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Introduction to Financial

Management

Arie Prasetyo
arieprasetyo@live.com

Financial Management DIV STAN 1


CLASS SCHEDULE
Class 1 : Introduction to Financial Management.
Class 2 : Financial Statement (Tax &Cash Flow) & Performance Evaluation
Class 3 : Financial Forecasting, Planning, and Budgeting
Class 4 : Time Value of Money
Class 5: Risk and Return
Class 6: Debt and Equity: Characteristics and Basic Valuation
Class 7: Capital Budgeting Decision Making
Class 8: Cash Flow and Other Capital Budgeting Issue
Class 9: Capital Budgeting, Risk Analysis and Cost of Capital
Class 10: Equity Valuation
Class 11: Raising Capital in Financial Market/ Leverage Analysis
Class 12: Capital Structure, Dividend Policy and Internal Financing
Class 13: Short-term Financing, WK Capital, Cash & Marketable Securities
Class 14: Receivable and Inventory Management
Class 15: Risk Management
Class 16: Term Loan and Leases 2
Class 1 : Introduction to Financial
Management

Definition of Financial Management


Corporations Ultimate Goal
Legal Structure of Corporation
Corporation and Financial Market
10 Axioms of Finance

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Financial Management DIV STAN
De#inition of Financial Management

4
Financial Management
Solomon,
It is concerned with the efficient use of an important economic resource namely,
capital funds

S.C. Kuchal
Financial Management deals with procurement of funds and their effective
utilization in the business

Howard and Upton


An application of general managerial principles to the area of financial decision-
making

Weston and Brigham


Area of financial decision-making, harmonizing individual motives and enterprise
goals

Joshep and Massie


The operational activity of a business that is responsible for obtaining and effectively
utilizing the funds necessary for efficient operations. 5
Common Element
Thus, Financial Management is mainly
concerned with
o Effective funds management in the business.
o Procurement of Funds
o Valuation

Financial Management
o Investment
o Corporate Finance

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Corporate Ultimate Goal

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7
1) Profit Maximization?
this goal ignores:

a) TIMING of Returns
(Time Value of Money)

b) UNCERTAINTY of Returns
(Risk)

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2) Shareholder Wealth Maximization?
this is the same as:

a) Maximizing Firm Value


b) Maximizing Stock Price

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Is stock price maximization the same as
prot maximization?
Generally high correlation amongst stock price, EPS,
and cash flow.
Current stock price relies upon current earnings, as well
as future earnings and cash flow.
Some actions may cause an increase in earnings, yet
cause the stock price to decrease (and vice versa).

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Financial Goals of the Corporation
The primary financial goal is shareholder wealth
maximization, which translates to maximizing
stock price.
o Do firms have any responsibilities to society at large?
o Is stock price maximization good or bad for society?
o Should firms behave ethically?

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Legal Structure of Corporation

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Alterna7ve Forms of Business Organiza7on

12
Alternative Forms of Business
Organization
Sole proprietorship
Partnership
Corporation

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Sole proprietorships & Partnerships
Advantages
o Ease of formation
o Subject to few regulations
Disadvantages
o Difficult to raise capital
o Unlimited liability
o Limited life

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Corporation
Advantages
o Unlimited life
o Easy transfer of ownership
o Limited liability
o Ease of raising capital
Disadvantages
o Double taxation
o Cost of set-up and report filing

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Role of Finance in a Typical
Business Organization
Board of Directors

President

VP: Sales VP: Finance VP: Operations

Treasurer Controller

Credit Manager Cost Accounting

Inventory Manager Financial Accounting

Capital Budgeting Director Tax Department

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Responsibility of the Financial Sta
Maximize stock value by:
o Forecasting and planning
o Investment and financing decisions
o Coordination and control
o Transactions in the financial markets
o Managing risk

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Corporation and Financial Market

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Financial Market
A market is a venue where goods and services are
exchanged.
A financial market is a place where individuals and
organizations wanting to borrow funds are brought
together with those having a surplus of funds.
The use of Financial Market
o Fischer Separation Theory

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Terms in Financial Market
Physical assets vs. Financial assets
Money vs. Capital
Primary vs. Secondary
Spot vs. Futures
Public vs. Private

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The Corporation and
Financial Markets

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The Corporation and
Financial Markets
Corporation

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The Corporation and
Financial Markets
Corporation Investors

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The Corporation and
Financial Markets
Corporation Investors

Government
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The Corporation and
Financial Markets
Corporation cash Investors

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Government
25
The Corporation and
Financial Markets
Corporation cash Investors
securities

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Government
26
The Corporation and
Financial Markets
Corporation cash Investors
securities

Secondary
markets

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Government
27
The Corporation and
Financial Markets
Corporation cash Investors
securities

