Description
the different areas which finance covers, what are Various types of Corporate Entities, principles of corporate finance. It also explains agency cost problem, Stockholder Interests vs. Management Interests, Stockholders' objectives vs. Bondholders' objectives. It also includes factors that affect the Level and risk of cash flows.
Corporate Finance and the Financial Manager
1
Contents
? Areas of Finance
? What are Various types of Corporate Entities? ? Role of the Finance Manager
? Separation of Ownership & Management
? Financial Markets
2
4 Basic Areas of Finance
? Corporate Finance
? Investments/ Investment Banking ? Financial Institutions/ Commercial Banking
? International Finance
? Insurance ? Other Financial Services
3
Financial Environment
? Businesses interact continually with the financial
markets. ? Financial Markets – all institutions and procedures for bringing buyers and sellers of financial instruments together. ? The purpose of financial markets is to efficiently allocate savings to ultimate users.
4
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
5
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES INVESTMENT SECTOR Businesses Government Households
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
6
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES SAVINGS SECTOR Households Businesses Government
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
7
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES FINANCIAL BROKERS Investment Bankers Mortgage Bankers
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
8
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES FINANCIAL INTERMEDIARIES
FINANCIAL BROKERS
SECONDARY MARKET
Commercial Banks Savings Institutions Insurance Cos. Pension Funds Finance Companies Mutual Funds
SAVINGS SECTOR
9
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES SECONDARY MARKET Security Exchanges OTC Market
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
10
Corporate Structure
There are 3 types of basic organizational forms ? Sole Proprietorship ? Partnership ? Corporation
? Private Limited ? Public Limited
11
Corporate Structure
Sole Proprietorships Unlimited Liability Personal tax on profits Partnerships Limited Liability Corporations Corporate tax on profits + Personal tax on dividends
12
SOLE PROPRIETORSHIP One Owner
All you need to do is just start operating ? Advantages
? Easy and inexpensive to form ? Few government regulations & reporting requirements ? No corporate income tax, only personal income tax
? Disadvantages
? Hard to obtain large amounts of borrowing
? Unlimited liability (owner liable for total debt)
? Difficult to transfer ownership
13
PARTNERSHIP written) between owners as to: An agreement (verbal or
? % of capital invested by each partner
? How are profits shared? ? How is it dissolved and/or ownership transferred?
? Same advantages and disadvantages as above ? Usually larger enterprise than sole proprietorship.
14
?
CORPORATION Needs to be registered
? Owners receive shares in corporation ? Shareholders elect board of directors. ? Board members expected to oversee the “proper” running of the company. ? Board of directors appoints managers, generally different from owners,
and is expected to ensure that managers act in the best interest of shareholders. ? Advantages
? unlimited life ? easy transfer of ownership ? limited liability; maximum loss is your investment in company
? Easier to raise capital; more info is publicly available on company
? Disadvantages
? double taxation: corporate earnings & dividend received ? increase in SEBI / RoC regulation and reporting.
15
What three questions does financial management seek to answer?
? What causes a company to have a
particular stock value?
? How can managers make choices that
add value to their companies?
? How can managers ensure that their
companies don’t run out of cash while executing their plans?
16
What is corporate finance?
? Every decision that a business makes has financial
implications. ? Any decision which affects the finances of a business is a corporate finance decision. ? Defined broadly, everything that a business does fits under the rubric of corporate finance.
17
The Three Major Decisions in Corporate Finance
? The Allocation decision ? Where do you invest the scarce resources of your business? ? What makes for a good investment?
18
The Three Major Decisions in Corporate Finance
? The Financing decision ? Where do you raise the funds for these investments? ? Generically, what mix of owner’s money (equity) or borrowed money(debt) do you use?
19
The Three Major Decisions in Corporate Finance
? The Dividend Decision ? How much of a firm’s funds should be reinvested in the business and how much should be returned to the owners?
20
1st Principles of Corporate Finance
? Invest in projects that yield a return greater than the minimum acceptable hurdle rate (or cost of capital).
? The hurdle rate should be higher for riskier projects and
reflect the financing mix used - owners’ funds (equity) or borrowed money (debt) ? Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects.
21
1st Principles of Corporate Finance
? Choose a financing mix that minimizes the hurdle rate
and matches the assets being financed. ? If there are not enough investments that earn the hurdle rate, return the cash to stockholders. ? The form of returns - dividends and stock buybacks - will depend upon the stockholders’ characteristics.
Objective: Maximize the Value of the Firm
22
Why do we need an objective?
? An objective specifies what a decision maker is trying to
accomplish and by so doing, provides measures that can be used to choose between alternatives.
23
Characteristics of a Good Objective Function
? It is clear and unambiguous
? It comes with a clear and timely measure that can be
used to evaluate the success or failure of decisions. ? It does not create costs for other entities or groups that erase firm-specific benefits and leave society worse off overall.
24
The Objective in Decision Making
? In traditional corporate finance, the objective in decision
making is to maximize the value of the firm. ? A narrower objective is to maximize stockholder wealth. When the stock is traded and markets are viewed to be efficient, the objective is to maximize the stock price.
25
Why traditional corporate financial theory often focuses on maximizing stock prices as opposed to firm value
? Stock price is easily observable and constantly updated
(unlike other measures of performance, which may not be as easily observable, and certainly not updated as frequently). ? The stock price is a real measure of stockholder wealth, since stockholders can sell their stock and receive the price now.
26
Maximize stock prices as the only objective function
? For stock price maximization to be the only objective in
decision making, we have to assume that
? The decision makers (managers) are responsive to the
owners (stockholders) of the firm ? Stockholder wealth is not being increased at the expense of bondholders and lenders to the firm; only then is stockholder wealth maximization consistent with firm value maximization.
27
Maximize stock prices as the only objective function
? For stock price maximization to be the only objective in
decision making, we have to assume that
? Markets are efficient; only then will stock prices reflect
stockholder wealth. ? There are no significant social costs; only then will firms maximizing value be consistent with the welfare of all of society.
28
The Classical Objective Function
STOCKHOLDERS Hire & fire managers - Board - Annual Meeting Lend Money Maximize stockholder wealth
BONDHOLDERS
Protect bondholder Interests
Managers
No Social Costs
SOCIETY
Costs can be traced to firm
Reveal information honestly and on time
Markets are efficient and assess effect on value
FINANCIAL MARKETS
29
Another Way of Presenting this is...
30
Goal of the Firm
Why Not Profit Maximization?
This goal ignores:
Time Value of Money Risk-Return Tradeoff
31
The Goal of Financial Management
The Goal of Financial Management
? What are firm decision-makers hired to do?
“General Motors is not in the business of making automobiles. General Motors is in the business of making money.”
