Fins 1613 Notes

FINS 1613 Notes

Lecture 1

Financial Management Considerations:

Capital Budgeting (investment decision)

• Process of managing a firm’s long term investments is capital budgeting
• Manager tries to identify investment opportunities where benefits > acquisition costs
• They do this by looking at size, timing and risk of future cash flows

• Size – how much cash expected to receive?
• Timing – when are they receiving cash?
• Risk – how likely are they going to receive cash?

Capital Structure (financing decision)

• Capital structure: mixture of debt/equity firm uses to finance operations
• Looks at how much a firm should raise and least expensive sources of funds

Working Capital Management (how to manage everyday financial activities of firm?)

• Working capital: short term assets and liabilities
• Ensures firm has sufficient resources to continue operations

Forms of Business Organisation

Sole Proprietorship

• Business owned by one person
• Simplest and least regulated
• Advantage: owner keeps all profit, less regulation,
• Disadvantages: unlimited liability for business debts (personal assets of owner can be taken if business unable to pay debts), life span of business limited to owner’s life span and amount of equity raised limited to owner’s personal wealth

Partnership

• Business owned by 2 or more people
• General partnership: all partners share in gains/losses and all have unlimited liability for all debts

• The way gains and losses are distributed outlined in partnership agreement

• Limited partnership: general partners run business and have unlimited liability but limited partners do not actively participate in business

• Limited partner’s liability for business debts is limited to amount partner contributed to partnership

• Advantages: easy and inexpensive to form
• Disadvantages: general partners have unlimited liability, equity raised limited to personal income, difficult to transfer ownership

Corporation

• Business created as distinct legal entity
• Forming corporation involves:

• Preparing constitution/charter (rules describing how corporation regulates own existence, has name, intended life, purpose and number of shares that can be issued)

• Advantages: ownership (through shares) can be readily transferred, limited liability for debts
• Disadvantages: double-tax (company tax + personal income tax through income earned through dividends)

Goal of Financial Management

• Maximise current value of existing shares (for corporations)
• Maximise current value of firm (more general)

• Good decisions increase value of firm increasing financial gain of investors

Agency Relationship – someone (principal) hires person (agent) to represent principal’s interest

• Agency problem: possibility of conflict of interest between owners and management of firm
• Agency cost: when managers fail to take advantage of a valuable opportunity available to firm
• Aligning management and owner goals can be done by:

• Compensation through better job prospects (for better performance) and getting managers to buy shares
• Threat of takeover – poorly managed firms are more attractive as acquisitions because of greater profit potential

Cash flows to and from the firm

• Firms selling shares (equity) and borrowing money (debt) to raise cash and cash flows from financial institutions to firms
• Cash is invested in current and fixed assets
• Assets generate more cash
• Some cash used to pay corporate taxes
• Some cash reinvested in firm
• Remaining cash paid to creditors and shareholders

Lecture 2

Simple Interest: Principal x Rate x Time

Future Value (FV)