Bài giảng Management theory and practice Financial: Chapter 1

PowerPoint Presentation prepared by Traven Reed Canadore College

Chapter 1 An Overview of Financial Management and the Financial Environment

Topics in Chapter

CH1

• Attributes of successful companies • Forms of business organization • Objective of the firm: maximize

wealth

• Determinants of fundamental value • Financial securities, financial

institutions, and financial markets

1-3

Attributes of Successful Companies

CH1

• Like a stool needs all three legs to stand, a successful business relies on: – Skilled people – Strong external relationship – Sufficient capital

1-4

The Corporate Life Cycle

CH1

• No two companies will develop in exactly

the same way

• A business usually begins as a small potato and hopefully finishes up as a major giant

• Structures of business organizations:

– Sole proprietorship – Partnership – Corporation Income trust –

1-5

Starting as a Proprietorship

CH1

• Advantages:

– Ease of formation – Subject to few regulations – No corporate income taxes

• Disadvantages:

– Difficult to raise capital to support

growth

– Unlimited liability – Limited life span

1-6

Starting as or Growing into a Partnership

CH1

• A partnership involves two or more entities with various privileges and responsibilities – General vs. limited partner – Limited liability partnership

• A partnership has roughly the same advantages and disadvantages as a sole proprietorship.

1-7

Becoming a Corporation

CH1

• A corporation is a legal entity separate from its owners and managers.

• File papers and prepare reports

with Corporation Canada. – Articles of incorporation – Bylaws

1-8

Advantages and Disadvantages of a Corporation

CH1

• Advantages: – Unlimited life – Easy transfer of ownership – Limited liability – Ease of raising capital

• Disadvantages: – Double taxation – Higher setup cost – Endless report filing

1-9

A Unique Twist: Income Trusts

CH1

• Expand 100 times to a market capitalization of

$192 billion from 1994 to 2007

• Growth ends as government has announced

•

plans in 2006 to tax trusts at the same rate as corporations In the past, income trust cash distributions are only taxed in the hands of investors, not at the firm level Investors see trusts as tax-efficient and are willing to pay more for a company converted to a trust

What should be management’s primary objective?

CH1

• The primary objective should be

shareholder wealth maximization, which translates to maximizing the fundamental share price, not just the current market price.

• Should firms behave ethically? YES! • Business ethics are a company’s attitude

and conduct toward its employees, customers, community and shareholders

CH1

Stock Price Maximization and Social Welfare

• Do firms have any responsibilities

to society at large? Yes!

• Unethical behavior destroys public

trust and confidence.

• Maximizing share price is good for

society. Why?

• Shareholders are also members of

society.

CH1

Is Maximizing stock price good for consumers?

• Consumer welfare is higher in

capitalist free market economies than in communist or socialist economies due to competition

• Consumers can improve quality of life by the direct or the indirect investments in the stock market

Is maximizing stock price good for employees?

CH1

• Employment growth is higher in firms that try to maximize stock price. On average, employment goes up in: – firms that make managers into owners

(such as LBO firms)

– firms that were owned by the

government but that have been sold to private investors

How do managers affect shareholder wealth?

CH1

•

Improve a firm’s ability to generate cash flows now and in the future by focusing on: – Amount of expected cash flows

(bigger is better)

– Timing of the cash flow stream

(sooner is better)

– Risk of the cash flows (less risk is

better)

Free Cash Flows (FCF)

CH1

• There are many ways firms can

increase free cash flows

• FCF are cash flows available (or

free) for distribution to all investors (stockholders and creditors).

• FCF = sales revenues - operating costs - operating taxes - required investments in operating capital.

What is the weighted average cost of capital (WACC)?

CH1

• WACC is the average rate of return required by all of the company’s investors.

• WACC is affected by:

of debt and equity)

– Capital structure (the firm’s relative amounts

– Interest rates – Risk of the firm – Investors’ overall attitude toward risk

Determinants of a Firm’s Value

CH1

Who are the providers (savers) and users (borrowers) of capital?

CH1

• Households: Net savers • Non-financial corporations: Net

users (borrowers)

• Governments: Net borrowers • Financial corporations: Slightly net borrowers, but almost breakeven

Capital Allocation Process

CH1

Transfer of Capital from Savers to Borrowers

CH1

• Direct transfer (e.g., corporation issues

•

commercial paper to insurance company) Indirect transfer through an investment banker (e.g., IPO, seasoned equity offering, or debt placement) Indirect transfer through a financial intermediary (e.g., individual deposits money in bank, bank loans to a firm)

Cost of Money

CH1

• Supply and demand of funds determine the price of money.

