Ross Fundamentals of Finance for Chapter One

Fundamentals of Finance explores the basic of Finance

1. Learning Objectives The basic types of financial management decisions and the role of the financial manager. (L01) The financial implications of the different forms of business organization. (L02) The goal of financial management. (L03) The conflicts of interest that can arise between managers and owners. (L04) The roles of financial institutions and markets. (L05) Types of financial institutions. (L06) Trends in financial markets. (L07)

2. Chapter Outline 1.1 Corporate Finance and the Financial Manager 1.2 Forms of Business Organization 1.3 The Goal of Financial Management 1.4 The Agency Problem and Control of the Corporation 1.5 Financial Markets and the Corporation 1.6 Financial Institutions 1.7 Trends in Financial Markets and Financial Management 1.8 Outline of the Text Summary and Conclusions

3. 1.1 Corporate Finance and the Financial Manager What Is Corporate Finance? No matter what type you started, you would have to answer the following three questions in some form or another: What long-term investments should the firm take on? Where will we get the long-term financing to pay for the investment? How will we manage the everyday financial activities of the firm? www.cfo.com

4. Financial managers try to answer some or all of these questions. The top financial manager within a firm is usually the Chief Financial Officer ( CFO ). Treasurer oversees cash management, capital expenditures and financial planning. Controller oversees taxes, cost accounting, financial accounting and data processing. 1.1 Corporate Finance and the Financial Manager

5. Financial Management Decisions Capital budgeting What long-term investments or projects should the business take on? Capital structure How should we pay for our assets? Should we use debt or equity? Working capital management How do we manage the day-to-day finances of the firm? 1.1 Corporate Finance and the Financial Manager

6. Three major forms in Canada: Sole proprietorship Partnership (General & Limited) Corporation In other countries, corporations are also called joint stock companies, public limited companies and limited liability companies. http://www.legalline.ca/ 1.2 Forms of Business Organization

7. Sole Proprietorship A business owned by a single individual. Advantages Easiest to start Least regulated Single owner keeps all the profits Taxed once as personal income Disadvantages Unlimited liability Limited to life of owner Equity capital limited to owner’s personal wealth Difficult to sell ownership interest 1.2 Forms of Business Organization

8. 1.2 Forms of Business Organization Partnership A business formed by two or more co-owners. Advantages Two or more owners More human and financial capital available Relatively easy to start Income taxed once as personal income Disadvantages Unlimited liability - General partnership - Limited partnership Partnership dissolves when one partner dies or wishes to sell Difficult to transfer ownership Possible disagreements between partners

9. Corporation A business created as a distinct legal entity owned by one or more individuals or entities. Advantages Limited liability Unlimited life Separation of ownership and management Transfer of ownership is easy Easier to raise capital Disadvantages Separation of ownership and management Double taxation (income is taxed at the corporate rate and then dividends are taxed at the personal rate) 1.2 Forms of Business Organization

10. Income Trust Business income trusts (also called income funds) hold the debt and equity of an underlying business and distribute the income generated to unit holders. Advantages Not subject to corporate income tax and income is typically taxed in hands of unit holders. Investors view income trusts as more tax efficient. Disadvantages Income trusts are not corporations and so, do not have the same advantages as one. 1.2 Forms of Business Organization

11. Co-operative (Co-op) A co-operative is an enterprise that is equally owned by its members, who share the benefits of co-operation based on how much they use the co-operative’s services. Advantages Equally owned by its members Helps its members compete more effectively while creating social capital Disadvantages Potentially difficult to reach decisions based on premise of equal ownership by members 1.2 Forms of Business Organization

12. Work the Web Example The Internet can help people to get information about how to start a new business One excellent site is www.canadabusiness.ca Click on the web surfer to go to the site and see what information you can find! 1.2 Forms of Business Organization

13. What should be the goal of a corporation? Maximize profit? Minimize costs? Maximize market share? Maximize the current value of the company’s stock? Does this mean we should do anything and everything to maximize owner wealth? 1.3 The Goal Of Financial Management

14. 1.3 The Goal of Financial Management Three equivalent goals of financial management: Maximize shareholder wealth Maximize share price Maximize firm value

15. 1.4 The Agency Problem and Control of the Corporation Agency Relationship Principal hires an agent to represent their interests. Stockholders (principals) hire managers (agents) to run the company. Agency Problem Conflicts of interest can exist between the principal and the agent. Agency Costs Direct agency costs Indirect agency costs

16. Managing Managers Managerial compensation Incentives can be used to align management and stockholder interests. The incentives need to be structured carefully to make sure that they achieve their goal. Corporate control The threat of a takeover may result in better management. Conflicts with other stakeholders 1.4 The Agency Problem and Control of the Corporation

17. Social Responsibility and Ethical Investing Investors are increasingly demanding that corporations behave responsibly. Issues include how a corporation treats the community in which it operates, their customers, corporate governance, their employees, the environment and human rights. Controversial business activities include alcohol, gaming, genetic engineering, nuclear power, pornography, tobacco and weapons. 1.4 The Agency Problem and Control of the Corporation

18. Work the Web Example The Internet provides a wealth of information about individual companies. One excellent site is ca.finance.yahoo.com. Click on the web surfer to go to the site, choose a company and see what information you can find! 1.4 The Agency Problem and Control of the Corporation

19. 1.5 Financial Markets and the Corporation Cash flows to and from the firm Money vs. capital markets Primary vs. secondary markets One excellent site for information on Canadian companies that trade in secondary markets is www.tmx.com Click on the web surfer to go to the site, choose a company and see what information you can find!

20. 1.5 Financial Markets and the Corporation Figure 1.4 Cash flows between the firm and the financial markets

21. 1.6 Financial Institutions Financial institutions act as intermediaries between suppliers and users of funds. Institutions earn income on services provided: Indirect finance - Earn interest on the spread between loans and deposits Direct finance - Service fees (i.e. bankers acceptance and stamping fees)

22. 1.7 Trends in Financial Markets and Financial Management Financial Engineering Derivative Securities Advances in Technology - i.e., E-business Deregulation Corporate Governance Reform Hedge Funds Sub-prime Market

23. Outline of Text Part 1: Overview of Corporate Finance Part 2: Financial Statements and Long-Term Financial Planning Part 3: Valuation of Future Cash Flows Part 4: Capital Budgeting Part 5: Risk and Return Part 6: Cost of Capital and Long-Term Financial Policy Part 7: Short-Term Financial Planning and Management Part 8: Topics in Corporate Finance Part 9: Derivative Securities and Corporate Finance

24. Summary and Conclusions You should know: The advantages and disadvantages between a sole proprietorship, partnership and corporation. The primary goal of the firm. What an agency relationship and agency cost are. What ethical investing is. The role of financial markets. The role of financial institutions.

25. What are the three types of financial management decisions and what questions are they designed to answer? What are the three major forms of business organization? What is the goal of financial management? What are agency problems and why do they exist within a corporation? What is the difference between a primary market and a secondary market? Quick Quiz