Ch. 1 - An Introduction to
Financial Management
 2002, Prentice Hall, Inc.
• What is Finance?
• Perspective of Finance
– Past – Financial Statement Analyses
– Present – Short-Term Financial Management
– Future – Capital Budgeting
• Goals of the Firm
• Ten Basic Principles of Finance
Goal of the Firm
1) Profit Maximization?
this goal ignores:
a) TIMING of Returns
(Time Value of Money - Ch. 5)
b) UNCERTAINTY of Returns
(Risk - Ch. 6)
Goal of the Firm
2) Shareholder Wealth
Maximization?
this is the same as:
a) Maximizing Firm Value
b) Maximizing Stock Price
GOALS OF THE CORPORATION
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
Maximize Shareholder’s Wealth
Optimum Cash Flow Management
Optimum Investment Management
Optimum Inventory Level Management
Optimum Debt-Equity Ratio
Optimum Risk-Return Trade-Off
Optimum Dividend Payout Ratio
Minimize Interest & Capital Cost
Minimize Tax Burden
Effective & Efficient Financial Control
Effective & Efficient Financing of Growth
Optimize Social & Societal Welfare
Avoiding Bankruptcy
Maximize Distribution of Wealth
Maximize Distribution of Ownership
Legal Forms of Business
1) Sole Proprietorship
• A business owned by a single individual.
• Owner maintains title to the firm’s assets.
• Owner has unlimited liability.
2) Partnership
• Similar to a sole proprietorship, except
that there are two or more owners.
Legal Forms of Business
2a) General Partnership
• All partners have unlimited liability.
2b) Limited Partnership
• Consists of one or more general partners,
who have unlimited liability, and
• One or more limited partners (investors)
whose liability is limited to the amount of
their investment in the business.
Legal Forms of Business
3) Corporation
• A business entity that legally functions
separate and apart from its owners.
• Owners’ liability is limited to the amount
of their investment in the firm.
• Owners hold common stock certificates,
and ownership can be transferred by
selling the certificates.
The Corporation and Financial
Markets
The Corporation and Financial
Markets
Corporation
The Corporation and Financial
Markets
Corporation
Investors
The Corporation and Financial
Markets
Corporation
Investors
Government
The Corporation and Financial
Markets
Corporation
cash
Government
Investors
The Corporation and Financial
Markets
Corporation
cash
securities
Government
Investors
The Corporation and Financial
Markets
Corporation
cash
Investors
securities
Secondary
markets
Government
The Corporation and Financial
Markets
Corporation
cash
Investors
securities
Secondary
markets
Government
The Corporation and Financial
Markets
Corporation
cash
Investors
securities
Secondary
markets
Government
The Corporation and Financial
Markets
Corporation
cash
Investors
securities
Secondary
markets
Cash flow
Government
The Corporation and Financial
Markets
Corporation
cash
Investors
securities
Secondary
markets
Cash flow
tax
Government
The Corporation and Financial
Markets
cash
Corporation
Investors
securities
reinvest
Secondary
markets
Cash flow
tax
Government
The Corporation and Financial
Markets
cash
Corporation
Investors
Debt & equity
securities
reinvest
Cash flow
Interest,
dividends,
etc.
tax
Government
Secondary
markets
BUSINESS
INVESTMENT
The Corporation and Financial
Markets
• Primary Market
The Corporation and Financial
Markets
• Primary Market
– Market in which new issues of a
security are sold to initial buyers.
The Corporation and Financial
Markets
• Primary Market
– Market in which new issues of a
security are sold to initial buyers.
• Secondary Market
The Corporation and Financial
Markets
• Primary Market
– Market in which new issues of a
security are sold to initial buyers.
• Secondary Market
– Market in which previously issued
securities are traded.
The Corporation and Financial
Markets
• Initial Public Offering (IPO)
The Corporation and Financial
Markets
• Initial Public Offering (IPO)
– The first time the firm’s stock is
sold to the general public.
The Corporation and Financial
Markets
• Initial Public Offering (IPO)
– The first time the firm’s stock is
sold to the general public.
• Seasoned New Issue
The Corporation and Financial
Markets
• Initial Public Offering (IPO)
– The first time the firm’s stock is
sold to the general public.
• Seasoned New Issue
– A new stock offering by a firm that
already has stock that is traded in
the secondary market.
FINANCIAL MARKETS, INSTITUITION &
INSTRUMENTS
 Primary Markets
 Secondary Markets
 Money Markets
o
o
o
o
o
o
o
o
T-Bills
Federal Agency Discount Notes
Short Term Munis
Federal Funds
Negotiable Certificate of Deposits
Commercial Paper
Bankers Acceptance
Repos
 Mortgage Markets
FINANCIAL MARKETS, INSTITUITION &
INSTRUMENTS
 Capital Markets
o Debt
o Equity
o Common Shares
o Preferred Shares
 Bond Markets
o
o
o
o
T-Bonds
Agency Debt
Munis Bonds
Corporate Bonds
 Futures Market, i.e., real or financial assets
o Options
o Forwards
o Derivatives
Financial Management Axioms
•
•
•
•
•
•
•
•
•
•
1) Risk - return trade-off
2) Time value of money
3) Cash - not profits - is king
4) Incremental cash flows count
5) The curse of competitive markets
6) Efficient capital markets
7) The agency problem
8) Taxes bias business decisions
9) All risk is not equal
10) Ethical dilemmas are everywhere in finance
BUSINESS
INVESTMENT
ASSETS
Ξ
FINANCE
S/T INV + L/T INV Ξ S/T FINANCE + L/T FINANCE
C A
+
Cash
Marketable Securities
Accounts Receivables
Inventory
Others
•
•
•
F A
Plant & Equipment
Machinery
Capital WIP
Land
Investments (Land)
=
C L
+ LTD + EQUITY
Short Term Loan
Current Maturities
Accounts Payable
Notes
Accrued Expenses
Proposed Dividend
Long Term
Preferred
Debt
Share
Bank Loans Ordinary Share
Notes
Share Premium
Treasury Stock
Bonds
Retained Earnings
Reserves
S/T= SHORT TERM, L/T=LONG TERM, INV= INVESTMENT
CA= CURRENT ASSETS, FA= FIXED ASSETS, CL= CURRENT LIABILITY
CM= CURRENT MATURITY, WIP= WORK IN PROGRESS