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Topic 1

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Đinh Trọng Khải Nguyên
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BU5201: Business Finance

Topic 1: Overview of Business Finance

Dr. James Kwan


PhD Finance (UWA), MBA (Strathclyde), MBA Investment & Finance (Hull),
MSc Applied Positive Psychology and Coaching Psychology (UEL), MBR (UWA),
MSc Educational Assessment (Oxford), MSc Digital Education (Edinburgh),
MRes (Lancaster), MSc Marketing (KCL), BAcc (NTU), FCA Singapore, ASEAN CPA,
FCPA (Australia), FAIA (Acad), FHEA, AMA (Aust), SDALT, BokTC (Harvard), ACTA
What is Business Finance?
•Business finance attempts to find the answers to the
following questions:

• What investments should the business take on?


THE INVESTMENT DECISION

• How can finance be obtained to pay for the required


investments?
THE FINANCE DECISION

• Should dividends be paid? If so, how much?


THE DIVIDEND DECISION

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The Investment Decision
•Capital budgeting is the planning and managing
of a firm’s investment in non-current assets.
• Determine the asset profile of a business
• Single projects & Portfolios

•Involves evaluating the:


• size of future cash flows
• timing of future cash flows
• risk to future cash flows.

3
Cash Flow Size

•Accounting income does not mean cash flow.

•For example, a sale is recorded at the time of sale,


and a cost is recorded when it is incurred, not
when the cash is exchanged.

4
Cash Flow Timing

•A dollar today is worth more than a dollar at some


future date.

•There is a trade-off between the size of an


investment’s cash flow, and when the cash flow is
received.

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Cash Flow Timing
• Which is the better project?

Future Cash Flows

Year Project A Project B

1 $0 $200 000

2 $100 000 $100 000

3 $200 000 $0

Total $300 000 $300 000

6
Cash Flow Risk

•The role of the financial manager is to deal with


the uncertainty associated with investment
decisions.

•Assessing the risk associated with the size and


timing of expected future cash flows is critical to
investment decisions.

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Cash Flow Risk

• Which is the better project?

Future Cash Flows

Pessimistic Expected Optimistic

$150 000 x $200 000 x $250 000 x


Project 1 0.2 0.5 0.3
= $30,000 = $100,000 = $75,000
$250 000 x $350 000 x
$50 000 x 0.2
Project 2 0.5 0.3
= $10,000
=$125,000 = $105,000

8
Capital Structure and Financing Decision

•A firm’s capital structure is the specific mix of debt and


equity maintained by the firm.
•Decisions need to be made on both the financing mix,
and how and where to raise the money.
• Dividend decision is part of financing decision
•Involves the decision of whether to pay a dividend to
shareholders or maintain the funds within the firm for internal
growth.
•Factors important to this decision include growth
opportunities, taxation and shareholders’ preferences.

9
Working Capital Management

•How much cash and inventory should be kept on hand?

•Should credit terms be extended? If so, what are the


conditions?

•How is short-term financing acquired?

10
Financial Management Tools
Tools needed to make investment/financing
decisions, ie. decide whether benefits > costs
•time value of money (TVM) / fin. Maths
•apply TVM to value real assets
•definitions of & calculation of risk
•understand features of financing alternatives
and apply TVM to determine value
•determining appropriate cost of capital

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Financial objective of business

Value = market value of debt


+ market value of equity
12
The Firm’s Objective

•The goal of financial management is to maximise


shareholders’ wealth.

•Shareholders’ wealth can be measured as the current


value per share of existing shares.

•This goal overcomes the problems encountered with


the goals outlined above.

13
Determining Value
• Fin markets will value debt & equity, taking into account the
expected cash flows & risk from investing in those securities

•SO
• VALUE depends on CASH FLOWS
•size
•timing
•risk

14
Determining value
– size & timing of CFs

• Time value of money: a dollar to-day is worth more than a


dollar in the future
• Due to inflation, purchasing power of money changes
• Funds can be invested to get a positive return

15
Determining value – risk of CFs
• Risk is equivalent to uncertainty, ie. the actual outcome may not equal
the expected outcome.
• Two broad categories of risk:
•Systematic risk: market wide factors
•Unsystematic risk: factor specific to a Co.
• Investors can diversify their investments to eliminate unsystematic risk
• Investors require higher returns to compensate them for higher
systematic risk

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NOT acceptable primary objectives

• Maximise size

• Maximise sales

• Maximise profit

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Goal of the firm- Max. wealth
Wealth maximisation - Economic value added (EVA)

(Source: Gitman et al., Principles of Managerial Finance, 2011, 6th ed, Pearson) 18
Agency relationships

• One party, the principal, delegates decision making authority


to another party, the agent

• In a company:
• Shareholders = principals
• Managers = agents

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Agency problems

• Conflict - manager vs shareholder wealth


• Agency costs  s/h wealth not maximized
• Aligning objectives
• monitoring
• compensation
• competition for control

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Do Managers Act in Shareholders’ Interests?

•The answer to this will depend on two factors:

•how closely management goals are aligned with


shareholder goals.

•the ease with which management can be replaced if it


does not act in shareholders’ best interests.

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