--Alfred P. Sloan
? Possible goals
? Three equivalent goals of financial management:
Maximize shareholder wealth Maximize share price
32
Corporate Finance
1. 2. 3.
Corporate Finance addresses the following three questions:
What long-term investments (projects) should the firm engage in? – Capital Budgeting How can the firm raise the money for these investments? – Capital Structure How much short-term cash flow does a company need to pay its bills? – Working Capital Management
33
The Four Basic Areas of Finance Corporate Finance
? Long-term investments ? Capital Budgeting ? Long-term financing ? Capital Structure ? Short-term financing ? Working Capital Management ? Risk management ? Derivative securities
34
The Balance-Sheet Model of the Firm
The Capital Budgeting Decision
Current Liabilities Current Assets Long-Term Debt
Fixed Assets 1 Tangible 2 Intangible
What longterm investments should the firm engage in?
Shareholders’ Equity
35
The Balance-Sheet Model of the Firm
The Capital Structure Decision
Current Liabilities Current Assets Long-Term Debt
Fixed Assets 1 Tangible
2 Intangible
How can the firm raise the money for the required investments?
Shareholders’ Equity
36
The Balance-Sheet Model of the Firm
The Net Working Capital Investment Decision
Current Liabilities Current Assets Net Working Capital Long-Term Debt
Fixed Assets
1 Tangible
2 Intangible
How much short-term cash flow does a company need to pay its bills?
Shareholders’ Equity
37
Cash Flows Between the Firm and the Financial Markets
38
Financial Markets
? Primary Market ? When a corporation issues securities, cash flows from investors to the firm. ? Usually an underwriter is involved ? Secondary Markets ? Involve the sale of “used” securities from one investor to another. ? Securities may be exchange traded or trade over-thecounter in a dealer market.
39
Financial Markets
Firms Stocks and Bonds Money A money Primary Market Investors securities B
Secondary Market
40
Separation of Ownership and Control
Board of Directors Shareholders Debtholders Management
Assets
Debt Equity
41
Finance Manager’s role
? What investments the firms should make?
? How should it finance those investments? ? Manage / service all stakeholders
42
Finance Manager’s Role
? Maximize the wealth of the Shareholders
? Pursue strategies, goals and policies to maximize
market cap or wealth ? Increase the value of the firm
43
Maximizing Market Value
? Making "best use" of existing operations/projects
through reengineering of products and processes. ? Creating additional market value by undertaking all "profitable“ investment projects such as:
? expansion into new areas of business ? expansion of existing line of business ? correct sizing ? choosing "best" dividend policy
? choosing "best" mix of financing sources
? choosing "best" organizational structure: flat vs.
hierarchy
44
Corporate Finance Decision
? Long-term investments ? Capital Budgeting ? Long-term financing ? Capital Structure ? Short-term financing ? Working Capital Management ? Risk management ? Derivative securities
45
Real Assets v/s Financial Assets
Firms Operate on Real Assets Fixed Assets Current Assets Tech knowhow Patents, Others Real Assets Purchase Real assets Finance Manager Sell securities for cash Financial Markets
Generate cash flows Re-invest in business
Repay loans
Investors Banks VCs Shareholder s Other Holders of financial assets
46
Who is The Financial Manager?
Chief Financial Officer
Treasurer
Comptroller
47
Ownership vs. Management
Difference in Information
? Stock prices and
Different Objectives
? Managers vs.
returns ? Issues of shares and other securities ? Dividends ? Financing
stockholders ? Top mgmt vs. operating mgmt ? Stockholders vs. banks and lenders
48
Manager’s Objective
? Objective of manager: ? high pay, prestige, leisure, and high dislike for risk ? Justification being: ? threat of hostile takeover, bankruptcy, & firing, manager would lose her job if does not meet objective.
49
The Agency Cost Problem
? The interests of managers, stockholders, bondholders
and society can diverge. What is good for one group may not necessarily for another.
? Managers may have other interests (job security, perks,
compensation) that they put over stockholder wealth maximization. ? Actions that make stockholders better off (increasing dividends, investing in risky projects) may make bondholders worse off.
50
The Agency Cost Problem
? Actions that increase stock price may not necessarily
increase stockholder wealth, if markets are not efficient or information is imperfect. ? Actions that makes firms better off may create such large social costs that they make society worse off. ? Agency costs refer to the conflicts of interest that arise between all of these different groups.
51
What can go wrong?
STOCKHOLDERS Have little control over managers Managers put their interests above stockholders Significant Social Costs SOCIETY Some costs cannot be traced to firm
Lend Money
BONDHOLDERS
Managers
Bondholders can get ripped off Delay bad news or provide misleading information
Markets make mistakes and can over react
FINANCIAL MARKETS
52
Stockholder Interests vs. Management Interests
? Theory: The stockholders have significant control over
management. The mechanisms for disciplining management are the annual meeting and the board of directors. ? Practice: Neither mechanism is as effective in disciplining management as theory posits.
53
The Annual Meeting as a disciplinary venue
? The power of stockholders to act at annual meetings is diluted by
three factors
? Most small stockholders do not go to meetings because the cost of
going to the meeting exceeds the value of their holdings. ? Incumbent management starts off with a clear advantage when it comes to the exercising of proxies. Proxies that are not voted becomes votes for incumbent management. ? For large stockholders, the path of least resistance, when confronted by managers that they do not like, is to vote with their feet.
54
ask the necessary tough questions..
? The CEO sets the agenda, chairs the meeting and
controls the information. ? The search for consensus overwhelms any attempts at confrontation.
55
Application Test: Who’s on board?
? Look at the board of directors for Listed companies.
Analyze
? How many of the directors are inside directors
(Employees of the firm, ex-managers)? ? Is there any information on how independent the directors in the firm are from the managers?
56
Application Test: Who owns/runs the firm?
Looking at the top 15 stockholders in the firm, consider the following:
? How many of the top 15 investors are institutional
investors? ? How many of the top 15 investors are individual investors? ? Are managers significant stockholders in the firm?
57
Overpaying on takeovers
? The quickest and perhaps the most decisive way
to impoverish stockholders is to overpay on a takeover. ? The stockholders in acquiring firms do not seem to share the enthusiasm of the managers in these firms. ? Stock prices of bidding firms decline on the takeover announcements a significant proportion of the time.
58
Stockholders' objectives vs. Bondholders' objectives
? In theory: there is no conflict of interests between
stockholders and bondholders. ? In practice: Stockholders may maximize their wealth at the expense of bondholders.
? Increasing dividends significantly: When firms pay cash out
as dividends, lenders to the firm are hurt and stockholders may be helped. This is because the firm becomes riskier without the cash.
