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1/18/2013

FINANCIAL MANAGEMENT

• THE SCOPE CORPORATE FINANCE

What is Corporate Finance?
• The activities involved in managing cash flows in a business environment • The goal of financial management is to maximize the current value per share of existing stock

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1/18/2013 The Five Basic Corporate Finance Functions • Financing: raising capital. • Corporate governance: refers to the set of systems. 2 . • Risk management: managing the firm’s exposure to risk in order to maintain the optimum risk risk-return return trade-off and maximize shareholder value. • Capital budgeting: selecting the best projects in which to invest the firm’s resources. principles and processes by which a company is governed The Financing Function Businesses can raise money in 2 ways: • Externally from investors or creditors • Venture capital • Initial public offering (IPO) • Money market Long-term term debt • Long • Internally by retaining operating cash flows • Most common method. a c a management a age e t: managing a ag g a firm’s s day day• Financial to-day cash flows.

The Financial Management Function • Managing daily d l cash h inflows fl and d outflows fl • Forecasting cash balances • Building a long-term financial plan • Choosing the right mix of debt and equity 3 . • Primary vs. • Most external financing is debt. secondary market transactions or offerings.1/18/2013 Raising Capital: Key Facts • Most financing from internal rather than external t l sources. • Financial intermediaries declining as a source of capital for large firms. • Securities markets growing in importance.

1/18/2013 The Capital Budgeting Function • The capital budgeting process consists of three steps. measuring.Identifying potential investments • Step 2 . • Financial instruments like forwards. and managing all types of risk exposures • Some risks are insurable.Implementing and monitoring the investments selected in Step 2 The Risk Management Function • Identifying. price. and currency fluctuations. 4 . and swaps may also be used to hedge market risks such as interest-rate.Analyzing those investments to identify which will create shareholder value • Step 3 . steps • Step 1 . futures. and some risks can be reduced through diversification. options.

The Core Principles of Finance • The time value of money • The opportunity to earn a return on invested funds means that a dollar today is worth more than a dollar in the future. • Compensation for risk • Investors expect compensation for bearing risk.1/18/2013 The Corporate Governance Function • Hires and promotes qualified. and other stakeholders often conflict. honest people. managers. 5 . g . and structures employees’ l ’ financial fi i l incentives i i to motivate them to maximize firm value • In practice the incentives of stockholders.

as residual claimants. • Markets are smart. have better incentives to maximize firm value. 6 . • Competition for information tends to make markets efficient. b k d l ki dependent on accounting principles • Does not fully consider cash flow timing • Ignores risk • Maximize Shareholder Wealth? • Maximize stock price. not profits • Shareholders. • No arbitrage • Risk-free money-making opportunities are extremely scarce. What Should a Financial Manager Try to Maximize? • Maximize Profit? • Earnings E i per share h are backward-looking. • Investors can achieve a more favorable trade off between risk and return by diversifying their portfolios.1/18/2013 The Core Principles of Finance • Don’t put all your eggs in one basket.

1/18/2013 THE TIME VALUE OF MONEY • Money earns interest over time • Money therefore has a ‘time value’ • The sooner money is received. the greater value is its The Role of Financial Markets • Voluntary transfer of wealth • Between individuals – Financial intermediaries • Across time – Future value – Present value • The chance to earn a return on invested funds means a dollar today is worth more than a dollar in the future 7 .

2 years.48 FV2 = 256(1 + .03 8 .08)16 = 877. how much can you withdraw in 1 year.08) = 276.1/18/2013 Future Value The Value of a Lump Sum or Stream of Cash Payments at a Future Point in Time FV = PV * (1 + r ) n n where: • r is the interest rate per period • n is the time that money remains invested • PV is the value at the beginning of the period COMPOUND INTEREST Future Value of a Lump Sum • EXAMPLE: If you deposit $256 at an 8% interest rate.08) 2 = 298. 16 years? FV1 = 256 + 256(0.60 FV16 = 256(1 + .

The longer the period of time. 2. The higher the interest rate.1/18/2013 The Power Of Compound Interest Future Value • Two key points: 1. 9 . the higher the future value. the higher the future value.

on the money Present Value Today's Value of a Lump Sum or Stream of Cash  Payments Received at a Future Point in Time FV n = PV * (1 + r ) n PV = FV n (1 + r ) n 10 .1/18/2013 Present Value • Compounding: • Finding d the h future f value l of f present dollars d ll invested d at a given rate • Discounting: • Finding the present value of a future amount. amount assuming an opportunity to earn a given return (r).

what is it worth today? y PV=100/(1+. what is it worth today PV = 100 /(1 + . If you can invest at 10%.1/18/2013 Present Value • EXAMPLE: You expect to receive $100 in ONE year.65 Present Value of $1 Discounted at Different Interest Rates 11 . If you can invest at 10%.1)8 = 46.90 • You expect to receive $100 in EIGHT years. y .1)= 90.

..+ CF 1+ r)n−n 1 *( 2 *( n *( • Or  n−t FV = ∑CF t * (1+ r) t =1 n 12 .1/18/2013 FV of a Mixed Cash Flow Stream FV of a Mixed Cash Flow Stream • CF: the cash flow at the and of year t FV = CF 1+ r)n−1 + CF 1+ r)n−2 +.

1/18/2013 FV of Annuities FV of Annuities • FV of an ordinary annuity: PMT: the annuity’s annual payment 13 .

000 Per Year Invested at 7% FV of Annuities • FV of an annuity due : PMT: the annuity’s annual payment 14 .1/18/2013 EX:FV of a 5-Year Ordinary Annuity of $1.

000 Per  Year Invested at 7% 15 .1/18/2013 EX:FV of a 5‐Year Annuity Due of $1.