CHAPTER 1 Disadvantages:

o Cost of set-up and report filing

What is Finance?
o Double taxation
 Finance is concerned with decisions Hybrid Forms of Business
about money (Cash Flows)  Limited Liability Partnership (LLP)
 Finance decisions deal with how money  Limited Liability Company (LLC)
is raised and used  S Corporation
 Everything else being equal: Business Organized as a Corporation:
Value Maximized
 More value is preferred to less
 Limited liability reduces risk increasing
 The sooner cash is received the market value
more value it has  Ease of raising capital allows taking
advantage of growth opportunities
 Less risky assets are more
valuable than riskier assets  Ownership can be easily transferred
thus investors would be willing to pay
General Areas of Finance more for a corporation
Goals of the Corporation
 Financial Markets and Institutions
 Primary goal: stockholder wealth
 Investments
maximization — translates to
 Financial Services
maximizing stock price.
 Managerial Finance
 Managerial incentives
Alternative Forms of Business Organization
 Social responsibility
 Proprietorship
Managerial Actions to Maximize
Advantages:
Stockholder Wealth
o Ease of formation
 Capital Structure Decisions
o Subject to few government
 Capital Budgeting Decisions
regulations
o No corporate income taxes  Dividend Policy Decisions
Limitations: Factors Influenced by Managers that Affect
o Unlimited personal liability Stock Price
o Limited life  Projected cash flows
o Transferring ownership is difficult  Timing of cash flow streams
o Difficult to raise capital  Risk of projected cash flows (earnings)
 Partnership  Use of debt (capital structure)
 Like a proprietorship, except two  Dividend policy
or more owners Agency Relationships
 A partnership has roughly the  An agency relationship exists whenever
same advantages and limitations as a principal hires an agent to act on his
a proprietorship or her behalf.
 Corporation  An agency problem results when the
Advantages: agent makes decisions that are not in
o Unlimited life the best interest of principals
o Easy transfer of ownership Stockholders versus Managers
o Limited liability  Managers are naturally inclined to act in
o Ease of raising capital their own best interests.
  Mechanisms to motivate managers to  Political risk
act in shareholder’s best interest
 Managerial compensation
(incentives) CHAPTER 2
 Shareholder intervention
The Annual Report
 Threat of takeover
Business Ethics  Discussion of Operations
 Webster: “A standard of conduct and
 Usually a letter from the chairman
moral behavior.”
 Business Ethics: A company’s attitude  Financial Statements
and conduct toward its employees,
 The Income Statement
customers, community, and
stockholders  The Balance Sheet
Corporate Governance
 Statement of Cash Flows
 The “set of rules’ that a firm follows
when conducting business  Statement of Retained Earnings
 As a result of the Sarbanes-Oxley Act of
Financial Statements
2002, firms are revising their corporate
governance policies  The Balance Sheet
 Good corporate governance generates  Represents a picture taken on a
higher returns to stockholders specific date that shows a firm’s
Forms of Business in Other Countries assets and how those assets are
 Non-US firms have higher financed (debt or equity)
concentrations of ownership  Cash & equivalents versus other
 Nature of relationship with assets
financial institutions differs  All assets stated in dollars - only
from U.S. cash and equivalents represent
 U.S. firms have a more dispersed money that can be spent
ownership  Accounting alternatives – e.g., FIFO
Multinational Corporations versus LIFO
Five reasons firms go “international”  Breakdown of the common equity
1. To seek new markets account
2. To seek raw materials  Common stock at par, paid-in
3. To seek new technology capital & retained earnings
4. To seek production efficiency  Book values often do not equal
5. To avoid political and regulatory hurdles market values
Factors Distinguishing Domestic Firms  The time dimension
from  A snapshot of the firm’s financial
Multinational Firms position during a specified period
 Different currency denominations of time
 Economic and legal ramifications  The Income Statement
 Language differences  Presents the results of business
operations during a specified period
 Cultural differences
of time
 Role of governments
  Summarizes the revenues generated statement accounts within firms and
and the expenses incurred between firms
 Statement of Cash Flows
The Purpose of Ratio Analysis
 Designed to show how the firm’s
operations have affected its cash  Gives an idea of how well the company
position is doing
 Examines investment decisions  Standardizes numbers; facilitates
(uses of cash) comparisons
 Examines financing decisions  Used to highlight weaknesses and
(sources of cash) strengths
 Statement of Retained Earnings
Five Major Categories of Ratios
 Changes in the common equity
accounts between balance sheet  Liquidity: is the firm able to meet its
dates current obligations
What Information Do Investors Use from
 Asset management: is the firm
Financial Statements
effectively managing its assets
 Net working capital
 Debt management: does the firm have
 = NWC = Current assets -
the right mix of debt and equity
Current liabilities
 Profitability: the combined effects of
 Operating cash flow
liquidity, asset and debt management
 = NOI (1-Tax rate) + Depreciation
 Market values: relates the firm’s stock
and amortization expense
price to its earnings and the book value
 = Net operating profit after taxes per share
+ Depreciation and amortization
expense
CHAPTER 3
 Free cash flow
The Financial Markets
 = FCF = operating cash flow -
Investments  Financial markets are a system that
includes individuals and institutions,
 = Operating cash flow - ( in fixed
instruments, and procedures that bring
assets + NOWC)
together borrowers and savers no
 Economic Value Added matter the location