59
Stockholders' objectives vs. Bondholders' objectives
? In practice: Stockholders may maximize their wealth at the
expense of bondholders.
? Taking riskier projects than those agreed to at the outset:
Lenders base interest rates on their perceptions of how risky a firm’s investments are. If stockholders then take on riskier investments, lenders will be hurt. ? Borrowing more on the same assets: If lenders do not protect themselves, a firm can borrow more money and make all existing lenders worse off.
60
Firms and Financial Markets
? In theory: Financial markets are efficient. Managers convey
information honestly and truthfully to financial markets, and financial markets make reasoned judgments of 'true value'. As a consequence? A company that invests in good long term projects will be rewarded.
? Short term accounting gimmicks will not lead to increases in market
value. ? Stock price performance is a good measure of management performance.
? In practice: There are some holes in the 'Efficient Markets'
assumption.
61
Managers control the release of information to the general public
? There is evidence that ? they suppress information, generally negative information ? they delay the releasing of bad news
?
?
bad earnings reports other news
? they sometimes reveal fraudulent information
62
Value set by Market may contain errors.
? Prices are much more volatile than justified by the underlying fundamentals ? Financial markets overreact to news, both good and bad ? Financial markets are short-sighted, and do not consider the long-term implications of actions taken by the firm
? Eg. the focus on next quarter's earnings
? Financial markets are manipulated by insiders; Prices do not have any relationship to value.
63
Are Markets Short term?
? Focusing on market prices will lead companies towards
short term decisions at the expense of long term value. ? I agree with the statement ? I do not agree with this statement
64
Are Markets Short Sighted? Some evidence that they are not..
? There are hundreds of start-up and small firms, with no
earnings expected in the near future, that raise money on financial markets ? If the evidence suggests anything, it is that markets do not value current earnings and cashflows enough and value future earnings and cashflows too much. ? The market response to research and development and investment expenditure is generally positive
65
Market Reaction to Investment Announcements
Type of Announcement Abnormal Returns on Announcement Day
Joint Venture Formations R&D Expenditures Product Strategies Capital Expenditures All Announcements 0.399% 0.251% 0.440% 0.290% 0.355%
Announcement Month
1.412% 1.456% -0.35% 1.499% 0.984%
66
Firms and Society
? In theory: There are no costs associated with the firm that cannot be traced to the firm and charged to it. ? In practice: Financial decisions can create social costs and benefits.
? A social cost or benefit is a cost or benefit that accrues to
society as a whole and NOT to the firm making the decision.
? ?
-environmental costs (pollution, health costs, etc..) Quality of Life' costs (traffic, housing, safety, etc.)
? Examples of social benefits include: ? creating employment in areas with high unemployment ? supporting development in inner cities
67
A Hypothetical Example
Assume that you work for The Big Bazaar and that you have an opportunity to open a store in an inner-city neighborhood. The store is expected to lose about Rs.10 lacs a year, but it will create much-needed employment in the area, and may help revitalize it.
68
A Hypothetical Example
? Questions:
? Would you open the store? ? Yes ? No
? If yes, would you tell your stockholders and let them vote
on the issue? ? Yes ? No ? If no, how would you respond to a stockholder query on why you were not living up to your social responsibilities?
69
So this is what can go wrong...
STOCKHOLDERS Have little control over managers Managers put their interests above stockholders Significant Social Costs Managers SOCIETY Bondholders can Some costs cannot be get ripped off traced to firm Lend Money Delay bad news or provide misleading information Markets make mistakes and can over react
BONDHOLDERS
FINANCIAL MARKETS
70
Traditional corporate financial theory breaks down when ...
? The interests/objectives of the decision makers in the firm conflict with the interests of stockholders. ? Bondholders (Lenders) are not protected against expropriation by stockholders.
? Financial markets do not operate efficiently, and stock prices do not reflect the underlying value of the firm. ? Significant social costs can be created as a byproduct of stock price maximization.
71
When traditional corporate financial theory breaks down, the solution is:
? To choose a different mechanism for corporate governance ? To choose a different objective: ? To maximize stock price, but reduce the potential for
conflict and breakdown:
? Making managers (decision makers) and employees into
stockholders ? By providing information honestly and promptly to financial markets
72
An Alternative Corporate Governance System
? Germany and Japan developed a different mechanism for
corporate governance, based upon corporate cross holdings.
? In Germany, the banks form the core of this system. ? In Japan, it is the keiretsus ? Other Asian countries have modeled their system after
Japan, with family companies forming the core of the new corporate families
73
Choose a Different Objective Function
? Firms can always focus on a different objective function.
Examples would include
? maximizing earnings ? maximizing revenues
? maximizing firm size
? maximizing market share ? maximizing EVA
74
Choose a Different Objective Function
? The key thing to remember is that these are
intermediate objective functions.
? To the degree that they are correlated with the long term
health and value of the company, they work well. ? To the degree that they do not, the firm can end up with a disaster
75
Maximize Stock Price, subject to ..
? The strength of the stock price maximization objective function is its internal self correction mechanism. ? Excesses on any of the linkages lead, if unregulated,
to counter actions which reduce or eliminate these excesses
76
The Bondholders’ Defense Against Stockholder Excesses
? More restrictive covenants on investment, financing and
dividend policy have been incorporated into both private lending agreements and into bond issues.
77
The Bondholders’ Defense Against Stockholder Excesses
? New types of bonds have been created to explicitly protect bondholders against sudden increases in leverage or other actions that increase lender risk substantially. Two examples of such bonds
? Puttable Bonds, where the bondholder can put the bond
back to the firm and get face value, if the firm takes actions that hurt bondholders ? Ratings Sensitive Notes, where the interest rate on the notes adjusts to that appropriate for the rating of the firm
78
The Bondholders’ Defense Against Stockholder Excesses
? More hybrid bonds (with an equity component, usually
in the form of a conversion option or warrant) have been used. This allows bondholders to become equity investors, if they feel it is in their best interests to do so.
79
The Financial Market Response
? While analysts are more likely still to issue buy rather than sell recommendations, the payoff to uncovering negative news about a firm is large enough that such news is eagerly sought and quickly revealed (at least to a limited group of investors)
? As information sources to the average investor proliferate, it is becoming much more difficult for firms to control when and how information gets out to markets.
80
The Financial Market Response
? As option trading has become more common, it has become much easier to trade on bad news. In the process, it is revealed to the rest of the market ? When firms mislead markets, the punishment is not
only quick but it is savage.
81
The Societal Response
? If firms consistently flout societal norms and create
large social costs, the governmental response (especially in a democracy) is for laws and regulations to be passed against such behavior.
