Business Finance

FN-340

Dr. Muhammad Ather Ashraf

University of Management and
Technology
 CHAPTER 1
An Overview of Financial
Management
 Career Opportunities
 Issues of the New Millennium
 Forms of Businesses
 Goals of the Corporation
 Agency Relationships
 Cost of Money
 Financial Markets
Career Opportunities in Finance

 Money and capital markets

 Investments
 Financial management
Successful Companies

 Products (Identify, Create and Deliver)

 Product Attributes Such That:
 Pricing for profit maximization
 To Compensate owners and Creditors
 Risk avoidance
Successful Companies,
Attributes
 Employees: Skilled, Leaders, Managers at all
Levels (Capable Workforce)
 Good Outside Relationships
 Funding or Financing
Responsibility of the Financial
Staff
 Maximize Company value by:
 Forecasting and planning
 Investment and financing decisions
 Coordination and control
 Transactions in the financial markets
 Managing risk
Role of Finance in a Typical
Business Organization

Board of Directors

President

VP: Sales VP: Finance VP: Operations

Treasurer Controller

Credit Manager Cost Accounting

Inventory Manager Financial Accounting

Capital Budgeting Director Tax Department

Financial Management Issues of
the New Millennium

 The effect of
changing
technology
 The globalization
of business
Percentage of Revenue and Net Income
from Overseas Operations for 10 Well-
Known Corporations, 2001
Company % of Revenue % of Net Income
from overseas from overseas
Coca-Cola 60.8 35.9
Exxon Mobil 69.4 60.2
General Electric 32.6 25.2
General Motors 26.1 60.6
IBM 57.9 48.4
JP Morgan Chase & Co. 35.5 51.7
McDonald’s 63.1 61.7
Merck 18.3 58.1
3M 52.9 47.0
Sears, Roebuck 10.5 7.8
Forms of Business
Organization
 Sole proprietorship
 Partnership
 Corporation
Sole proprietorships &
Partnerships
 Advantages
 Ease of formation
 Subject to few regulations
 No corporate income taxes
 Disadvantages
 Difficult to raise capital
 Unlimited liability
 Limited life
Corporation
 Legal Entity under State Laws
 Separate from its owners/Managers
 Advantages
 Unlimited life
 Easy transfer of ownership
 Limited liability
 Ease of raising capital
 Disadvantages
 Double taxation
 Cost of set-up and report filing
 S Corporation
 Taxes are paid like proprietorship or partnership
Corporation: Setting it Up
 Charter
 By Laws
 Professional Organization
 Entrepreneur
 IPO
 Debt
Corporation: Organization
Financial Goals of the
Corporation
 The primary financial goal is shareholder
wealth maximization, which translates to
maximizing stock price.
 Do firms have any responsibilities to society
at large?
 Is stock price maximization good or bad for
society?
 Should firms behave ethically?
Is stock price maximization the
same as profit maximization?
 No, despite a generally high correlation
amongst stock price, EPS, and cash flow.
 Current stock price relies upon current
earnings, as well as future earnings and
cash flow.
 Some actions may cause an increase in
earnings, yet cause the stock price to
decrease (and vice versa).
Agency relationships

 An agency relationship exists whenever a

principal hires an agent to act on their behalf.
 Within a corporation, agency relationships
exist between:
 Shareholders and managers
 Shareholders and creditors
Shareholders versus Managers

 Managers are naturally inclined to act in their

own best interests.
 But the following factors affect managerial
behavior:
 Managerial compensation plans
 Direct intervention by shareholders
 The threat of firing
 The threat of takeover
Shareholders versus Creditors

 Shareholders (through managers) could take

actions to maximize stock price that are
detrimental to creditors.
 In the long run, such actions will raise the
cost of debt and ultimately lower stock price.
Factors that affect stock price
 Large Extent owners of
stock are society
 Employee Benefit
 Consumer Benefit
 Projected cash flows
to shareholders
 Timing of the cash
flow stream
 Riskiness of the
cash flows
Capital Allocation Process
Financial Securities

 Equity
 Debt
 May be Derivatives.
Cost of Money
 Debt
 Interest Rates
 Equity
 Dividends
 Capital Gains Shareholders Expect
Cost of Money: Factors