• What do we call the price (or cost) of debt capital? Of equity capital? – Interest rate – Cost of equity = required return = dividend

yield + capital gain

• Both are the rate fund users pay to

fund providers

What four fundamental factors affect the cost of money?

CH1

• Production opportunities • Time preferences for consumption • Risk • Expected inflation

What economic conditions affect the cost of money?

CH1

• Bank of Canada policies • Budget deficits/surpluses • Level of business activity (recession or

•

boom) International trade deficits/surpluses

• Country risk depending on its economic,

political, and social environment

• Exchange rate risk

Financial Securities

CH1

• Financial securities are contracts

granting owners specific rights and claims on specific values • Vary in risk and maturity • Nature of claims: debt, equity, and

derivatives

• Money market instrument (T<1),

and capital market instrument (T≥1)

Financial Securities

CH1

Debt

Equity

Derivatives

Money Market

•Options •Futures •Forward contract •T-Bills •Banker’s Acceptances •Commercial papers •MMMFs •EuroCanadian dollars

Capital Market

•Canadian Government-Bonds •Mortgages •Corporate bonds

•Common stock •Preferred stock •LEAPS •Swaps

Typical Rates of Return

CH1

Instrument

Rate (April 2009)

Gov’t of Canada T-bills

2.05%

Banker’s acceptances

3.57

Commercial paper

5.39

Money Market mutual funds

3.50

EuroCanadian market time

3.45

Commercial loans:

Tied to prime

5.25 +

or LIBOR

3.05 +

Typical Rates (cont’d)

CH1

Instrument

Rate (April 2009)

Gov’t of Canada bonds

3.56%

Mortgages

6.50

Corporate bonds

5.11

Leases

5.11

Common Stock

10.9

What are some financial institutions?

CH1

•

Investment banks • Commercial banks • Trust companies • Credit unions • Life insurance companies • Mutual funds

– Money Market Funds (MMMFs) – Exchanged Traded Funds (ETFs)

• Pension funds • Hedge funds

Types of Financial Markets

CH1

• A financial market brings together

savers and borrowers.

• Physical asset vs. financial asset

markets

• Spot versus future markets • Money versus capital markets • Primary versus secondary markets • Private versus public markets

CH1

Physical- vs. Financial-asset Markets

• Physical (a.k.a. tangible or real)

asset markets – Products as wheat, autos and real

estates

• Financial asset markets

– Primitive securities and derivative

securities

Spot vs. Futures Markets

CH1

• Spot (a.k.a. cash) markets

– Assets are bought or sold for “on-the-

spot” delivery • Futures markets

– Assets are bought or sold for delivery

at some future date

Primary vs. Secondary Markets

CH1

• Primary

– New issue (IPO or seasoned) – Key factor: issuer receives the

proceeds from the sale.

• Secondary

– Existing owner sells to another party. – Issuing firm doesn’t receive proceeds

and is not directly involved.

Private vs. Public Markets

CH1

• Private markets

– Transactions are worked out directly

between two parties

– Lack of liquidity • Public markets

– Standardized contracts are traded on

an organized

– More liquid and transparent

Bài giảng Management theory and practice Financial: Chapter 1

Chapter 1 An Overview of Financial Management and the Financial Environment

Topics in Chapter

CH1

Attributes of Successful Companies

CH1

The Corporate Life Cycle

CH1

Starting as a Proprietorship

CH1

Starting as or Growing into a Partnership

CH1

Becoming a Corporation

CH1

Advantages and Disadvantages of a Corporation

CH1

A Unique Twist: Income Trusts

CH1

What should be management’s primary objective?

CH1

CH1

Stock Price Maximization and Social Welfare

CH1

Is Maximizing stock price good for consumers?

CH1

How do managers affect shareholder wealth?

CH1

Free Cash Flows (FCF)

CH1

What is the weighted average cost of capital (WACC)?

CH1

Determinants of a Firm’s Value

CH1

Who are the providers (savers) and users (borrowers) of capital?

CH1

Capital Allocation Process

CH1

Transfer of Capital from Savers to Borrowers

CH1

Cost of Money

CH1

What four fundamental factors affect the cost of money?

CH1

What economic conditions affect the cost of money?

CH1

Financial Securities

CH1

Financial Securities

CH1

Typical Rates of Return

CH1

Typical Rates (cont’d)

CH1

What are some financial institutions?

CH1

Types of Financial Markets

CH1

CH1

Physical- vs. Financial-asset Markets

Spot vs. Futures Markets

CH1

Primary vs. Secondary Markets

CH1

Private vs. Public Markets

CH1

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