? e.g.: Laws against using underage labor
82
The Societal Response
? For firms catering to a more socially conscious clientele, the failure to meet societal norms (even if it is legal) can lead to loss of business and value
? e.g. Specialty retailers being criticized for using under
age labor in other countries (where it might be legal)
? Finally, investors may choose not to invest in stocks of firms that they view as social outcasts.
? e.g.. Tobacco firms
83
The Counter Reaction
STOCKHOLDERS 1. More activist investors 2. Hostile takeovers Protect themselves Managers of poorly run firms are put on notice. Corporate Good Citizen Constraints
BONDHOLDERS
Managers
1. Covenants 2. New Types Firms are punished for misleading markets
SOCIETY
1. More laws 2. Investor/Customer Backlash
Investors and analysts become more skeptical
FINANCIAL MARKETS
84
So what do you think?
? Which is the right objective function for decision making in
a business: ? Maximize stock price or stockholder wealth, with no constraints ? Maximize stock price or stockholder wealth, with constraints on being a good social citizen. ? Maximize profits or profitability ? Maximize market share ? Maximize Revenues ? Maximize social good ? None of the above
85
The Modified Objective Function
? For publicly traded firms in reasonably efficient markets,
where bondholders (lenders) are protected:
? Maximize Stock Price: This will also maximize firm value
? For publicly traded firms in inefficient markets, where
bondholders are protected:
? Maximize stockholder wealth: This will also maximize firm value,
but might not maximize the stock price ? Maximize firm value, though stockholder wealth and stock prices may not be maximized at the same point.
86
The Modified Objective Function
? For private firms, maximize stockholder wealth (if
lenders are protected) or firm value (if they are not)
87
Factors that affect the value of a firm’s stock price:
? Cash flows
– – Cash is king, pays the bills Sales or profits not the same as cash inflows; you can’t spend them
? Timing of cash flows
– Cash received sooner is better than cash received later; time value of money
? Risk
– – Definite cash inflows are generally preferred to uncertain cash inflows Risky cash flow valued lower than definite cash flows; not all risk is the same
88
Three Determinants of Cash Flows
? Sales ? Current level ? Short-term growth rate in sales ? Long-term sustainable growth rate in sales ? Operating expenses ? Capital expenses
89
Factors that Affect the Level and Risk of Cash Flows
? Decisions made by financial managers: ? Investment decisions (product lines, production processes, geographic market, use of technology, marketing strategy) ? Financing decisions (choice of debt policy and dividend policy) ? The external environment
90
Careers in Finance
? Investment Banking
? Corporate Finance ? Commercial Banking
? Insurance
91
Investment Banking
? ? ? ? ? ? ? ? ? ? ? ?
Mergers and Acquisitions Project Finance Trading Structured Finance Derivatives Advisory Equity and Fixed Income Research International Sales/Emerging Markets Public Finance Retail Brokerage (Stockbroker) Institutional Sales Ratings Analyst
92
Corporate Finance
? Treasurer
? Financial Analyst ? Credit Manager
? Cash Manager
? Benefits Officer (Provident Fund) ? Investor Relations Officer
? Controller
? Financial Planning
93
Commercial Banks
? Credit Analyst
? Loan Officer ? Branch Manager
? Mortgage Banker
? Personal Banking
94
Insurance
? Actuary
? Agent and Broker ? Claims Adjuster
? Loss Control Specialist
? Risk Manager / Underwriter
95
Assignment
? Examine the overview and critical skills and talent for
positions in Commercial Banking, Corporate Finance and Investment Banking. What similarities do you find in the skills and talents for these finance jobs? Are there any significant differences in the skills and talent sections for the positions? ? What appear to be the critical differences between the Treasurer and the Controller? ? How is the outlook for women in the field? What levels of salaries can CFOs hope to attain? ? What are the simple themes - examine management issues in the corporate finance area - that appear to set the best companies apart?
? Assignment Date: June 30, 2007
96
Financial Functions in a Corporation
? Planning
? Provision of Capital
? Administration of Funds ? Accounting and Control
? Protection of Assets
? Tax Administration ? Investor Relations
? Evaluation and Consulting
? Management Information Systems
97
Responsibilities of Financial Manager
? Investment and financing decisions
? Dealing with the financial markets
? Forecasting and planning ? Coordination and control ? Risk Management
98
Duties of Financial Managers
? ? ? ? ? ?
Measure a firm’s performance Forecast financial consequences Recommend new investment Locate external financing Recommend best financing mix Determine financial expectations of owners
99
Planning
? long and short-term financial planning ? budgeting for capital expenditures ? budgeting for operations ? sales forecasting ? performance evaluation ? pricing policies ? economic appraisals ? analysis of acquisitions and divestments
100
Accounting and Control
? ? ? ? ? ? ? ?
establishment of accounting policies development & reporting of accounting data cost standards internal auditing systems and procedures (accounting) government reporting reporting & interpreting operations results comparing performance with operating plans and standards
101
A Simplified Organizational Chart
102
Three Interrelated Areas
Capital Markets & Institutions
Financial Management
Investments
103
Role of The Financial Manager
(1)
Firm's operations Financial manager Financial markets
(1) Cash raised from investors
104
Role of The Financial Manager
(2) (1)
Firm's operations Financial manager Financial markets
(1) Cash raised from investors (2) Cash invested in firm
105
Role of The Financial Manager
(2) (1)
Firm's operations Financial manager Financial markets
(3)
(1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations
106
Role of The Financial Manager
(2) (1)
Firm's operations Financial manager
(4a)
Financial markets
(3)
(1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested
107
Role of The Financial Manager
(2) (1)
Firm's operations Financial manager
(4a)
Financial markets
(3)
(1) Cash raised from investors (2) Cash invested in firm
(4b)
(3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors
108
Who is The Financial Manager?
Chief Financial Officer
109
Who is The Financial Manager?
Chief Financial Officer
Treasurer
Comptroller
110
Stakeholders and Competing Desires
? Stakeholder:
? Managers ? Creditors ? Customers ? Employees ? Suppliers ? Society ? Owners
What their goals are (what they want):
High Salary and perquisites. Low risk, return of their money and interest Low prices and lots of features High salaries, job security High prices and long relationships Good citizenship and taxes Dividends or stock appreciation
111
Summary
? A corporation has many stakeholders with conflicting
?
?
?
?
?
desires. Wealth creation for the shareholders is our goal. Accounting income is not a sufficient measure of performance because it ignores risk and the cost of the invested funds. Economic profit and net present value are two ways we measure wealth creation in a single period and multiple periods. Capital projects create most of the wealth for the firm but not all projects are equal or should even be considered. Strategy and competitive advantage should guide the capital budgeting process.
