1. Introduction
Chapter 1

2. What is finance?
Finance is the study and practice of making investments.
An investment is anything that requires forgoing
present consumption in exchange for hopefully higher future consumption.
Investments can be:
Short-term
Long-term

3. Real and Financial Assets
Two types of investments:
Real assets
Financial assets
Who makes these investments?
Real assets (operating investment or business investment) are:
Corporations
Government
Financial assets are:
Individuals

4. Four Fundamental Questions
What are the tree or four principal questions associated with any investments?
Retrospective
Prospective 1 2 3 4

5. Four Fundamental Questions
What are the tree or four principal questions associated with any investments?
Retrospective
Prospective 1
Expenditure 2
Return realized
Expected return 3
Risk 4
Was it a good investment?
Is this a good investment?

6. Real Asset Real Asset: an asset that has two defining characteristics:
Is not created by legal contract between specific individuals
Some operation is required to produce a return
Examples:

7. Financial Asset
Financial Asset - a legal contract between specific individuals
whereby one party promises to make future payments to the other (typically in exchange for immediate cash).
Payments are often contingent.
For a financial asset, no operation is generally required to receive a return.
Examples:
Mortgage
Common share

8. Financial Asset
The individual who makes the promised future payments is called:
seller of the FA
writer of the FA
issuer of the FA
short position
The individual who receives the payment is called:
owner of the FA
holder of the FA
investor
long position

9. The Corporate Organizational Form
Why corporations are so successful in terms of business activity compared to alternatives (sole proprietorship, partnerships)?
Legal identity of a corporation
Limited liability for shareholders
Tax advantages (deferral)
Separation of ownership (shareholders) and control (management)
Unlimited life

10. The Corporate Organizational Form
Disadvantages of the corporate organizational form?
Shareholders are not entitled to private corporate information
Agency problem
Solution for the Principal-Agent problem:
Managerial compensation plan (bonuses, stock options) that ties managers and shareholders interests together
Managerial labor market

11. The Objectives of Corporate Business Activity
The Canadian Business Corporation Act describes the duties of directors of corporations as “managing the business and affairs of a corporation.” This directive is often interpreted with-respect-to financial management to the maximization of shareholders’ wealth. Wealth is the amount receivable from an asset upon actual or hypothetical sale. Therefore, an interpretation of objective of firms in their operation is maximization of the sale price of a firm upon hypothetical sale (for a private corporation) or maximization of share-price of a public corporation.

12. Measuring Wealth Creation
The increment to corporate/shareholders’ wealth from an investment by a firm is often represented as the Net-Present- Value of the investment.
Value of an investment = Net present value (NPV) =
= Discounted cash flow analysis (DCF)
Three fundamental inputs to any NPV problem:
Timing of cash flows
Amount of predicted cash flows
Discounted factor/opportunity cost
The opportunity cost is the rate-of-return that financial asset holder could earn on financial assets that have risk approximately the same as the investment considered.

13. NPV example Business investment:
Invest $300,000 now to generate $70,000 per annum indefinitely starting in 1 year.
Opportunity cost: rate of return for shareholders 7% per annum.
4 Questions:
Expenditure -
Risk –
Return –
Is this a good investment?
Internal Rate of Return (IRR) – hypothetical discount rate that makes NPV equal to zero.

14. The Finance vs. Accounting Perspective
Assumptions:
This corporation has only one business investment
Business investment is a proprietary idea
Business investment is not yet financed, but will be financed with equity
No prior transactions for this business
Public corporation

15. The Finance vs. Accounting Perspective
Before Financing and Capital Expenditure
After Financing and Capital Expenditure
Accounting
Balance Sheet
Financial (Market Value)
Balance Sheet
NPV = $700,000
Accounting
Balance Sheet
300,000
Financial (Market Value)
Balance Sheet
PV = $1,000,000

16. Market to Book Ratio
Market to Book = Value to Expenditure = Price to Book =