Finance

10200A
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CLASS 1
INTRODUCTION TO
CORPORATE FINANCE
Chapter 1 – Fundamentals of Corporate Finance

:these slides are different than the ones in the clips

 What did you see in class 1?
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A. What is finance? What is corporate finance?

B. The types of financial management decisions
C. The goal of the financial manager
D. Agency relationship in financial management
E. Capital markets
F. Different forms of business organization
 Why finance? Four Branches of Finance…
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1. Investments
 Decision-making on financial assets to buy / or to sell
 Analysis and selection of financial securities
 Role: portfolio managers, brokers ...

2. Corporate finance
 Financial decision-making for a company

 Role of: Financial Manager, CFO, Treasurer, etc

3. Institutional finance
 Financial decision-making for a financial institution

 Role of: credit manager, account manager ...

4. Personal finance
 Decision-making on the overall financial situation of an individual

 Role of: financial planner, personal banker, financial advisor ..

 Recap Class 1…
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Three equivalent goals of financial management

(or financial manager) :
 Maximize shareholder wealth
 Maximize share price
 Maximize firm value

 Does this mean we should do anything and everything

to maximize owner wealth??? No!

 Managerial compensation and an independent BoD is a

great way to reduce costs associated with agency
problems
 Class 2 CLIP 1: Basic definitions and single CF
valuation
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A. The concept of value

B. Basic definitions
C. Simple interest and compound interest
D. Single CF valuation
 The concept of value
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Time value of money ... Principle of interest!

A dollar earned today is worth more than a dollar earned tomorrow!

$1,000 $1,000 $1,000 $1,000

t
today In 1 year In 5 years 50 years from now

3 components of interest rate:

 Time premium (premium for deferred consumption)
 Inflation premium (prices rise, on average)
 Risk Premium (uncertainty, variability)
What is risk ??
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The concept of value… key points to remember
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**A dollar earned today is worth more than a dollar earned

tomorrow because you can invest it and make $$$

A certain dollar is worth more than an uncertain dollar

 How to draw and read a timeline?
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 Recall: in this course, we exclusively focus on compound interest (eg: earn
interest each period on the original principal and reinvested interest)
 Financial Calculator – (1/2)
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Before you start solving a problem…

 Draw a time line ****

 Identify and state the key variables

 To solve problems we use a financial calculator

Always use four decimals for interest rates:

BAII+: 2nd format 4 ENTER
 Single cash flow valuation
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Future value and present value : general formulas

FV = PV(1 + r)t
 FV = future value
 PV = present value
 r = period interest rate, expressed as a decimal
 T = number of periods

PV = FV(1 + r)-t= FV / (1 + r)t

 Financial Calculator – (2/2)
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Texas Instruments BA-II Plus

 Clear the registers (CLR TVM) before each problem: 2ND FV

 FV = future value
 PV = present value
 I/Y = period interest rate  r
 Interest is entered as a percent, not a decimal
 N = number of periods 2Nd FV
 Other calculators are similar in format Erase memory

4 decimals: 2nd format 4 ENTER

IMPORTANT – Sign convention: the calculator views cash inflows as positive

numbers and cash outflows as negative numbers. Be sure and remember the sign
convention or you will receive an error when solving for r or t
TRICK for sign convention: always put PV as negative. It will always work. The
answer you get might be negative – but that’s ok. Just disregard the negative sign
when writing the answer
 Let’s now work through a few exercises….
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Legend

Exercises to be completed by Shady

Exercises to be completed alone

 Example 1
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You think you can sell a piece of art in 5 years at a price of $3,200. Your
required annual rate of return is 6%.

a) What is the current value of this artwork?

b) Assuming you can buy it today for $2,000, is it a good idea to buy it?

c) If you buy it today for $2,000, what will be the yearly return on your
investment if you sell it for $3,200 in 5 years ?
 Example 2
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 You want to buy a new car in exactly 4 years. This car will cost you
$35,000. How much money should you put into your bank account
today so you can buy the desired car in 4 years? It should be noted that
your bank account earns you a rate of 4% per year.
 Example 3
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a) At a 10% interest rate, how long does it take for a certain

amount of money to double in value?

b) What interest rate is required to double the value of a given

amount in 10 years?
 Example 4
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A picasso painting, entitled Naked

at the sculptor's tray, was sold for
$106.5 million in 2010, an all-time
record at that time (record
surpassed in November 2017),
through the famous art dealer
Christie's.

In 1950, the same painting was

sold for just $17,000.

Assuming that whoever bought it

in 1950 is the same person who
sold it in 2010, what annual return
did he get for this investment?