FINANCIAL MANAGEMENT (KETE307) Nguyen Thu Hang nguyenthuhang.cs2@ftu.edu.vn 1 Outline • Chapter 1: Introduction to Financial Management • Chapter 2: Financial Statement Analysis • Chapter 3: The time value of Money • Chapter 4: Interest rates and Bond valuation • Mid-term test • Chapter 5: Stock Valuation • Chapter 6: Capital Budgeting • Chapter 7: Return, Risk, and the Security Market Line 2 Assessment • Performance +warming-up activities: 10% • Mid-term test (30 mins-MCQ and essay questions): 30% • Final exam (60 mins-MCQ and essay questions): 60% 3 Course materials 1. Ross, Westerfiled & Jordan (2019), Corporate Finance 2. Berk DeMarzo (2019) Corporate Finance 3. CFA Program Curriculum, Level II, Volume 3, Corporate Finance 4. CFA Program Curriculum, Level I, Volume 3, Financial Reporting Analysis 4 CHAPTER 1 INTRODUCTION TO FINANCIAL MANAGEMENT ( 6 hours) 5 Learning Objectives • Four major types of firms (main advantages and disadvantages). • Financial decisions in corporations. • Goal of Corporate Finance Decisions/ Goal of CEO • Agency problem • Solutions to the agency problem 6 Four types of firms A business is an organization involved in the trade of goods, services, or both to consumers, for profit or not-for profit. Types of Business Ownership (Sole) Proprietorships. Partnerships. Limited Liability Companies Corporations 7 (Sole) Proprietorship • Is a business owned and run by one person • Sole proprietorships are very small with few, if any, employees. • Although they do not account for much sales revenue in the economy, they are the most common type of firm in the world. • Straightforward to set up. • The firm can have only one owner. • The owner has unlimited personal liability of any firm’s debts. • The life of a sole proprietorship is limited to the life of the owner It is difficult to transfer ownership of a sole proprietorship. 8 Partnership • A partnership is identical to a sole proprietorship except it has more than one owner. • All partners are liable for the firm’s debt. • The partnership ends on the death or withdrawal of any single partner, although partners can avoid liquidation if the partnership agreement provides for alternatives such as a buyout of a deceased or withdrawn partners. • A limited partnership is a partnership with two kinds of owners, general partners and limited partners. 9 Limited Liability Companies (LLC) • A limited liability company (LLC) is a limited partnership without a general partner. • All the owners have limited liability, but unlike limited partners, they can also run the business. 10 Corporations • The distinguishing feature of a corporation is that it is a legally defined, artificial being (a judicial person or legal entity), separate from its owners it is solely responsible for its own obligations. • The owners of a corporation are not liable for any obligations the corporation enters into. • The corporation is not liable for any personal obligations of its owners. • A corporation has many of the legal powers that people have. 11 Ownership of a corporation • No limit on the number of owners a corporation can have. • The entire ownership stake of a corporation is divided into shares known as stock. The collection of all the outstanding shares of a corporation is known as the equity of the corporation. • Shareholders, or stockholders or equity holders are entitled to dividend payments. 12 Four types of firms (Re: CFAI 2013, Volume 2, SS. 4) 13 Types of U.S. Firms Ref: Berg, Ch 1 14 Four types of U.S. firms (Re: U.S. Bureau of Census, 2012 Statistical Abstract) 15 Four types of firms (Re: General Statistics Office) 16 • What is corporate finance? 17 Financial system The Financial System Public Finance Financial Market Financial Institutions Corporate Finance Personal Finance 18 Financial system (cont.) Public Finance Government operations to implement policy. Efficient resources allocation, income distribution and economic stabilization. Business Finance (Corporate Finance) Business operations to maximize owner’s wealth. Investing and financing decisions. Personal Finance Individual or family activities. Maximize utilities. 19 What is corporate finance? Corporate Finance is the study of financial decisions in corporations. Types of Decisions in a Corporation Investment decisions. Financing decisions. Which type of decisions comes first? 20 21 Ownership versus Control of Corporations • Corporate Management Team – In a corporation, ownership and direct control are typically separate. – Board of Directors • Elected by shareholders • Have ultimate decision-making authority – Chief Executive Officer (CEO) • Board typically delegates day-to-day decision making to CEO. 22 Figure 1.2 Organizational Chart of a Typical Corporation 23 Financial Manager Ref: Mayers, Principles of Corporate Finance, Ch1 24 Financial Manager • Within the corporation, financial managers are responsible for three main tasks: - Making investment decisions - Making financing decisions - Managing the firm’s cash flows. 25 Investment decisions • Weigh the costs and benefits of all investments and projects Decide which of them qualify as good uses of the money stockholders have invested in the firm. • Shape what the firm does and whether it will add value for its owners. 26 Financing decisions • Decide how to pay for the investments. • Decide whether to raise more money from new and existing owners by selling more shares of stock (equity) or to borrow the money (debt). 27 Cash Management • Ensure that the firm has enough cash on hand to meet its day-to-day obligations. • Commonly known as managing working capital. • In a young or growing company, it can mean the difference between success and failure. 