112
doc_216454744.pptx
the different areas which finance covers, what are Various types of Corporate Entities, principles of corporate finance. It also explains agency cost problem, Stockholder Interests vs. Management Interests, Stockholders' objectives vs. Bondholders' objectives. It also includes factors that affect the Level and risk of cash flows.
Corporate Finance and the Financial Manager
1
Contents
? Areas of Finance
? What are Various types of Corporate Entities? ? Role of the Finance Manager
? Separation of Ownership & Management
? Financial Markets
2
4 Basic Areas of Finance
? Corporate Finance
? Investments/ Investment Banking ? Financial Institutions/ Commercial Banking
? International Finance
? Insurance ? Other Financial Services
3
Financial Environment
? Businesses interact continually with the financial
markets. ? Financial Markets – all institutions and procedures for bringing buyers and sellers of financial instruments together. ? The purpose of financial markets is to efficiently allocate savings to ultimate users.
4
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
5
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES INVESTMENT SECTOR Businesses Government Households
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
6
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES SAVINGS SECTOR Households Businesses Government
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
7
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES FINANCIAL BROKERS Investment Bankers Mortgage Bankers
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
8
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES FINANCIAL INTERMEDIARIES
FINANCIAL BROKERS
SECONDARY MARKET
Commercial Banks Savings Institutions Insurance Cos. Pension Funds Finance Companies Mutual Funds
SAVINGS SECTOR
9
Flow of Funds in the Economy
INVESTMENT SECTOR FINANCIAL INTERMEDIARIES SECONDARY MARKET Security Exchanges OTC Market
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
10
Corporate Structure
There are 3 types of basic organizational forms ? Sole Proprietorship ? Partnership ? Corporation
? Private Limited ? Public Limited
11
Corporate Structure
Sole Proprietorships Unlimited Liability Personal tax on profits Partnerships Limited Liability Corporations Corporate tax on profits + Personal tax on dividends
12
SOLE PROPRIETORSHIP One Owner
All you need to do is just start operating ? Advantages
? Easy and inexpensive to form ? Few government regulations & reporting requirements ? No corporate income tax, only personal income tax
? Disadvantages
? Hard to obtain large amounts of borrowing
? Unlimited liability (owner liable for total debt)
? Difficult to transfer ownership
13
PARTNERSHIP written) between owners as to: An agreement (verbal or
? % of capital invested by each partner
? How are profits shared? ? How is it dissolved and/or ownership transferred?
? Same advantages and disadvantages as above ? Usually larger enterprise than sole proprietorship.
14
?
CORPORATION Needs to be registered
? Owners receive shares in corporation ? Shareholders elect board of directors. ? Board members expected to oversee the “proper” running of the company. ? Board of directors appoints managers, generally different from owners,
and is expected to ensure that managers act in the best interest of shareholders. ? Advantages
? unlimited life ? easy transfer of ownership ? limited liability; maximum loss is your investment in company
? Easier to raise capital; more info is publicly available on company
? Disadvantages
? double taxation: corporate earnings & dividend received ? increase in SEBI / RoC regulation and reporting.
15
What three questions does financial management seek to answer?
? What causes a company to have a
particular stock value?
? How can managers make choices that
add value to their companies?
? How can managers ensure that their
companies don’t run out of cash while executing their plans?
16
What is corporate finance?
? Every decision that a business makes has financial
implications. ? Any decision which affects the finances of a business is a corporate finance decision. ? Defined broadly, everything that a business does fits under the rubric of corporate finance.
17
The Three Major Decisions in Corporate Finance
? The Allocation decision ? Where do you invest the scarce resources of your business? ? What makes for a good investment?
18
The Three Major Decisions in Corporate Finance
? The Financing decision ? Where do you raise the funds for these investments? ? Generically, what mix of owner’s money (equity) or borrowed money(debt) do you use?
19
The Three Major Decisions in Corporate Finance
? The Dividend Decision ? How much of a firm’s funds should be reinvested in the business and how much should be returned to the owners?
20
1st Principles of Corporate Finance
? Invest in projects that yield a return greater than the minimum acceptable hurdle rate (or cost of capital).
? The hurdle rate should be higher for riskier projects and
reflect the financing mix used - owners’ funds (equity) or borrowed money (debt) ? Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects.
21
1st Principles of Corporate Finance
? Choose a financing mix that minimizes the hurdle rate
and matches the assets being financed. ? If there are not enough investments that earn the hurdle rate, return the cash to stockholders. ? The form of returns - dividends and stock buybacks - will depend upon the stockholders’ characteristics.
Objective: Maximize the Value of the Firm
22
Why do we need an objective?
? An objective specifies what a decision maker is trying to
accomplish and by so doing, provides measures that can be used to choose between alternatives.
23
Characteristics of a Good Objective Function
? It is clear and unambiguous
? It comes with a clear and timely measure that can be
used to evaluate the success or failure of decisions. ? It does not create costs for other entities or groups that erase firm-specific benefits and leave society worse off overall.
24
The Objective in Decision Making
? In traditional corporate finance, the objective in decision
making is to maximize the value of the firm. ? A narrower objective is to maximize stockholder wealth. When the stock is traded and markets are viewed to be efficient, the objective is to maximize the stock price.
25
Why traditional corporate financial theory often focuses on maximizing stock prices as opposed to firm value
? Stock price is easily observable and constantly updated
(unlike other measures of performance, which may not be as easily observable, and certainly not updated as frequently). ? The stock price is a real measure of stockholder wealth, since stockholders can sell their stock and receive the price now.
26
Maximize stock prices as the only objective function
? For stock price maximization to be the only objective in
decision making, we have to assume that
? The decision makers (managers) are responsive to the
owners (stockholders) of the firm ? Stockholder wealth is not being increased at the expense of bondholders and lenders to the firm; only then is stockholder wealth maximization consistent with firm value maximization.
27
Maximize stock prices as the only objective function
? For stock price maximization to be the only objective in
decision making, we have to assume that
? Markets are efficient; only then will stock prices reflect
stockholder wealth. ? There are no significant social costs; only then will firms maximizing value be consistent with the welfare of all of society.
28
The Classical Objective Function
STOCKHOLDERS Hire & fire managers - Board - Annual Meeting Lend Money Maximize stockholder wealth
BONDHOLDERS
Protect bondholder Interests
Managers
No Social Costs
SOCIETY
Costs can be traced to firm
Reveal information honestly and on time
Markets are efficient and assess effect on value
FINANCIAL MARKETS
29
Another Way of Presenting this is...
30
Goal of the Firm
Why Not Profit Maximization?
This goal ignores:
Time Value of Money Risk-Return Tradeoff
31
The Goal of Financial Management
The Goal of Financial Management
? What are firm decision-makers hired to do?
