Chapter 1
Introduction
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–1
Learning Objectives
•
Identify the major types of business entity.
•
Explain the role of the financial manager.
•
Specify the objective that is necessary to ensure
the financial manager makes rational investment
and financing decisions.
•
Identify the major financial decisions made by the
managers of business entities.
•
Identify and explain the basic concepts of finance.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–2
The Nature of Business Finance
•
Broad aspects of finance
–
–
–
•
Corporate finance: the financial management
of companies.
Financial institutions and markets.
Investments.
Focus is mainly on corporate finance, but also
considers financial institutions and markets,
and investments.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–3
Financial Decisions
•
Major financial decisions are:
–
–
•
Investment decisions — decisions that determine the
asset profile of a business (amount and composition
of investments).
Financing decisions — how the assets are to be funded
(debt and equity). Financing decisions also involve
dividend decisions.
Ultimate objective of investment and financing
decisions is to maximise the owners’ wealth.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–4
Business Structures
•
Sole proprietorship
–
•
Partnership
–
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Business owned by two or more people acting as partners.
Company
–
•
Business owned by one person.
Separate legal entity formed under the Corporations
Act 2001.
Focus is on financial decision making by managers
of public companies.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–5
The Finance Function: Major Roles of
Financial Managers
• Project evaluation.
• Dividend and share repurchase decisions.
• Dividend distributions.
• Collection and custody of cash and payment
of bills.
• Management of investments in current assets.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–6
The Finance Function: Major Roles of
Financial Managers (cont.)
• Assessing the viability of growth through
acquisitions.
• Planning the future development of the business.
• Interest rate and exchange rate risk management.
• Development and implementation of
financial policies.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–7
A Company’s Financial Objective
•
In order to study the behaviour of financial
managers and understand their decisions,
we need to understand the objective of their
decision making.
•
The maximisation of market value of a company’s
shares is the overriding objective.
•
We are able to rationalise theories and important
results in finance by appealing to this ultimate
objective of financial decision makers.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–8
Basic Concepts of Finance
•
Value
–
The value of a company (V ) on the financial markets may
be expressed as:
V  DE
where D  the value of debt
E  the value of equity
–
Financial markets will value debt and equity, taking into
account the risk and expected return from investing in
these securities.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–9
Basic Concepts of Finance (cont.)
•
Time and uncertainty
–
The value of an investment will depend on the amount
and timing of the cash flows generated by the investment.
–
Time value of money: a dollar today is worth more than
a dollar in the future.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–10
Basic Concepts of Finance (cont.)
•
Nominal and real amounts
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The cost of an asset expressed as the number of dollars
paid to acquire the asset is the nominal price.
–
However, due to inflation and deflation, the purchasing
power of money changes.
–
Therefore, it is necessary to distinguish between the
‘nominal’ or ‘face’ value of money and the ‘real’ or
‘inflation-adjusted’ value of money.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–11
Basic Concepts of Finance (cont.)
•
Market efficiency and asset pricing
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Market efficiency means that we should expect securities
and other assets to be fairly priced, given their expected
risks and returns.
–
Trade-off between risk and expected return under the
capital asset pricing model (CAPM):
Systematic risk — market-wide factors (non-diversifiable or
market risk).
 Unsystematic risk — factors that are specific to a particular
company (diversifiable or unique risk).

–
According to the CAPM, investors can diversify their
investments to eliminate unsystematic risk.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–12
Basic Concepts of Finance (cont.)
•
Arbitrage
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If two identical assets were to trade in the same market
at the same time at different prices, and if there were no
transaction costs, then an arbitrage opportunity would exist.
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A risk-free profit could be made by simultaneously
purchasing at the lower price and selling at the higher price.
–
However, competition among traders will force the two
alternative prices to become the same.
–
Arbitrage precludes perfect substitutes from selling at
different prices in the same market.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–13
Basic Concepts of Finance (cont.)
•
Agency relationships
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Where one party, the principal, delegates decisionmaking authority to another party, the agent.
–
In a company setting:
 The agents are usually managers.
 The principals are usually shareholders.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–14
Basic Concepts of Finance (Cont.)
•
Agency relationships (cont.)
–
Agency costs reflect the fact that there is a conflict of
interest between the principal and agent.
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Reduced value due to managers acting in their own best
interests rather than in the interests of shareholders.
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Costs associated with monitoring managers’ behaviour
to ensure their actions are consistent with shareholders’
interests.
–
Bonding costs: costs of incentive and remuneration
schemes that align the interests of managers with those
of shareholders.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–15
Summary
•
Business entities include sole proprietorships,
partnerships and companies. We focus on public
companies.
•
We study corporate finance, along with investments
and the structure of financial markets and
institutions.
•
We consider broad finance issues such as
valuations, market efficiency, asset pricing
and arbitrage, along with agency issues.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder
Prepared by Dr Buly Cardak
1–16