28 Goal of Corporate Finance Decisions Goal of CEO: Maximize shareholders (long-term) value. How? 29 Reading 1 CFA Corporate Finance, Level II, Reading 26 • Stakeholders and corporate performance • Profitability, profit growth, and Stakeholder claim 30 How to maximize shareholders’ wealth? • The best way for managers to generate the funds for future dividend payments and to keep the stock price appreciating is to pursue strategies that maximize the company’s longrun profitability and grow the profits of the company over time. 31 Agency cost and information asymmetry Principal-Agent Problem Separation between ownership and control. Managers act for their own self-interest, which may substantially differs from the interest of the shareholders. Manager- Shareholder conflicts, directorShareholder conflicts That imposes a cost to shareholders to monitor managers (agency cost). 32 Reading 2 CFA Corporate Finance, Level II, Reading 27 • Manager- Shareholder conflicts • Director-Shareholder conflicts 33 Methods to Mitigate Principal-Agent Problem Ownership. Jensen and Meckling (1976): positive relationship between management ownership and performance. Himmelberg, C. P., R. G. Hubbard, D. Palia (1999), Understanding the determinants of managerial ownership and the link between ownership and performance, Journal of Financial Economics 53: No significant relationship! Incentive pay. Long-term contract. Corporate Governance (Refer: CFAI 2013, Volume 2, SS4) 34 Corporate Governance Is the system of principles, policies, procedures, and clearly defined responsibilities and accountabilities used by stakeholders to: o Eliminate or reduce conflicts of interest. o Use the company's assets in a manner consistent with the best interests of stakeholders. 35 Corporate Governance Effective Corporate Governance System Define the rights of shareholders and other important stakeholders. Define and communicate to stakeholders the responsibilities of managers and directors. Provide for fair and equitable treatment in all dealings between managers, directors, and shareholders. Have complete transparency and accuracy in disclosures regarding operations, performance, risk, and financial position. 36 Corporate Governance Effective Board of Directors Composition of the board, election and independence of board members. Qualifications of the directors. Frequency of meetings. Responsiveness to shareholder proxy votes. … 37 The agency problem Why does it arise? • Divergence of ownership and control • Managers’ goals differ from shareholders’ • Asymmetry of information. What are the consequences? • Shareholder wealth is no longer maximised. 38 Reading 3 CFA Corporate Finance, Level II, Reading 27 • Corporate governance: objectives and guiding principles • Corporate governance evaluation (board of directors) Internal regulations on corporate governance of VNM 39 Case 1: Divergence VS Concentration of Ownership Phương Xuân wants to expand her chain of fashion shop. She may borrow or sell 30% of her equity in the chain to raise fund. If Phương Xuân borrows fund (or sells equity ), $1 incremental income (or expense) from the shops will increase Phương Xuân’s income by how much? Predict Phương Xuân’s behavior in each case. 40 Case 2: Management Entrenchment Phương Xuân Corp. (100% equity) has $100 mil cash. Corporate tax rate 25%, personal tax rate 15%. Bank-deposit interest rate 5%. No investment opportunity is viable. Should Tuấn Bách, CEO of Phương Xuân Corp. keep this amount of cash to deposit it on a bank account or should he pay out the money to shareholders (by dividend)? 41 Case 2: Management Entrenchment Phương Xuân Corp. (100% equity) has $100 mil cash. Corporate tax rate 25%, personal tax rate 15%. Bank-deposit interest rate 5%. There is an investment opportunity. Before-tax cost of debt 8%, cost of equity 15%. Should Tuấn Bách consider the use of debt? 42 Case 3: Shareholders VS Debtholders Phương Xuân Limited Liability Company has a debt of 100 bil. on the balance sheet payable in one year. Value of all asset is now 80 bil. There is one investment opportunity available: Initial investment 50 bil. In one year there is a probability of 30% that the return is 100 bil (win). and 70% that the return is 0 (fail). Phương Xuân is the only owner and manager of the company. Phương Xuân owns a house whose value is 10 bil.. She also has a 10 bil bank deposit. 43 Case 3: Shareholders VS Debtholders 1. If Phuong Xuan decides not to invest. In one year, the value to Phuong Xuan and debtholders will be: a/ 80 bil and 20 bil b/ 100 bil and 0 bil c/ Other 2. If Phuong Xuan decides to invest and fail, in one year the value to Phuong Xuan and debtholders will be: a/ 100 bil and 0 bil b/ 80 bil and 20 bil c/ 50 bil and 0 bil d/ Other 44 Case 3: Shareholders VS Debtholders 3. If Phuong Xuan decides to invest and win. In one year, the value to Phuong Xuan and debtholders will be: a/ 100 bil and 0 bil b/ 80 bil and 20 bil c/ 100 bil and 50 bil d/ Other 4. If you were Phuong Xuan, what would you do? a/ Invest b/ Do not invest c/ Go America d/ Other 45 Case 4: Share Issues in Financial Distress Phương Xuân Limited Liability Company has a debt of 100 bil. on the balance sheet payable in one year. Value of all asset is now 40 bil. There is one investment opportunity available: Initial investment 50 bil. In one year there is a probability of 70% that the return is 100 bil (win). and 30% that the return is 0 (fail). Lenders refuse to lend. Phuong Xuan can only raise capital through equity issue. 46 Corporate governance and performance • • • • • • • • • • Duality Independence of board Board size Managerial ownership Institutional ownership State ownership Foreign Ownership Ownership concentration Block Shareholder ….. 47 • End of Chapter 1 48