 =EVA = NOI (1 - Tax rate) -  The primary role of financial markets is

[(Invested capital) X (After-tax to facilitate the flow of funds from
cost of capital as a percent)] individuals and businesses that have
surplus funds to individuals, businesses,
Financial Statement (Ratio) Analysis
and governments that need funds in
 Ratios are accounting numbers excess of their incomes
translated into relative values Flow of Funds
 Ratios are designed to show
relationships between financial  Three financial phases
  Young adults borrow  The primary market - additional shares
sold by established, publicly owned
 Older working adults save
companies
 Retired adults use savings
 IPO market - new public offerings by
 Funds transferred from savers to privately held firms
borrowers
Stock Markets
 Direct transfer
 Physical stock exchanges
 Investment banking house
 NYSE, AMEX, and regional
 Financial intermediary exchanges

Market Efficiency  Exchange members

 Economic Efficiency - Funds are  Floor brokers

allocated to their optimal use at the
 Specialists
lowest costs
 To have a stock listed
 Informational Efficiency - Investment
prices are adjusted quickly to reflect  Apply to the exchange
current information
 Pay a relatively small fee
 Weak-form - all information
 Meet the exchange’s minimum
contained in past price
requirements
movements is reflected in current
market prices  Over-the-Counter Markets and the
Nasdaq
 Semistrong-form - current prices
reflect all publicly available  Network of brokers and dealers
information
 Auction market
 Strong-form current prices reflect
 Organized Investment Network
all pertinent information, both
public and private  Electronic Communications
Networks
Types of Financial Markets
Regulation of Securities Markets
 Money versus capital markets
 Securities and Exchange Commission
 Debt versus equity markets
(SEC)
 Primary versus secondary markets
 Jurisdiction over most interstate
 Derivatives markets offerings of new securities to the
general public
General Stock Market Activities
 Regulation of national securities
 The secondary market - trading in the
exchanges
outstanding, previously issued shares of
established, publicly owned companies  Power to prohibit manipulation of
securities’ prices
  Control over stock trades by associated with the purchase and
corporate insiders distribution of a new issuance of
securities
The Investment Banking Process
 Lead or Managing Underwriter:
 Investment Banker
The member of an underwriting
 Helps corporations design syndicate who actually manages
securities attractive to investors the distribution and sale of a new
security offering
 Buys these securities from the
corporation  Selling Group: A network of
brokerage firms formed for the
 Resells the securities to investors
purpose of distributing a new
 Raising Capital: Stage I Decisions issuance of securities

 Dollars to be raised  Shelf Registrations

 Type of securities used  Securities registered with the

SEC for sale at a later date
 Competitive bid versus
negotiated deal  Held “on the shelf” until the sale

 Selection of an investment  Maintenance of the Secondary Market

banker
 When a company is going public
 Raising Capital: Stage II Decisions for the first time, the investment
banker is obligated to maintain a
 Reevaluating the initial decisions
market for the shares after the
 Best efforts or underwritten issue has been completed.
issues
 The lead underwriter agrees to
 Underwritten Arrangement “make a market” in the stock and
- investment bank keep it reasonably liquid.
guarantees the sale by
Types of Financial Intermediaries
purchasing the securities
from the issuer  Commercial banks

 Best Effort Arrangement -  Credit unions

investment bank gives no
 Savings and loan associations
guarantee that the
securities will be sold  Mutual funds

 Issuance (flotation) Costs  Whole life insurance companies

 Setting the offering price  Pension funds

 Selling Procedures The Role of Financial Intermediaries

 Underwriting Syndicate: A  Facilitate the transfer of funds from

syndicate of investment firms those who have funds (savers) to those
formed to spread the risk who need funds (borrowers)
  Manufacturing a variety of financial
products that take the form of either
loans or savings instruments
Benefits of Financial Intermediaries
 Reduced costs
 Risk/diversification
 Funds divisibility/pooling
 Financial flexibility
 Related services
International Financial Markets

 U.S. stock markets represent less than

50% of the total value worldwide

 U.S. markets still dominate the stock

markets in other countries

 U.S. investors can participate in

international markets by using American
Depository Receipts - mutual funds that
hold stocks or foreign securities
certificates issued in dollar
denominations

Financial Organizations in Other Parts of

the World

 U.S. financial institutions are more

heavily regulated
 U.S. financial institutions face greater
limitations on branching, services and
relationships with non-financial
businesses