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L01 - Topic 1

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L01 - Topic 1

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Ten Nine
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Chapter 1

Introduction

Copyright  2006 McGraw-Hill Australia Pty Ltd


PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 1–1
Prepared by Dr Buly Cardak
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 1–2
Prepared by Dr Buly Cardak
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 1–3
Prepared by Dr Buly Cardak
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 1–4
Prepared by Dr Buly Cardak
Business Structures
• Sole proprietorship
– Business owned by one person.

• Partnership
– Business owned by two or more people acting as partners.

• Company
– 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 1–5
Prepared by Dr Buly Cardak
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 1–6
Prepared by Dr Buly Cardak
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 1–7
Prepared by Dr Buly Cardak
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 1–8
Prepared by Dr Buly Cardak
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 1–9
Prepared by Dr Buly Cardak
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 1–10
Prepared by Dr Buly Cardak
Basic Concepts of Finance (cont.)
• Nominal and real amounts
– 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 1–11
Prepared by Dr Buly Cardak
Basic Concepts of Finance (cont.)
• Market efficiency and asset pricing
– 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 1–12
Prepared by Dr Buly Cardak
Basic Concepts of Finance (cont.)
• Arbitrage
– 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.

– 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 1–13
Prepared by Dr Buly Cardak
Basic Concepts of Finance (cont.)
• Agency relationships
– Where one party, the principal, delegates decision-
making 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 1–14
Prepared by Dr Buly Cardak
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.

– Reduced value due to managers acting in their own best


interests rather than in the interests of shareholders.

– 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 1–15
Prepared by Dr Buly Cardak
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 1–16
Prepared by Dr Buly Cardak

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