Secondary
markets

Financial Management DIV STAN


Government
28
The Corporation and
Financial Markets
Corporation cash Investors
securities

Secondary
markets

Financial Management DIV STAN


Government
29
The Corporation and
Financial Markets
Corporation cash Investors
securities

Secondary
markets
Cash ow

Financial Management DIV STAN


Government
30
The Corporation and
Financial Markets
Corporation cash Investors
securities

Secondary
markets
Cash ow
tax

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Government
31
The Corporation and
Financial Markets
Corporation cash Investors
securities
reinvest
Secondary
markets
Cash ow
tax

Financial Management DIV STAN


Government
32
The Corporation and
Financial Markets
Corporation cash Investors
securities
reinvest
Secondary
markets
dividends,
Cash ow etc.

tax

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Government
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The Corporation and
Financial Markets
Primary Market

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The Corporation and
Financial Markets
Primary Market
oMarket in which new issues of a
security are sold to initial
buyers.

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The Corporation and
Financial Markets
Primary Market
oMarket in which new issues of a
security are sold to initial
buyers.
Secondary Market

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The Corporation and
Financial Markets
Primary Market
oMarket in which new issues of a
security are sold to initial
buyers.
Secondary Market
oMarket in which previously
issued securities are traded.

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The Corporation and
Financial Markets
Initial Public Offering (IPO)

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The Corporation and
Financial Markets
Initial Public Offering (IPO)
oThe first time the firms stock is
sold to the general public.

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The Corporation and
Financial Markets
Initial Public Offering (IPO)
oThe first time the firms stock is
sold to the general public.
Seasoned New Issue

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The Corporation and
Financial Markets
Initial Public Offering (IPO)
oThe first time the firm s stock is
sold to the general public.
Seasoned New Issue
oA new stock offering by a firm
that already has stock that is
traded in the secondary
market.
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10 Axioms of Finance
1. The risk-return trade-o
2. The 7me value of money
3. Cash- not prots- is king
4. Incremental cash ows

Financial Management DIV STAN


5. The curse of compe77ve markets
6. Ecient capital market
7. The agency problem
8. Taxes bias business decisions
9. All risk is not equal
10. Ethical behavior is doing the right thing, and ethical
dilemmas are everywhere in nance 42
#1 The risk-return trade-o

We wont take on additional risk unless we expect to


be compensated with additional return.

The greater the risk, the greater the expected return.

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#2 The time value of money

A dollar received today is worth more than a dollar


received in the future.

A dollar received today is worth more than a dollar


received tomorrow because a dollar received today
can earn a days interest by tomorrow.

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#3 Cash- not prots- is king

Accounting profit or loss frequently does not coincide


with the actual transfer of money.

The first rule of running any business: Do not run out of


cash.

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#4 Incremental cash ows

Its only what changes that counts.

Think incrementally. How will a decision change the


cash flow of the company?

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Basic Valuation Model
CF1 CF2 CFn
Value = 1
+ 2
++
(1 + k) (1 + k) (1 + k) n
n
CFt
= t
.
t =1 (1 + k)

To estimate an assets value, one estimates the cash flow for


each period t (CFt), the life of the asset (n), and the
appropriate discount rate (k)
Throughout the course, we discuss how to estimate the
inputs and how financial management is used to improve
them and thus maximize a firm s value.

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#5 The curse of competitive markets

Why its hard to find exceptionally profitable projects.


Success attracts competition.
Competition lowers profits.

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#6 Ecient capital market

The markets are quick and the prices are right.


Security prices adjust very quickly and appropriately
to new information.

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#7 The Agency Problem
An agency relationship exists whenever a principal
hires an agent to act on their behalf.

Managers wont work for owners unless its in their best


interest.

Within a corporation, agency relationships exist


between Shareholders and managers, and
Shareholders and creditors

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Shareholders versus Managers
Managers are naturally inclined to act in their own
best interests.
But the following factors affect managerial
behavior:

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Shareholders versus Creditors
Shareholders (through managers) could take
actions to maximize stock price that are detrimental
to creditors.
In the long run, such actions will raise the cost of
debt and ultimately lower stock price.

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#8 Taxes bias business decisions
Decisions using cash flows must always use after-tax
cash flows

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#9 All risk is not equal
Some risk can be diversified away
and some cannot.

Total risk is a combination of firm-specific risk, which


can be diversified away, and market risk, which
cannot be diversified away.

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#10 Ethical behavior is doing the right thing, and
ethical dilemmas are everywhere in nance

Businesses that are not trusted by other businesses or


by customers will not maximize the wealth of
stockholders.

Perhaps the primary goal of firms should address


stakeholders and not just stockholders.

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