Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder Prepared by Dr Buly Cardak 1–1 Chapter 1 Introduction

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder Prepared by Dr Buly Cardak 1–2 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 Prepared by Dr Buly Cardak 1–3 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 Prepared by Dr Buly Cardak 1–4 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 Prepared by Dr Buly Cardak 1–5 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 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 Prepared by Dr Buly Cardak 1–6 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 Prepared by Dr Buly Cardak 1–7 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 Prepared by Dr Buly Cardak 1–8 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 Prepared by Dr Buly Cardak 1–9 Basic Concepts of Finance Value – The value of a company (V ) on the financial markets may be expressed as: – 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 Prepared by Dr Buly Cardak 1–10 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 Prepared by Dr Buly Cardak 1–11 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 Prepared by Dr Buly Cardak 1–12 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 Prepared by Dr Buly Cardak 1–13 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 Prepared by Dr Buly Cardak 1–14 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 Prepared by Dr Buly Cardak 1–15 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 Prepared by Dr Buly Cardak 1–16 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.