“General Motors is not in the business of making automobiles. General Motors is in the business of making money.”
--Alfred P. Sloan
? Possible goals
? Three equivalent goals of financial management:
Maximize shareholder wealth Maximize share price
32
Corporate Finance
1. 2. 3.
Corporate Finance addresses the following three questions:
What long-term investments (projects) should the firm engage in? – Capital Budgeting How can the firm raise the money for these investments? – Capital Structure How much short-term cash flow does a company need to pay its bills? – Working Capital Management
33
The Four Basic Areas of Finance Corporate Finance
? Long-term investments ? Capital Budgeting ? Long-term financing ? Capital Structure ? Short-term financing ? Working Capital Management ? Risk management ? Derivative securities
34
The Balance-Sheet Model of the Firm
The Capital Budgeting Decision
Current Liabilities Current Assets Long-Term Debt
Fixed Assets 1 Tangible 2 Intangible
What longterm investments should the firm engage in?
Shareholders’ Equity
35
The Balance-Sheet Model of the Firm
The Capital Structure Decision
Current Liabilities Current Assets Long-Term Debt
Fixed Assets 1 Tangible
2 Intangible
How can the firm raise the money for the required investments?
Shareholders’ Equity
36
The Balance-Sheet Model of the Firm
The Net Working Capital Investment Decision
Current Liabilities Current Assets Net Working Capital Long-Term Debt
Fixed Assets
1 Tangible
2 Intangible
How much short-term cash flow does a company need to pay its bills?
Shareholders’ Equity
37
Cash Flows Between the Firm and the Financial Markets
38
Financial Markets
? Primary Market ? When a corporation issues securities, cash flows from investors to the firm. ? Usually an underwriter is involved ? Secondary Markets ? Involve the sale of “used” securities from one investor to another. ? Securities may be exchange traded or trade over-thecounter in a dealer market.
39
Financial Markets
Firms Stocks and Bonds Money A money Primary Market Investors securities B
Secondary Market
40
Separation of Ownership and Control
Board of Directors Shareholders Debtholders Management
Assets
Debt Equity
41
Finance Manager’s role
? What investments the firms should make?
? How should it finance those investments? ? Manage / service all stakeholders
42
Finance Manager’s Role
? Maximize the wealth of the Shareholders
? Pursue strategies, goals and policies to maximize
market cap or wealth ? Increase the value of the firm
43
Maximizing Market Value
? Making "best use" of existing operations/projects
through reengineering of products and processes. ? Creating additional market value by undertaking all "profitable“ investment projects such as:
? expansion into new areas of business ? expansion of existing line of business ? correct sizing ? choosing "best" dividend policy
? choosing "best" mix of financing sources
? choosing "best" organizational structure: flat vs.
hierarchy
44
Corporate Finance Decision
? Long-term investments ? Capital Budgeting ? Long-term financing ? Capital Structure ? Short-term financing ? Working Capital Management ? Risk management ? Derivative securities
45
Real Assets v/s Financial Assets
Firms Operate on Real Assets Fixed Assets Current Assets Tech knowhow Patents, Others Real Assets Purchase Real assets Finance Manager Sell securities for cash Financial Markets
Generate cash flows Re-invest in business
Repay loans
Investors Banks VCs Shareholder s Other Holders of financial assets
46
Who is The Financial Manager?
Chief Financial Officer
Treasurer
Comptroller
47
Ownership vs. Management
Difference in Information
? Stock prices and
Different Objectives
? Managers vs.
returns ? Issues of shares and other securities ? Dividends ? Financing
stockholders ? Top mgmt vs. operating mgmt ? Stockholders vs. banks and lenders
48
Manager’s Objective
? Objective of manager: ? high pay, prestige, leisure, and high dislike for risk ? Justification being: ? threat of hostile takeover, bankruptcy, & firing, manager would lose her job if does not meet objective.
49
The Agency Cost Problem
? The interests of managers, stockholders, bondholders
and society can diverge. What is good for one group may not necessarily for another.
? Managers may have other interests (job security, perks,
compensation) that they put over stockholder wealth maximization. ? Actions that make stockholders better off (increasing dividends, investing in risky projects) may make bondholders worse off.
50
The Agency Cost Problem
? Actions that increase stock price may not necessarily
increase stockholder wealth, if markets are not efficient or information is imperfect. ? Actions that makes firms better off may create such large social costs that they make society worse off. ? Agency costs refer to the conflicts of interest that arise between all of these different groups.
51
What can go wrong?
STOCKHOLDERS Have little control over managers Managers put their interests above stockholders Significant Social Costs SOCIETY Some costs cannot be traced to firm
Lend Money
BONDHOLDERS
Managers
Bondholders can get ripped off Delay bad news or provide misleading information
Markets make mistakes and can over react
FINANCIAL MARKETS
52
Stockholder Interests vs. Management Interests
? Theory: The stockholders have significant control over
management. The mechanisms for disciplining management are the annual meeting and the board of directors. ? Practice: Neither mechanism is as effective in disciplining management as theory posits.
53
The Annual Meeting as a disciplinary venue
? The power of stockholders to act at annual meetings is diluted by
three factors
? Most small stockholders do not go to meetings because the cost of
going to the meeting exceeds the value of their holdings. ? Incumbent management starts off with a clear advantage when it comes to the exercising of proxies. Proxies that are not voted becomes votes for incumbent management. ? For large stockholders, the path of least resistance, when confronted by managers that they do not like, is to vote with their feet.
54
ask the necessary tough questions..
? The CEO sets the agenda, chairs the meeting and
controls the information. ? The search for consensus overwhelms any attempts at confrontation.
55
Application Test: Who’s on board?
? Look at the board of directors for Listed companies.
Analyze
? How many of the directors are inside directors
(Employees of the firm, ex-managers)? ? Is there any information on how independent the directors in the firm are from the managers?
56
Application Test: Who owns/runs the firm?
Looking at the top 15 stockholders in the firm, consider the following:
? How many of the top 15 investors are institutional
investors? ? How many of the top 15 investors are individual investors? ? Are managers significant stockholders in the firm?
57
Overpaying on takeovers
? The quickest and perhaps the most decisive way
to impoverish stockholders is to overpay on a takeover. ? The stockholders in acquiring firms do not seem to share the enthusiasm of the managers in these firms. ? Stock prices of bidding firms decline on the takeover announcements a significant proportion of the time.
58
Stockholders' objectives vs. Bondholders' objectives
? In theory: there is no conflict of interests between
stockholders and bondholders. ? In practice: Stockholders may maximize their wealth at the expense of bondholders.
? Increasing dividends significantly: When firms pay cash out
as dividends, lenders to the firm are hurt and stockholders may be helped. This is because the firm becomes riskier without the cash.
