Financial Management

Tutorial 1

Tutorial NPV 1
 Introduction to Financial
Management
 What is finance?
 What is the distinction between financial
and real assets?
 What is corporate finance?
 What is the role of financial assets in
corporate finance?

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Financial Markets and Financial Instruments

 How do firms finance their investments?

 Earnings (free cash flow, internal capital)
 Equity capital (external – public or private)
 Debt capital (external)

 Public and private capital

 Trading of public capital
 New issues
 Secondary trading

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 Equity Issues
 First time a firm seeks public equity is
called an initial public offering (IPO)
 Primary issue: new equity is issued
 Secondary issue: existing private equity is
sold to outside investors (most privatisations
take this form)
 Legal and underwriting services provided by
investment banks

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 Debt Issues
 Bank loans – not publicly traded
 Corporate Bonds – traded actively in the
secondary market

 Debt capital and equity capital account for

most of the firm’s financial capital

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 Definition of Debt
 Fixed claim
 Specifies what needs to be repaid to the
investor and when
 Default risk – risk that the repayment plan is
not fulfilled
 Conversion options – covenants that allow
debt to be reclassified as equity

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 Definition of Equity
 Residual claim
 Does not specify a repayment plan
 Repayment is defined as the residual:
whatever is not claimed by other claim
holders should go to the equity holders
 Voting rights: Equity holders normally have a
right to vote on important corporate decisions
 Mergers, takeovers
 Large investments
 Board representation

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 Trends in Financial Management
 Globalisation
 Deregulation
 Financial innovation
 Technological advances in the financial
system
 Securitization

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 Decision Making
 Financial decisions:
 Companies make investment decisions about which
real assets to purchase
 They make financing decisions about how to raise cash
 The usual criterion for success is value
 The shareholders are the ultimate owners of the firm,
and managers act as their agents.
 The financial manager should make decisions that will
increase the value of the shareholders’ stake in the firm
 At the same time there is clearly a further duty to honor
the firm’s obligations to its creditors, its work force, and
society at large.

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 Decision Making

 Four Aspects of the Financial Manager’s Job:

 Understanding capital markets
 The financial manager is an intermediary between the firm’s
operations and the capital markets in which the firm’s securities are
traded.
 Correct investment and financing decisions require an
understanding of how capital markets work.
 Understanding value
 We can’t expect to make financial decisions that will consistently
increase the wealth of shareholders unless we understand
 How financial assets are valued
 Understanding the effect of time and uncertainty
 Most investments do not repay themselves for some years.
 And their outcomes are often very uncertain

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 Decision Making

 The financial manager must understand how the timing and

uncertainty of future earnings affect the value of a prospective
investment
 Understanding people
 The financial manager needs the opinions and the cooperation of
many people
 Understanding how people tick is essential if damaging
misunderstandings or conflicts of interest are to be avoided.

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 Decision Making

 The Financial Manager:

 No one person is responsible for all the financial
decisions described in this subject.
 The term financial manager is used to refer to anyone
responsible for a significant financial decision of an
organization.
 The power of ultimate financial decisions often rests
with the board of directors
 Although the authority for approving small-or medium-
sized investments is commonly delegated

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 What you should take home
 You should be able to
 Understand the distinction between a fixed claim and
a residual claim
 List the main attributes of a debt claim
 List the main attributes of an equity claim
 Describe the ways in which firms raise funds for new
investment
 Describe the difference between private and public
equity
 Describe the difference between bank loans and
corporate bonds

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 Decision Making
 List of terms:
 Bond
 Controller
 Financial assets
 Financing
 Intangible assets
 Investment
 Real assets
 ٍShare stock
 Tangible assets
 treasurer

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 Decision Making
 Exercise:
 Fill-in Questions:
1. A company’s----------------- consist of the tangible and
intangible assets that it uses to carry on its business.
2. ------------ assets consist of physical assets such as
factories, offices, plant, machinery & equipments
3. Trademarks, patents, and technical expertise are
examples of --------------assets.
4. Stocks and bonds are pieces of paper that represent
claims on real assets. They are called----------- assets.
5. A corporate ----------- is a certificate which shows that
money has been lent to a company
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 Decision Making

6. A -------- (or -----------) represents a claim to the

ownership of fraction of the company
7. The firm’s ------- decisions are concerned with what
assets it should purchase
8. The firm’s ------- decisions are concerned with how
cash should be raised
9. The markets in which financial assets are traded are
called ---------- markets.
10. The ------- is the principal financial manager of the firm
11. Large corporations may have a further financial
executive, called a ---------, who is responsible for
budgeting, accounting, and auditing.
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 Decision Making

 Problems:
1. Which of the following are investment decisions
and which are financing ones:
a. Issuing common stock
b. Developing a new product
c. Buying a factory
d. Paying a dividend to stockholders
e. Borrowing from a bank
f. Selling a warehouse
g. Purchasing shares of another company
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 Decision Making

2. Which of the following are real assets and which

are financial assets:
a. A patent
b. An office building leased by the company
c. A debenture
d. Raw materials inventory
e. A lease
f. A bank loan.

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 Problems
1. Why do firms use underwriters when
they issue new equity?
2. In what ways do you think it matters that
debt holders have a fixed claim when
equity holders have not?
3. In what ways do you think it matters that
equity holders have voting rights when
debt holders have not?
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 Review problems
1. Invest 95 and sell for 102 – what is the return?
2. Invest 95 and sell for 102. Each transaction is charged
a 1% trading commission – what is the return?
3. Invest 95 and sell for 102. You receive additional
interest payments/dividends of 2 during the holding
period. What is the return?
4. Invest 95 and sell for 110 three years later – what is
the annual return on your investment?
5. Invest 95 now and another 98 next year. In the
following year you sell your investment for a total of
202. What is the annual return on your investment?

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 Decision Making

 Essay Question:
 Explain what capital markets are and why
financial managers need to understand them

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End of Tutorial 1

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