Financial Management

FIN 512
Nadeem Aftab
Abu Dhabi University, Al Ain

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1-1

Introduction To Corporate
Finance

Chapter One

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Chapter Outline
1.
2.
3.
4.
5.

Corporate Finance and the Financial Manager

Forms of Business Organization
The Goal of Financial Management
The Agency Problem and Control of the
Corporation
Financial Markets and Institutions

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Corporate Finance
Some important questions that are answered using
finance
1. What long-term investments should the firm
take on? (lines of business, buildings,
machinery, equipments, )
2. Where will we get the long-term financing to
pay for the investment? (equity or debt)
3. How will we manage the everyday financial
activities of the firm? (collecting from
customers and paying suppliers)
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Financial Manager
Financial managers try to answer some or all of
these questions
The top financial manager within a firm is usually
the Chief Financial Officer (CFO)
Treasurer oversees cash management, capital
expenditures and financial planning
Controller oversees taxes, cost accounting,
financial accounting and data processing

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Financial Management
Decisions
Capital budgeting: the process of planning and
managing a firms long-term investments

What long-term investments or projects

should the business take on?
Evaluate the size, timing, and risk of future
CFs
An example: extend the activity, open a new
store, develop a new software, acquire license,

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Financial Management Decisions (contd)

Capital structure: the mixture of debt and
equity maintained by a firm
How should we pay for our assets?
Should we use debt or equity?
The mixture chosen will affect both the risk
and the value of the firm
If you have to decide, what will be the
chosen capital structure? Why?
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Financial Management Decisions (contd)

Working capital management: A firms short-term
assets and liabilities (ex. Inventory, money owed
to suppliers, )
How do we manage the day-to-day finances of
the firm?
Answer the following questions:
Should we sell on credit (what term and to
whom)?
Purchase on credit or borrow and pay cash?....
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Forms of Business
Organization
Three major forms
Sole proprietorship
Partnership
Corporation

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Sole Proprietorship
Advantages

Easiest to start
Least regulated
Single owner keeps all
the profits
Taxed once as personal
income

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Disadvantages

Unlimited liability
Limited to life of owner
Equity capital limited to
owners personal wealth
Difficult to sell
ownership interest

1.8

Partnership
Advantages

Two or more owners

More capital available
Relatively easy to start
Income taxed once as
personal income

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Disadvantages

Unlimited liability
Partnership dissolves
when one partner dies
or wishes to sell
Difficult to transfer
ownership

Corporation
Advantages

Limited liability
Unlimited life
Separation of ownership
and management
Transfer of ownership is
easy
Easier to raise capital

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Disadvantages

Separation of ownership
and management
Double taxation
(income is taxed at the
corporate rate and then
dividends are taxed at
the personal rate)

Goal Of Financial
Management
What should be the goal of a corporation?
Maximize profit?
Minimize costs?
Maximize market share?
Maximize the current value of the
companys stock?
Does this mean we should do anything and
everything to maximize owner wealth?
(illegal or unethical actions)
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Possible Goals of Financial

Management
1.
2.
3.
4.
5.
6.
7.

Survival
Avoid financial distress and bankruptcy
Beat the competition
Maximize sales or market share
Minimize costs
Maximize profits
Maintain steady earnings growth

The most important or popular goal of

financial management is to maximize
shareholders wealth.
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1-14

Agency Relationships
The agency relationship is the relationship
between the shareholders (owners) and the
management of a firm.
The agency problem is the possibility of
conflict of interests between these two parties.
Agency costs refer to the direct and indirect
costs arising from this conflict of interest.
This can be explained in terms of risk
appetite of the two parties.
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1-15

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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1-16

Alignment of Goals
The conflict of interests is limited due to:
1. Management compensation schemes
2. Monitoring of management
3. The threat of takeover
4. Other stakeholders.

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1-17

Financial Markets: The troika

Institutions

Markets

Com. Banks
Debt
Invest. banks
Capital
Stock
Money
Exchanges
Foreign Ex.
Insurance
Commodities
cos.
Derivatives
Venture
capitals
Mutual funds
Pension
funds
Primary vs. secondary markets.
Fund of funds
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Instruments
Cash
Bond
Stocks

Financial Markets and Corporations

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Example: Financial Markets

Financial markets bring together the buyers
and sellers of debt and equity securities.

Money markets
involve trading of
short-term debt
securities.
Primary markets
involve the original sale
of securities.

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Capital markets
involve trading of
long-term debt
securities.
Secondary
markets
involve the continual
buying and selling of
issued securities.

1-20

Structure of Financial Markets

F in a n c ia l M a r k e t s
M o n e y M a rk e t
P r im a r y M a r k e t

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S e c o n d a ry M a rk e t

C a p it a l M a r k e t
P r im a r y M a r k e t

S e c o n d a ry M a rk e t

1-21

Summary
You should know:
Basic Definitions
Three basic questions in financial
management
The advantages and disadvantages of
sole proprietorship, partnership and
corporation
The primary goal of the firm
What an agency relationship and cost are
The role of financial markets
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