59
Stockholders' objectives vs. Bondholders' objectives
? In practice: Stockholders may maximize their wealth at the
expense of bondholders.
? Taking riskier projects than those agreed to at the outset:
Lenders base interest rates on their perceptions of how risky a firm’s investments are. If stockholders then take on riskier investments, lenders will be hurt. ? Borrowing more on the same assets: If lenders do not protect themselves, a firm can borrow more money and make all existing lenders worse off.
60
Firms and Financial Markets
? In theory: Financial markets are efficient. Managers convey
information honestly and truthfully to financial markets, and financial markets make reasoned judgments of 'true value'. As a consequence? A company that invests in good long term projects will be rewarded.
? Short term accounting gimmicks will not lead to increases in market
value. ? Stock price performance is a good measure of management performance.
? In practice: There are some holes in the 'Efficient Markets'
assumption.
61
Managers control the release of information to the general public
? There is evidence that ? they suppress information, generally negative information ? they delay the releasing of bad news
?
?
bad earnings reports other news
? they sometimes reveal fraudulent information
62
Value set by Market may contain errors.
? Prices are much more volatile than justified by the underlying fundamentals ? Financial markets overreact to news, both good and bad ? Financial markets are short-sighted, and do not consider the long-term implications of actions taken by the firm
? Eg. the focus on next quarter's earnings
? Financial markets are manipulated by insiders; Prices do not have any relationship to value.
63
Are Markets Short term?
? Focusing on market prices will lead companies towards
short term decisions at the expense of long term value. ? I agree with the statement ? I do not agree with this statement
64
Are Markets Short Sighted? Some evidence that they are not..
? There are hundreds of start-up and small firms, with no
earnings expected in the near future, that raise money on financial markets ? If the evidence suggests anything, it is that markets do not value current earnings and cashflows enough and value future earnings and cashflows too much. ? The market response to research and development and investment expenditure is generally positive
65
Market Reaction to Investment Announcements
Type of Announcement Abnormal Returns on Announcement Day
Joint Venture Formations R&D Expenditures Product Strategies Capital Expenditures All Announcements 0.399% 0.251% 0.440% 0.290% 0.355%
Announcement Month
1.412% 1.456% -0.35% 1.499% 0.984%
66
Firms and Society
? In theory: There are no costs associated with the firm that cannot be traced to the firm and charged to it. ? In practice: Financial decisions can create social costs and benefits.
? A social cost or benefit is a cost or benefit that accrues to
society as a whole and NOT to the firm making the decision.
? ?
-environmental costs (pollution, health costs, etc..) Quality of Life' costs (traffic, housing, safety, etc.)
? Examples of social benefits include: ? creating employment in areas with high unemployment ? supporting development in inner cities
67
A Hypothetical Example
Assume that you work for The Big Bazaar and that you have an opportunity to open a store in an inner-city neighborhood. The store is expected to lose about Rs.10 lacs a year, but it will create much-needed employment in the area, and may help revitalize it.
68
A Hypothetical Example
? Questions:
? Would you open the store? ? Yes ? No
? If yes, would you tell your stockholders and let them vote
on the issue? ? Yes ? No ? If no, how would you respond to a stockholder query on why you were not living up to your social responsibilities?
69
So this is what can go wrong...
STOCKHOLDERS Have little control over managers Managers put their interests above stockholders Significant Social Costs Managers SOCIETY Bondholders can Some costs cannot be get ripped off traced to firm Lend Money Delay bad news or provide misleading information Markets make mistakes and can over react
BONDHOLDERS
FINANCIAL MARKETS
70
Traditional corporate financial theory breaks down when ...
? The interests/objectives of the decision makers in the firm conflict with the interests of stockholders. ? Bondholders (Lenders) are not protected against expropriation by stockholders.
? Financial markets do not operate efficiently, and stock prices do not reflect the underlying value of the firm. ? Significant social costs can be created as a byproduct of stock price maximization.
71
When traditional corporate financial theory breaks down, the solution is:
? To choose a different mechanism for corporate governance ? To choose a different objective: ? To maximize stock price, but reduce the potential for
conflict and breakdown:
? Making managers (decision makers) and employees into
stockholders ? By providing information honestly and promptly to financial markets
72
An Alternative Corporate Governance System
? Germany and Japan developed a different mechanism for
corporate governance, based upon corporate cross holdings.
? In Germany, the banks form the core of this system. ? In Japan, it is the keiretsus ? Other Asian countries have modeled their system after
Japan, with family companies forming the core of the new corporate families
73
Choose a Different Objective Function
? Firms can always focus on a different objective function.
Examples would include
? maximizing earnings ? maximizing revenues
? maximizing firm size
? maximizing market share ? maximizing EVA
74
Choose a Different Objective Function
? The key thing to remember is that these are
intermediate objective functions.
? To the degree that they are correlated with the long term
health and value of the company, they work well. ? To the degree that they do not, the firm can end up with a disaster
75
Maximize Stock Price, subject to ..
? The strength of the stock price maximization objective function is its internal self correction mechanism. ? Excesses on any of the linkages lead, if unregulated,
to counter actions which reduce or eliminate these excesses
76
The Bondholders’ Defense Against Stockholder Excesses
? More restrictive covenants on investment, financing and
dividend policy have been incorporated into both private lending agreements and into bond issues.
77
The Bondholders’ Defense Against Stockholder Excesses
? New types of bonds have been created to explicitly protect bondholders against sudden increases in leverage or other actions that increase lender risk substantially. Two examples of such bonds
? Puttable Bonds, where the bondholder can put the bond
back to the firm and get face value, if the firm takes actions that hurt bondholders ? Ratings Sensitive Notes, where the interest rate on the notes adjusts to that appropriate for the rating of the firm
78
The Bondholders’ Defense Against Stockholder Excesses
? More hybrid bonds (with an equity component, usually
in the form of a conversion option or warrant) have been used. This allows bondholders to become equity investors, if they feel it is in their best interests to do so.
79
The Financial Market Response
? While analysts are more likely still to issue buy rather than sell recommendations, the payoff to uncovering negative news about a firm is large enough that such news is eagerly sought and quickly revealed (at least to a limited group of investors)
? As information sources to the average investor proliferate, it is becoming much more difficult for firms to control when and how information gets out to markets.
80
The Financial Market Response
? As option trading has become more common, it has become much easier to trade on bad news. In the process, it is revealed to the rest of the market ? When firms mislead markets, the punishment is not
only quick but it is savage.
81
The Societal Response
? If firms consistently flout societal norms and create
large social costs, the governmental response (especially in a democracy) is for laws and regulations to be passed against such behavior.
