1. Finance and The Financial Manager
Chapter 1
Principles of
Corporate
Finance
Ninth Edition
Finance and The Financial Manager
McGraw Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved

2. Topics Covered What Is A Corporation?
The Role of The Financial Manager
Who Is The Financial Manager?
Separation of Ownership and Management

3. Personal tax on profits
Corporate Structure
Sole Proprietorships
Unlimited Liability
Personal tax on profits
Partnerships
Limited Liability
Corporate tax on profits +
Personal tax on dividends
Corporations

4. Finance Within the Organisation
Board of Directors
Chief Executive Officer (CEO)
Chief Operating Officer (COO)
Marketing, Production, Human Resources, and Other Operating Departments
Chief Financial Officer (CFO)
Accounting, Treasury, Credit, Legal, Capital Budgeting, and Investor Relations
1-4

5. Organizing a Business 4 4 4 4 5 4

6. What Is Finance? Finance is the study of managing money.
At the most basic level, this involves determining where to get money and what to do with it.
The Study of Markets and Institutions:
Markets:
The determination of interest rates, and how the market prices and distributes securities
Financial institutions:
Banks, the Federal Reserve (RBNZ), and finance companies increase the efficiency of financial transactions.

7. What Is Finance? (continued)
Investments:
How can dollars available today be turned into more dollars in the future?
Portfolios, diversification, risk-return tradeoff
Market prices
Corporate Finance:
Finance applied in a business setting
Evaluation of Long-Term Projects
Study of How to Acquire Funds
Analysing Firm Performance

8. Financial Market Functions
Source of funding
Investor liquidity
Risk management
Source of information

9. Role of The Financial Manager
(2) Cash invested in firm
(2)
(1) Cash raised from investors
(1)
Firm's
(4a) Cash reinvested
(4a)
Financial
Financial
manager
operations
markets
(3) Cash generated by operations
(3)
(4b) Cash returned to investors
(4b)

10. Role of The Financial Manager
Common Finance Terminology
Real assets
Financial assets / Securities
Capital markets and financial markets
Investment / capital budgeting
Financing

11. Who is The Financial Manager?
Chief Financial Officer
Treasurer
Controller

12. Ownership vs. Management
Difference in Information
Stock prices and returns
Issues of shares and other securities
Dividends
Financing
Different Objectives
Managers vs. stockholders
Top mgmt vs. operating mgmt
Stockholders vs. banks and lenders

13. Should the Financial Manager Maximise Profits?
Not necessarily—this may result in:
1. Short-run decision making
2. Ignoring risk
3. Ignoring the timing of cash flows

14. Stock Prices and Shareholder Value
The primary financial goal of management is shareholder wealth maximisation, which means maximising stock price.
Value of any asset is present value of the cash flow stream to owners.
Most significant decisions are evaluated in terms of their financial consequences.
Stock prices change over time as conditions change and as investors obtain new information about a company’s prospects.
Managers have an obligation to behave ethically
Share price depends on cash flows a “marginal” investor expects to receive
Good decisions – share price increases: bad decisions oppposite effect
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15. Determinants of Intrinsic (True) Values and Stock Prices
Managerial Actions, the Economic Environment, Taxes, and the Political Climate
“True” Investor Returns
“True” Risk
“Perceived” Investor Returns
“Perceived” Risk
Stock’s Intrinsic Value
Stock’s Market Price
Market Equilibrium: Intrinsic Value = Stock Price
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16. Stock Prices and True Value
In equilibrium, a stock’s price should equal its “true” or intrinsic value.
It reflects the long-term value of the business
To the extent that investor perceptions are wrong, a stock’s price in the short run may be different to its true value.
Ideally, managers should avoid actions that reduce true value, even if those decisions increase the stock price in the short run.
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17. Some Important Business Trends
Recent corporate scandals have reinforced the importance of business ethics, and have spurred additional regulations and corporate oversight.
Increased globalisation of business.
The effects of ever-improving information technology have had a profound effect on all aspects of business finance.
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18. Managers will not always maximise stockholders’ wealth because of:
Agency Costs
The financial interests of the manager may be different to those of the shareholders
Costs of meeting legislative requirements aimed at protecting shareholders
Social Conscience
The judgements of the manager on social issues may be different to those of the shareholders

19. Conflicts Between Managers and Stockholders
Managers are naturally inclined to act in their own best interests (which are not always the same as the interest of stockholders).
But the following factors affect managerial behavior:
Managerial compensation (pay) packages
Direct intervention by shareholders
The threat of firing
The threat of takeover
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20. Conflicts Between Stockholders and Bondholders
Stockholders are more likely to prefer riskier projects, because they receive more of the upside if the project succeeds. By contrast, bondholders receiving fixed payments are more interested in limiting risk.
Bondholders are particularly concerned about the use of additional debt.
Bondholders attempt to protect themselves by including covenants in bond agreements that limit the use of additional debt and constrain managers’ actions.
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21. Five Key Concepts of Finance
Greater returns require taking greater risks
Good deals disappear fast
Time value of money
Cash flows determine value
Information is not freely available to all

22. Five Key Concepts of Finance
Greater returns:
require taking greater risks
when an investor buys a risky security, the required expected return is high over the long term .
the actual return over any period may be equal to the expected return, or it may be more, or it may be less.

23. Five Key Concepts of Finance (cont)

24. Five Key Concepts of Finance (cont)
Good deals disappear fast (also known as the “Theory of Efficient Markets” )
As new information becomes available to investors, security prices will adjust so that the return to investors is fair
If financial markets are efficient, the price of a security is an accurate estimate by the market of its true value.

25. Five Key Concepts of Finance (cont)
3. The value of money:
depends upon when it is received
A dollar received today is worth more than a dollar received in the future.

26. Five Key Concepts of Finance (cont)
Cash flows determine value
Cash flows are what investors can invest and firms can use to pay dividends
Accounting earnings (or profits) are not cash – they can be manipulated, and may never be converted into cash e.g. Bad debts

27. Five Key Concepts of Finance (cont)
Information is not freely available to all
Asymmetric information is the difference in the information set held by different participants in the financial marketplace
Investors may not know what the firm’s insiders know.
A bank may not know what a borrower plans to do with a loan.
An insurance agent may not know how well an insured person will act to protect against loss

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