Intro Finance

Chapter 1: Introduction
Copyright  2002 McGraw-Hill Australia Pty Ltd.

PPT t/a Business Finance 8e by Peirson et al.
1-1
Learning Objectives
 Identify the major types of business entities.

 Explain the role of the financial manager.
 Specify the objective that is necessary to ensure
the financial manager makes rational investment
and financing decisions.
 Identify the major financial decisions made by the
managers of business entities.
 Identify and explain the basic concepts of finance.

1-2
The Nature of Business
Finance
 Broad aspects of finance:
 corporate finance — the financial management
of companies
 financial institutions and markets
 investments
 Focus is mainly on corporate finance, but also
considers financial institutions and markets, and
investments.

1-3
Financial Decisions
 Major financial decisions are:

 investment decisions — decisions that
determine the asset profile of a business
(amount and composition of investments)
 financing decisions — how the assets are to be
funded (debt and equity)
 financing decisions also involve dividend
decisions

1-4
Business Structures
 Sole proprietorship
 business owned by one person
 Partnership
 business owned by two or more people acting as
partners
 Company
 separate legal entity formed under the
Corporations Act
 Focus is on financial decision making by
managers of public companies.

1-5
The Finance Function: Major Roles of
Financial Managers
 Project evaluation
 Evaluating, obtaining and servicing short- and
long-term financing
 Dividend distributions
 Collection and custody of cash and payment of
bills
 Management of investments in current assets

1-6
The Finance Function: Major
Roles of Financial Managers
(cont.)
 Assessing the viability of growth through
acquisitions
 Planning the future development of the
business
 Interest rate and exchange rate risk
management
 Development and implementation of financial
policies

1-7
A Company’s Financial
Objective
The maximisation of market value of a
company’s shares is the overriding
objective.

1-8
Basic Concepts of Finance
 Value
 The value of a company (V ) on the financial
markets may be expressed as :
V = D + E
where D = the value of debt
E = the value of equity
 Financial markets will value debt and equity,
taking into account the risk and expected return
from investing in these securities.

1-9
(cont.)
 Time and Uncertainty
 The value of an investment will depend on the
amount and timing of the cash flows generated
by the investment.
 Time value of money: a dollar today is worth

more than a dollar in the future.

1-10
(cont.)
 Nominal and Real Amounts
 The cost of an asset expressed as the number of
dollars paid to acquire the asset is the nominal
price.
 However, due to inflation and deflation, the
purchasing power of money changes.
 Therefore, it is necessary to distinguish between
the nominal or face value of money and the real
or inflation-adjusted value of money.

1-11
(cont.)
 Market Efficiency and Asset Pricing
 Market efficiency means that we should expect securities
and other assets to be fairly priced, given their expected
risks and returns.
 Trade-off between risk and expected return under the
capital asset pricing model (CAPM):
 Systematic risk: market-wide factors (non-diversifiable or
market risk).
 Unsystematic risk: factors that are specific to a particular
company (diversifiable or unique risk).
 According to the CAPM, investors can diversify their
investments to eliminate unsystematic risk.

1-12
(cont.)
 Arbitrage
 If two identical assets were to trade in the same
market at the same time at different prices, and if
there were no transaction costs, then an arbitrage
opportunity would exist.
 A risk-free profit could be made by simultaneously
purchasing at the lower price and selling at the
higher price.
 However, competition among traders will force the
two alternative prices to become the same.
 Arbitrage precludes perfect substitutes from
selling at different prices in the same market.

1-13
(cont.)
 Agency Relationships
 One party, the principal, delegates decision-
making authority to another party, the agent.
 In a company:
 managers = agents
 shareholders = principals

1-14
(cont.)
 Agency Relationships (cont.)
 Agency costs: conflict of interest between
parties creates costs
 reduced value due to managers acting in their
own best interests
 costs associated with monitoring managers’
behaviour
 bonding costs

1-15
Summary
 Business entities include sole
proprietorship, partnership and company.
We focus on public companies.
 We study corporate finance along with
investments and the structure of financial
markets and institutions.
 We consider broad finance issues such as
valuations, market efficiency, asset pricing
and arbitrage, along with agency issues.

1-16

Intro Finance

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Chapter 1: Introduction

Copyright  2002 McGraw-Hill Australia Pty Ltd.

 Identify the major types of business entities.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

 Major financial decisions are:

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

 Time value of money: a dollar today is worth

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

Copyright  2002 McGraw-Hill Australia Pty Ltd.

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