9/8/2010 FIN 3200 Business Finance Professor Christopher p Korth christopher.korth@wmich.edu homepages.wmich.edu/~korth Prerequisites Business Statistics • MATH 2160 • MATH 3660 Principles of Accounting • ACTY 2100 C. M. Korth 2 Office & Office Hours Room 3342 Tuesday & Thursday: • 9 - 10:00 A.M. • 2 - 3:00 P.M. Monday: 2 – 4:00 P.M. C. M. Korth 3 1 9/8/2010 Text Essentials of Corporate Finance (7th) Ross,, Westerfield & Jordan [McGraw--Hill/Irwin: 2011] [McGraw C. M. Korth 4 Other Materials Financial calculator (mandatory (mandatory) ) • Hewlitt Hewlitt--Packard 10 10--B • Texas Instruments BA II + Study Guide (recommended) C. M. Korth 5 Objectives of FIN 3200— 3200— to Understand: The role of financial management in the firm Basic financial p principals p & analytical techniques The nature of financial markets Current events affecting finance C. M. Korth 6 2 9/8/2010 Evaluation Class participation Exams • I • II • III 15% 25% 30% 30% C. M. Korth 7 Participation You are expected to attend all classes • More than 3 absences will reduce your participation grade 5% per absence. b Assigned readings and problems are to be done before class. class. There will be extensive class discussion. 8 Final Grade 90% 85% 80% 75% 5% 70% 65% 60% <60% A BA B CB C C DC D E C. M. Korth 9 3 9/8/2010 Chapter 1 Overview of Financial Management Major Topics of Chapter 1 1. The 4 basic areas of finance 2. The 3 forms of business organizations 3. The 3 basic financial problems 4. The key financial managers C. M. Korth 11 Major Topics of Chapter 1 5. The primary goals of the firm 6. The owner owner--manager conflict 7. Financial ethics C. M. Korth 12 4 9/8/2010 The 4 Basic Areas of Finance C. M. Korth 13 The 4 Basic Areas of Finance 1. Institutional finance 2. Investments 3. Financial institutions 4. International finance C. M. Korth 14 1. Institutional Finance Businesses— Businesses —not just corporations Governments & their agencies Non--profit institutions Non C. M. Korth 15 5 9/8/2010 2. Investments Short term vs. long term Debt vs. equity q y Organized exchanges vs. private markets C. M. Korth 16 3. Financial Institutions Commercial banks Investment banks Stock markets Debt markets C. M. Korth 17 4. International Finance Foreign--exchange (FX) markets Foreign Foreign stock & debt markets “Offshore” debt markets C. M. Korth 18 6 9/8/2010 What is the difference between debt and equity? What Wh t d does the th b borrower pay? ? What does the stock issuer pay? C. M. Korth 19 The 3 Forms of Business Organizations Proprietorships P t Partnerships hi Corporations C. M. Korth 20 Proprietorships A single owner Not incorporated ~ 75% of all US businesses are proprietorships C. M. Korth 21 7 9/8/2010 Advantages of Proprietorships Easy & inexpensive to form (Usually) least regulated of all business forms • Minimum reporting requirements C. M. Korth 22 Other Advantages of Proprietorships The proprietor is the sole decision maker. All profits belong to the proprietor. No double taxation of profits C. M. Korth 23 Disadvantages of Proprietorships Unlimited liability for investor Proprietor is sole owner— owner—can’t sell stock to raise capital Difficult to borrow Difficult to transfer ownership Death of proprietor 24 8 9/8/2010 Partnership Businesses with 2 or more owners that are not incorporated ~ 10% of all US businesses are partnerships C. M. Korth 25 Advantages of Partnerships Simpler & less expensive than corporation to form Generally have less regulation & required reports No double taxation of profits C. M. Korth 26 Disadvantages of Partnerships Unlimited liability More difficult & expensive to form than proprietorships Detailed partnership contract C. M. Korth 27 9 9/8/2010 Other Disadvantages of Partnerships Difficulties involving: • Withdrawal of a partner • Death of a partner C. M. Korth 28 General Partnerships Similar to a proprietorship All partners have unlimited liability! • Regardless of how much of the business they own!!! C. M. Korth 29 Limited Partnerships General partners