE EXPENSIVE TO SET UP AND MAINTAIN
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TAKE AWAYRESEARCH THE REQUIREMENTS NEEDED TO LIST A COMPANY.
CHOSE A COMPANY YOU WOULD LIKE TO BASE YOUR ASSIGNMENT ON. EMAIL ME:
• NAME
• COMPANY CHOSEN – MUST BE LISTED ON A MARKET
FIRST COME, FIRST SERVE.
EVERYONE HAS TO CHOSE A DIFFERENT COMPANY
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