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FINANCIAL MANAGEMENT

THE SCOPE CORPORATE FINANCE

What is Corporate Finance?

The activities involved in managing cash flows in a business environment The goal of financial management is to maximize the current value per share of existing stock

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The Five Basic Corporate Finance Functions

Financing: raising capital. a c a management a age e t: managing a ag g a firms s day day Financial to-day cash flows. Capital budgeting: selecting the best projects in which to invest the firms resources. Risk management: managing the firms exposure to risk in order to maintain the optimum risk risk-return return trade-off and maximize shareholder value. Corporate governance: refers to the set of systems, principles and processes by which a company is governed

The Financing Function

Businesses can raise money in 2 ways:

Externally from investors or creditors

Venture capital Initial public offering (IPO) Money market Long-term term debt Long Internally by retaining operating cash flows Most common method.

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Raising Capital: Key Facts

Most financing from internal rather than external t l sources. Most external financing is debt. Primary vs. secondary market transactions or offerings. Financial intermediaries declining as a source of capital for large firms. Securities markets growing in importance.

The Financial Management Function

Managing daily d l cash h inflows fl and d outflows fl Forecasting cash balances Building a long-term financial plan Choosing the right mix of debt and equity

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The Capital Budgeting Function

The capital budgeting process consists of three steps. steps Step 1 - Identifying potential investments Step 2 - Analyzing those investments to identify which will create shareholder value Step 3 - Implementing and monitoring the investments selected in Step 2

The Risk Management Function

Identifying, measuring, and managing all types of risk exposures Some risks are insurable, and some risks can be reduced through diversification. Financial instruments like forwards, futures, options, and swaps may also be used to hedge market risks such as interest-rate, price, and currency fluctuations.

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The Corporate Governance Function

Hires and promotes qualified, honest people, and structures employees l financial fi i l incentives i i to motivate them to maximize firm value In practice the incentives of stockholders, g , and other stakeholders often conflict. managers,

The Core Principles of Finance

The time value of money The opportunity to earn a return on invested funds means that a dollar today is worth more than a dollar in the future. Compensation for risk Investors expect compensation for bearing risk.

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The Core Principles of Finance

Dont put all your eggs in one basket. Investors can achieve a more favorable trade off between risk and return by diversifying their portfolios. Markets are smart. Competition for information tends to make markets efficient. No arbitrage Risk-free money-making opportunities are extremely scarce.

What Should a Financial Manager Try to Maximize?

Maximize Profit? Earnings E i per share h are backward-looking, b k d l ki dependent on accounting principles Does not fully consider cash flow timing Ignores risk Maximize Shareholder Wealth? Maximize stock price, not profits Shareholders, as residual claimants, have better incentives to maximize firm value.

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THETIMEVALUEOFMONEY
Money earns interest over time Money therefore has a time value The sooner money is received, the greater value is its

The Role of Financial Markets

Voluntary transfer of wealth Between individuals Financial intermediaries Across time Future value Present value The chance to earn a return on invested funds means a dollar today is worth more than a dollar in the future

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Future Value
The Value of a Lump Sum or Stream of Cash Payments at a Future Point in Time
FV = PV * (1 + r ) n n

where: r is the interest rate per period n is the time that money remains invested PV is the value at the beginning of the period

COMPOUNDINTEREST
FutureValueofaLumpSum
EXAMPLE: If you deposit $256 at an 8% interest rate, how much can you withdraw in 1 year, 2 years, 16 years?

FV1 = 256 + 256(0.08) = 276.48 FV2 = 256(1 + .08) 2 = 298.60 FV16 = 256(1 + .08)16 = 877.03

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The Power Of Compound Interest

Future Value
Two key points: 1. The higher the interest rate, the higher the future value. 2. The longer the period of time, the higher the future value.

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Present Value
Compounding: Finding d the h future f value l of f present dollars d ll invested d at a given rate Discounting: Finding the present value of a future amount, amount assuming an opportunity to earn a given return (r),

on the money

Present Value
Today'sValueofaLumpSumorStreamofCash PaymentsReceivedataFuturePointinTime

FV

= PV * (1 + r ) n

PV

FV n (1 + r ) n

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Present Value
EXAMPLE: You expect to receive $100 in ONE year. If you can invest at 10%, y , what is it worth today? y PV=100/(1+.1)= 90.90 You expect to receive $100 in EIGHT years. If you can invest at 10%, what is it worth today

PV = 100 /(1 + .1)8 = 46.65

Present Value of $1 Discounted at Different Interest Rates

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FV of a Mixed Cash Flow Stream

FV of a Mixed Cash Flow Stream

CF:thecashflowattheandofyeart
FV = CF 1+ r)n1 + CF 1+ r)n2 +...+ CF 1+ r)nn 1 *( 2 *( n *( Or
nt FV = CF t * (1+ r) t =1 n

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FV of Annuities

FV of Annuities
FV of an ordinary annuity:

PMT: the annuitys annual payment

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EX:FV of a 5-Year Ordinary Annuity of $1,000 Per Year Invested at 7%

FV of Annuities
FV of an annuity due :

PMT: the annuitys annual payment

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EX:FVofa5YearAnnuityDueof$1,000Per YearInvestedat7%

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