have unlimited liability. Limited partners have limited liability! • A limited partner must be passive— passive— cannot be actively engaged in the business. C. M. Korth 30 10 9/8/2010 Hybrid Businesses Special business forms that combine: • Limited Li it d liability li bilit off a corporation ti • Tax advantages of a partnership C. M. Korth 31 Hybrid Businesses Limited-liability partnership Limited(LLP) Li i d li Limited liability bili company (LLC) Professional corporation C. M. Korth 32 The 3 Basic Financial Problems 1. What major expenditures should the business make? capital budgeting C. M. Korth 33 11 9/8/2010 The 3 Basic Financial Problems 2. The financing decision: decision: How should the firm pay for the investments chosen in the capital--budgeting process? capital Debt vs. equity Short vs. longlong-term debts Capital structure C. M. Korth 34 The 3 Basic Tasks of Corporate Finance 3. Day Day--toto-day financial operations operations:: • Gathering the funds • Paying the bills • Investing surplus funds working--capital management working 35 The Key Financial Managers Chief financial officer (CFO CFO) ) • Treasurer: chief financing manager • Controller: chief accounting officer • Risk manager: primarily external • Internal auditor: primarily internal C. M. Korth 36 12 9/8/2010 Primary Goal of the Firm Widely said to be shareholder wealth maximization (SWM) • Capital gain plus dividends C. M. Korth 37 Shareholder Wealth Maximization SWM is used almost exclusively in Anglo--American countries Anglo However, SWM ignores the firm’s reliance upon, and responsibility to its other major stakeholders! C. M. Korth 38 Shortcomings to Shareholder Wealth Maximization Encourages short short--term focus Encourages excessive debt Can harm relationships w/ other stakeholders C. M. Korth 39 13 9/8/2010 What are stockholders? What are stakeholders? C. M. Korth 40 The Stakeholders Shareholders (the owners) Managers Other employees C stome s Customers Creditors Suppliers Governments Local community C. M. Korth 41 Stakeholder Complaints Shareholders (wasteful spending) Managers (nepotism) Other employees (unfair layoffs) Customers (poor service) Creditors (paying late) Suppliers (paying late) Governments (tax evasion) Local community (pollution) C. M. Korth 42 14 9/8/2010 Corporate Wealth Maximization Stresses the importance of numerous stakeholders It is the management philosophy in most of the rest of the world. C. M. Korth 43 Not Simply Profit Maximization!!! Short--term focus Short Encourages g managers g to target g profits to maximize their bonuses C. M. Korth 44 The Owner Owner--Management Conflict In large businesses, owners do not usually actually manage the firm. They y hire managers— managers g —the agents g of the owners. The interests of the managers are not always the same as those of the owners— owners—the agency conflict. conflict. C. M. Korth 45 15 9/8/2010 Overcoming the Agency Conflict Compensation • Salary • Bonus • Stock options • Retirement package C. M. Korth 46 Financial Ethics in Business Treating all stakeholders “fairly.” “Fairness” and “ethics” are not moral,, ethnic or p political absolutes. • What is ethical in one culture or country, may not be ethical in others others.. C. M. Korth 47 Next Class The Financial Environment & Interest Rates C. M. Korth 48 16 9/8/2010 Financial Environment Forms of financing and investing • Debt • Equity C. M. Korth 49 The Financial Institutions Commercial banks Investment banks Organized exchanges (stock, bond, commodity, FX) C. M. Korth 50 The Markets Money markets Capital p Markets Primary markets Secondary markets C. M. Korth 51 17 9/8/2010 The Players Commercial bankers Investment bankers Dealers [the “market makers”] Brokers C. M. Korth 52 The Institutional Investors Insurance companies P Pension i & other th retirement ti t funds f d Mutual funds C. M. Korth 53 Interest Rates Nominal USG interest rate • = Real interest rate + inflation • Real interest rate— rate—no risks of any sort C. M. Korth 54 18