 Production
 Efficiency, Opportunities
 Time Preference for Consumption
 Risk
 Inflation
 Economic Conditions
Cost of Money:
Economic Conditions
 Federal Reserve Policy/------
 Budget Deficits or Surpluses
 Business Activity
 International Trade Deficits or Surpluses
 International Country Risk
 Exchange Rate Risks
Financial Institutions
 Investment Banks and Brokerage
 Underwrite Securities to raise Capital
 Advise, design and pricing of new securities
 Buy these securities from issuing corporations
 Resell them to Investors
Financial Institutions
 Deposit taking Financial Institutions
 Saving and Loan Associations (S&Ls)
 Deposits from small Investors
 Loan them to home buyers and consumers
 Later, allowed to make riskier investments like real
estate development
 Mutual Saving Banks (MSBs), Northern States
 Most are all acquired by Banks
Financial Institutions
 Credit Unions
 Cooperative Associations, who have common
Bonds
 Same Firm employees, same neighborhood
 Member savings is loaned only to other members
 Autos, Home mortgages or improvement Loans
 Often the cheapest source of funding for
individuals
Financial Institutions
 Mutual Funds
 Corporations, money from savers and use them
to buy Financial instruments.
 Money Market Funds invest in short term low risk
securities such as Treasury Bills and Commercial
papers.
 Traditional Mutual Funds, redemption only at the
close of Business Day.
 Exchange Traded Fund (ETF)
Financial Institutions
 Hedge Funds
 Raise Money from Investors
 Engage in variety of investment activities
 Different types of securities
 Private Equity Funds
 Similar to Hedge Fund
 Own Stock Equity in different Companies
 Often Control those Companies
 Mutual Funds small % of (Pass Through Certificates) PTCs,
PEF virtually all PTCs
Financial Markets
 Physical Asset Markets
 Tangible or Real Asset Markets
 Wheat, autos, real estate, computers, machinery
 Financial Asset Markets
 Stocks
 Bonds
 Notes
 Mortgages
Financial Markets
 Spot markets
 Bought on spot
 Delivery in few days
 Futures markets
 Bought on spot
 Delivery in Future Date
Financial Markets
 Money Markets
 Capital Markets
 Mortgage Markets
 Residential, Agricultural, Commercial & Industrial
 Consumer Credit Markets
 Autos, Appliances, Education extra.
 World, National, Regional & Local Markets
 Organization size and Scope of Operation
Financial Markets
 Primary Markets
 Raise New Capital
 Secondary Markets
 Already available equity
 Private Markets
 Directly between two Parties.
Market Transactions
 IPO
 Seasoned Equity Offerings
 Secondary Market
Secondary Markets
 NYSE
 300 members
 NASDAQ
 National Association of Securities Dealers (NASD)
is Self Regulatory Body
 Dow 30
 S&P 500
 NASDAQ 100
The Global Economic Crises
 ARM (Adjustable Rate Mortgage)
 CDO (Collateral Debt Obligation)
 MBS (RMBS, CMBS)
The Global Economic Crises
 Regulator’s Approval of Subprime Mortgages
 Federal Reserve, Easy Money
 Home Buyers, more for less, Greed
 Mortgage Brokers, did not care
 Appraisers were not stringent
 Insurance rules were not tight
 AIG, Fennie Mae and Freddie Mac
Basic Valuation Models

CF1 CF2 CFn

Value  1
 2

(1  k) (1  k) (1  k)n
n
CFt
 t
.
t 1 (1  k)

 To estimate an asset’s value, one estimates the cash flow for

each period t (CFt), the life of the asset (n), and the
appropriate discount rate (k)
 Throughout the course, we discuss how to estimate the inputs
and how financial management is used to improve them and
thus maximize a firm’s value.
 FCF = Sales revenues − Operating costs − Operating taxes −
Required new investments in operating capital
Basic Valuation Models
Factors that affect the Level and
Riskiness of Cash Flows
 Decisions made by financial managers:
 Investment decisions
 Financing decisions (the relative use of debt
financing)
 Dividend policy decisions
 The external environment
Thanks for your Attention
Questions?
Discussion Please!!!