Lecture 1 SFM

Introduction

IMSciences-Peshawar 05/01/17
What is in todays lecture?

Introducti
on to SFM

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What is finance?
Corporate finance is an area of finance dealing
with financial decisions business enterprises make
and the tools and analysis used to make these
decisions (wikipedia.com)
Corporate Financial Management deals with the
decisions of a firm related to investment, financing
and dividend (Veshvanath)
To carry on business, a firm invests in tangible
assets like plant and machinery, buildings, and
intangible assets like goodwill and patents. This
comprises the investment decision
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 These assets dont come free; one has to pay for
them, so a company needs to tap various sources of
funds including shares, bonds, bank loans. This
forms the financing decision

The investment in assets generates revenues and

cash flows for a specific period of time. The
managers of the company can either retain cash
with the company for further investment or
distribute to the owners of the companythe
shareholders. This constitutes the dividend decision

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 In short, a finance manager will be concerned with such
financial decisions as:
Which investment/s should the company accept and what are
the financial implications of undertaking the same?

How should the company finance those investments? What

should be the mix of owners contribution equity and
borrowed funds, i.e., debt at any given point in time?

How much of the income generated from operations should be

returned to shareholders in the form of dividends and how
much is to be retained for further investment?

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Financial decisions: Time perspective
Capital investment decisions are long-term
choices about which projects receive investment,
whether to finance that investment with equity or
debt, and when or whether to pay dividends to
shareholders

On the other hand, the short term decisions can be

grouped under the heading "Working capital
management".

This subject deals with the short-term balance of

current assets and current liabilities;
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 The focus here is on managing cash,
inventories, and short-term borrowing and
lending (such as the terms on credit extended
to customers).

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Objective of financial managers
Corporate Finance theoreticians generally agree
that the objective of a firm is to maximize wealth
Whose wealth? whether it should be the wealth of
shareholders or the wealth of the firm, which
includes bondholders and preferred stockholders

Shareholder wealth maximization rule requires

managers to work towards a sustainable increase
in the price of the firms stock

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 Alternative to the above rule is to maximize
profit, social value, or growth of the firm
The underlying assumption is that, an increase in
any of these proxies results in an increase in the
value of the firm (alternatively, shareholder value)

Maximize Profit? Increase sales, suppress

expenses, extract the last rupee from the customer,
pay the lowest possible price to suppliers, pay less
salaries to employees,
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 Can social responsibility be an objective?
Businessmen are supposed to be socially
responsible
But social welfare activities have conceptual
propblems? What is right or wrong, how much to
spend on social responsibility? Moreover, what
was considered moral 30 years ago could be
immoral now?

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 Can growth be an objective of a firm?
Business in pakistan, india and south Korea are
dominated by family groups, and conglomerates.
Businesses groups in south Korea are called
chaebol, typically own 3050 companies in all
key business areas; and the big fiveDaewoo,
Samsung, Hyundai, LG, and SKaccount for 20
percent of all borrowing and contribute to almost
50 percent of GDP

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 Debt ratios at the top 30 chaebol are in the range
of 550 percent; they suck up a major portion of
the available credit and drive out smaller
businesses
The chaebol understand only one language:
borrow to the hilt; focus on size and not profit;
focus on growth and not productivity; invest
aggressively and acquire companies
Productivity in South Korea is about half that of
US levels

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 When earnings fall due to recession, competition,
or some such thing, these companies will default
on borrowings
To summarize, growth, though important, need
not necessarily lead to an increase in shareholder
value

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 Do Firms Pursue Multiple Objectives?
In a survey of management views on alternative
objectives, Porwal5 found in his sample that in 67
percent companieswith high profitabilitythe
first preference is given to the objective of
maximizing percent ROI and, in 33 percent
companies, the first preference is given to the
objective of maximizing aggregate earnings

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Impediments to shareholder wealth maximization

There could be potential conflict of interest

between shareholders and bondholders, managers
and shareholders, majority and minority
shareholders. So, maximizing wealth of one group
could be achieved at the expense of other groups
Shareholders vs Bondholders
Managers vs Shareholders
Shareholder vs Shareholder

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Conclusion
The objective of a firm should not be to make a
profit or even maximize profit, increase market
share or sales, but to maximize shareholders
wealth
But this should not be achieved at the expense of
other investor groups
Financial markets are efficient to some extent,
they can see whether a firm is adding value or not;
this will be reflected in the share price of the firm

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What is strategic financial management
The identification of the possible strategies
capable of maximizing an organization's net
present value, the allocation of scarce capital
resources among the competing opportunities, and
the implementation and monitoring of the chosen
strategy so as to achieve stated objectives

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