Fundamentals of Business Finance (Autumn 2013)
University of Technology, Sydney
Chapter One: Introduction to Financial Management
1) Financial Management in the real world: Corporate executive compensation
Compensation of corporate executives in the United States of America continues to be
a red hot issue. It is viewed that CEO pay has grown to extravagant levels when
compared to average weekly earnings of the ordinary worker.
Government involvement in corporate compensation became the norm after the
Global Financial Crisis. In early 2009, in the midst of a severe financial crisis, the
Obama administration announced a cap of $500, 000 on executive compensation for
companies that received bailout funds from the federal government.
1.1 What is Finance and how is it different from Economics and Accounting?
Finance is the science of money management in capital and financial markets. It
involves understanding how to get it, how to spend it and how to manage it.
Accounting is the language of business that records transactions and analyses
financial statements. In Economics you are concerned with real asset management to
maximise utility for businesses, households and governments.
1.2 What functions does a Chief Financial Officer do?
“The Chief Financial Officer is the senior manager responsible for overseeing the
financial activities of an entire company. The CFO's duties include financial planning
and monitoring cash flow. He or she analyses the company's financial strengths and
weaknesses and suggests plans for improvement. The CFO is similar to a treasurer or
controller in that he or she is responsible for overseeing the accounting and finance
departments and for ensuring that the company's financial reports are accurate and
completed on time.
The CFO reports to the president, but has a major say in the company's capital
structure, investments and how the company manages its income and expenses. The
CFO works closely with other executives and plays a major role in any company's
success, especially in the long run. Becoming a CFO requires extensive financial
management experience as well as educational credentials in finance and/or
accounting.”
Source: Investopedia.com
1.3 What does the study of Finance involve?
A) Financial Management- = Corporate Finance = Business Finance. It involves
managing the finances of the business.
B) Financial Economics: The study of the Financial System i.e.
i)
Financial Markets (capital markets or money markets)
ii)
Financial Institutions (Banking or Non banking institutions)
iii)
Financial Instruments (Stocks, bonds, derivatives and currencies)
C) Investments – purchase of financial instruments to get returns (Capital Gain,
Interest and Rent):
i)
Security analysis- determining the fundamental value or intrinsic value of
financial instruments.
ii)
Portfolio theory- subject of how to construct a mix of financial instruments
i.e. more than one stock or one bond.
iii)
Market analysis- analysing financial markets like the stock market and
macro economy.
iv)
Behavioural Investment analysis- applied psychology to financial
instrumental investments.
D) Personal Finance
E) Public Finance
F) International Finance- financial managers need to be familiar with exchange
rates and geo-political risk.
1.4 What are the key Financial Decisions?
A) Capital budgeting- managing a firm’s long term investments e.g. expanding
plant and expanding the product range offered to the market.
B) Capital structure- mix of debt and shareholders’ / owners’ equity e.g. issuing
new shares and having capital raisings that can be used to retire debt.
C) Working Capital Management- short term assets and liabilities of a firm e.g.
modifying customer credit collection policies i.e. accounts receivable (asset).
1.5 What are the forms of Business Organisations?
1.6 What is the goal of Financial Management?
Maximizing shareholder wealth is a financial manager’s goal.
Maximizing profits can be achieved in a number of ways.
This (incorrect) goal also ignores cash flow, timing and risk.
2) Financial Management in the real world: Corporate Law and Ethics
Large corporations are sometimes guilty of illegal and unethical behaviour. Often this
illegal behaviour takes the form of misleading and deceptive financial statements. In
one of the largest corporate fraud cases in history, energy giant Enron Corporation
was forced to file for bankruptcy in December 2001 amid allegations that the
company’s financial statements were deliberately misleading and deceptive. Enron’s
bankruptcy not only destroyed that company, but its auditor Arthur Andersen as well.
1.7 What is the Agency Problem?
It is defined as the possibility of conflict of interest between the owners and
management of a firm.
Stakeholder- someone other than a stockholder or creditor who potentially has a claim
on the cash flows of the firm.
Quick Quiz 2
1. What are the major areas in finance?
2. Besides wanting to pass this subject, why do you need to
understand finance?
3. What is the capital budgeting decision?
Critical Thinking and Concepts Review Chapter 1
1.1 The Financial Management Decision Process. What are the three types of
financial decisions? For each type of decision, give an example of a business
transaction that would be relevant.
1.2 Sole Proprietorships, Partnerships and Corporations. What are the four
primary disadvantages to the sole proprietorship and partnership forms of business
organisation? What benefits are there to these types of business organisations as
opposed to the corporate form?
1.3 Corporations
Chapter Two: Financial Statements, Taxes and Cash flow
2.1 The Balance Sheet
The Balance Sheet is the financial statement showing a firm’s accounting value on a
particular date.
Chapter four: the Time Value of Money
1) Financial Management in the real world
On March 2012, Audi Motor Credit Corporation (AMCC), a subsidiary of Audi
Motor, offered some financial securities for sale to the public. Under the terms of the
contract, AMCC
Simple Interest
Interest paid only on the principal.
A quick method of calculating the interest charge on a loan; simple interest
is determined by multiplying the interest rate by the principal (Present value) by the
number of periods.
Where:
P is the loan amount
I is the interest rate
N is the duration of the loan, using number of periods
Simple interest is called simple because it ignores the effects of compounding. The
interest charge is always based on the original principal, so interest on interest is not
included. This method may be used to find the interest charge for short-term
loans, where ignoring compounding is less of an issue.
Below are the formulas for Future Value Simple Interest (FVSI) and Present Value
Simple Interest (PVSI).
Discount rate
Noun
1.
The minimum interest rate set by the Reserve Bank of Australia for lending to
other banks.
2.
A rate used for discounting bills of exchange.
PV is the present value - also known as present discounted value the future amount of
money that has been discounted to reflect its current value, as if it existed today. The present
value is always less than or equal to the future value because money has interest-earning
potential, a characteristic referred to as the time value of money[1]. Time value can be
described with the simplified phrase, “A dollar today is worth more than a dollar tomorrow”.
Here, 'worth more' means that its value is greater. A dollar today is worth more than a dollar
tomorrow because the dollar can be invested and earn a day's worth of interest, making the
total accumulate to a value more than a dollar by tomorrow. Interest can be compared to
rent[2]. Just as rent is paid to a landlord by a tenant, without the ownership of the asset being
transferred, interest is paid to a lender by a borrower who gains access to the money for a
time before paying it back. By letting the borrower have access to the money, the lender has
sacrificed their authority over the money, and is compensated for it in the form of interest. The
initial amount of the borrowed funds (the present value) is less than the total amount of
money paid to the lender.
Present value calculations, and similarly future value calculations, are used to evaluate loans,
mortgages, annuities, sinking funds, perpetuities, and more.
Practice Questions
1. A) Sath invests $200, 000 over three years (2010-2013) at 10 per
cent simple interest.
PV = $200 000
I = 0.10
N=3
FVSI= PV+ (PV * i* n)
FVSI= 200 000 + (200 000 * 0.1* 3)
=$260,000
Compound Interest
Compound interest is earning interest on interest with a changing principal.