? e.g.: Laws against using underage labor
82
The Societal Response
? For firms catering to a more socially conscious clientele, the failure to meet societal norms (even if it is legal) can lead to loss of business and value
? e.g. Specialty retailers being criticized for using under
age labor in other countries (where it might be legal)
? Finally, investors may choose not to invest in stocks of firms that they view as social outcasts.
? e.g.. Tobacco firms
83
The Counter Reaction
STOCKHOLDERS 1. More activist investors 2. Hostile takeovers Protect themselves Managers of poorly run firms are put on notice. Corporate Good Citizen Constraints
BONDHOLDERS
Managers
1. Covenants 2. New Types Firms are punished for misleading markets
SOCIETY
1. More laws 2. Investor/Customer Backlash
Investors and analysts become more skeptical
FINANCIAL MARKETS
84
So what do you think?
? Which is the right objective function for decision making in
a business: ? Maximize stock price or stockholder wealth, with no constraints ? Maximize stock price or stockholder wealth, with constraints on being a good social citizen. ? Maximize profits or profitability ? Maximize market share ? Maximize Revenues ? Maximize social good ? None of the above
85
The Modified Objective Function
? For publicly traded firms in reasonably efficient markets,
where bondholders (lenders) are protected:
? Maximize Stock Price: This will also maximize firm value
? For publicly traded firms in inefficient markets, where
bondholders are protected:
? Maximize stockholder wealth: This will also maximize firm value,
but might not maximize the stock price ? Maximize firm value, though stockholder wealth and stock prices may not be maximized at the same point.
86
The Modified Objective Function
? For private firms, maximize stockholder wealth (if
lenders are protected) or firm value (if they are not)
87
Factors that affect the value of a firm’s stock price:
? Cash flows
– – Cash is king, pays the bills Sales or profits not the same as cash inflows; you can’t spend them
? Timing of cash flows
– Cash received sooner is better than cash received later; time value of money
? Risk
– – Definite cash inflows are generally preferred to uncertain cash inflows Risky cash flow valued lower than definite cash flows; not all risk is the same
88
Three Determinants of Cash Flows
? Sales ? Current level ? Short-term growth rate in sales ? Long-term sustainable growth rate in sales ? Operating expenses ? Capital expenses
89
Factors that Affect the Level and Risk of Cash Flows
? Decisions made by financial managers: ? Investment decisions (product lines, production processes, geographic market, use of technology, marketing strategy) ? Financing decisions (choice of debt policy and dividend policy) ? The external environment
90
Careers in Finance
? Investment Banking
? Corporate Finance ? Commercial Banking
? Insurance
91
Investment Banking
? ? ? ? ? ? ? ? ? ? ? ?
Mergers and Acquisitions Project Finance Trading Structured Finance Derivatives Advisory Equity and Fixed Income Research International Sales/Emerging Markets Public Finance Retail Brokerage (Stockbroker) Institutional Sales Ratings Analyst
92
Corporate Finance
? Treasurer
? Financial Analyst ? Credit Manager
? Cash Manager
? Benefits Officer (Provident Fund) ? Investor Relations Officer
? Controller
? Financial Planning
93
Commercial Banks
? Credit Analyst
? Loan Officer ? Branch Manager
? Mortgage Banker
? Personal Banking
94
Insurance
? Actuary
? Agent and Broker ? Claims Adjuster
? Loss Control Specialist
? Risk Manager / Underwriter
95
Assignment
? Examine the overview and critical skills and talent for
positions in Commercial Banking, Corporate Finance and Investment Banking. What similarities do you find in the skills and talents for these finance jobs? Are there any significant differences in the skills and talent sections for the positions? ? What appear to be the critical differences between the Treasurer and the Controller? ? How is the outlook for women in the field? What levels of salaries can CFOs hope to attain? ? What are the simple themes - examine management issues in the corporate finance area - that appear to set the best companies apart?
? Assignment Date: June 30, 2007
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Financial Functions in a Corporation
? Planning
? Provision of Capital
? Administration of Funds ? Accounting and Control
? Protection of Assets
? Tax Administration ? Investor Relations
? Evaluation and Consulting
? Management Information Systems
97
Responsibilities of Financial Manager
? Investment and financing decisions
? Dealing with the financial markets
? Forecasting and planning ? Coordination and control ? Risk Management
98
Duties of Financial Managers
? ? ? ? ? ?
Measure a firm’s performance Forecast financial consequences Recommend new investment Locate external financing Recommend best financing mix Determine financial expectations of owners
99
Planning
? long and short-term financial planning ? budgeting for capital expenditures ? budgeting for operations ? sales forecasting ? performance evaluation ? pricing policies ? economic appraisals ? analysis of acquisitions and divestments
100
Accounting and Control
? ? ? ? ? ? ? ?
establishment of accounting policies development & reporting of accounting data cost standards internal auditing systems and procedures (accounting) government reporting reporting & interpreting operations results comparing performance with operating plans and standards
101
A Simplified Organizational Chart
102
Three Interrelated Areas
Capital Markets & Institutions
Financial Management
Investments
103
Role of The Financial Manager
(1)
Firm's operations Financial manager Financial markets
(1) Cash raised from investors
104
Role of The Financial Manager
(2) (1)
Firm's operations Financial manager Financial markets
(1) Cash raised from investors (2) Cash invested in firm
105
Role of The Financial Manager
(2) (1)
Firm's operations Financial manager Financial markets
(3)
(1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations
106
Role of The Financial Manager
(2) (1)
Firm's operations Financial manager
(4a)
Financial markets
(3)
(1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested
107
Role of The Financial Manager
(2) (1)
Firm's operations Financial manager
(4a)
Financial markets
(3)
(1) Cash raised from investors (2) Cash invested in firm
(4b)
(3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors
108
Who is The Financial Manager?
Chief Financial Officer
109
Who is The Financial Manager?
Chief Financial Officer
Treasurer
Comptroller
110
Stakeholders and Competing Desires
? Stakeholder:
? Managers ? Creditors ? Customers ? Employees ? Suppliers ? Society ? Owners
What their goals are (what they want):
High Salary and perquisites. Low risk, return of their money and interest Low prices and lots of features High salaries, job security High prices and long relationships Good citizenship and taxes Dividends or stock appreciation
111
Summary
? A corporation has many stakeholders with conflicting
?
?
?
?
?
desires. Wealth creation for the shareholders is our goal. Accounting income is not a sufficient measure of performance because it ignores risk and the cost of the invested funds. Economic profit and net present value are two ways we measure wealth creation in a single period and multiple periods. Capital projects create most of the wealth for the firm but not all projects are equal or should even be considered. Strategy and competitive advantage should guide the capital budgeting process.
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