1、,chapter 1 & 3 Scope and environment of financial management,Development of Financial Management,Early 20th century:Concentrated on reporting to outsiders.,Early 21st century:Insiders managing and controlling the firms financial operations.,At the turn of the twentieth century financial topics focus
2、ed on the formation of new companies and their legal regulation and the process of raising funds in the capital markets. The companys secretary was in charge of raising funds and producing the annual reports, as well as the accounting function.,Business failures during the Great Depression of the 19
3、30s helped change the focus of finance. Increased emphasis was placed on bankruptcy, liquidity management and avoidance of financial problems.,After World War the emphasis of corporate finance switched from financial accounting and external reporting to cost accounting and reporting and financial an
4、alysis on behalf of the firms managers. That is, the perspective of finance changed from reporting only to outsiders to that of an insider charged with the management and control of the firms financial operations.,Capital budgeting became a major topic in finance. This led to an increased interest i
5、n related topics, most notably firm valuation. Interest in these topics grew and in turn spurred interest in security analysis, portfolio theory and capital structure theory.,Typical Finance Structure,Chief accountant is also called financial controller, whose responsibilities include financial repo
6、rting to outsiders as well as cost and managerial accounting and financial analysis on behalf of the firms managers. Corporate treasurer is in charge of raising funds, managing liquidity and banking relationships and controlling risks.,Financial Goal of the Firm,Profit maximisation?,In microeconomic
7、s courses profit maximisation is frequently given as the financial goal of the firm. Profit maximisation functions largely as a theoretical goal.,Problems: UNCERTAINTY of returns TIMING of returns,Shareholder wealth maximisation?,Same as: Maximising firm value Maximising share values,It takes into a
8、ccount uncertainty or risk, time, and other factors that are important to the owners. But many things affect share prices.,Difficulty: The agency problem,Agency problem,The agency problem refers to the fact that a firms managers will not work to maximise benefits to the firms owners unless it is in
9、the managers interest to do so.This problem is the result of a separation of the management and ownership of the firm.,Agency Costs,The costs, such as reduced share price, associated with potential conflict between managers and investors when these two groups are not the same.,In order to lessen the
10、 agency problem, some companies have adopted practices such as issuing stock options (share options) to their executives.,Financial Decisions and Risk-return Relationships,Almost all financial decisions involve some sort of risk-return trade-off.The more risk the firm is willing to assume, the highe
11、r the expected return from a given course of action.,Risk and Returns,Why Prices Reflect Value,Efficient Markets,Markets in which the values of all assets and securities at any instant in time fully reflect all available information.,Assumption,Organisational Forms,Sole proprietorshipsPartnershipsCo
12、mpanies,Nature of the organisational forms,Sole proprietorship Owned by a single individual Absence of any formal legal business structure The owner maintains title to the assets and is personally responsible, generally without limitation, for the liabilities incurred. The proprietor is entitled to
13、the profits from the business but also absorb any losses.,Partnership The primary difference between a partnership and a sole proprietorship is that the partnership has more than one owner. Each partner is jointly and severally responsible for the liabilities incurred by the partnership.,Company A c
14、ompany may operate a business in its own right. That is, this entity functions separately and apart from its owners. The owners elect a board of directors, whose members in turn select individuals to serve as corporate officers, including the manager and the company secretary. The shareholders liabi
15、lity is generally limited to the amount of his or her investment in the company.,Limited company (Ltd) and proprietary limited company (Pty Ltd) Ltd companies are generally public companies whose shares may be listed on a stock exchange, ownership in such shares being transferable by public sale thr
16、ough the exchange. Pty Ltd companies are basically private entities, as the shares can only be transferred privately.,Comparison of Organisational forms,Organisation requirements and costs Liability of owners Continuity of business Transferability of ownership Management control Ease of capital rais
17、ing Income taxes,The flow of funds,Savings deficit units Savings surplus units Financial markets facilitate transfers of funds from surplus to deficit units Direct flows of finds Indirect flows of funds,Direct transfer of funds,savers,firms,Types of securities,Treasury Bills and Treasury Bonds Corpo
18、rate Bonds Preferred Shares Ordinary Shares,Risk?,High Returns?,Relationship?,Broking & investment banking,How do brokers / investment bankers help firms issue securities?Advising the firm Underwriting the issue Distributing the issue Enhancing Credibility,Indirect transfer of funds,financial interm
19、ediary,firms,savers,Components of financial markets,Primary and secondary markets Capital and money markets Foreign-exchange markets Derivatives markets Stock exchange markets,Primary and secondary markets,Primary markets Selling of new securities Funds raised by governments and businesses Secondary
20、 markets Reselling of existing securities Adds marketability and liquidity to primary markets Reduces risk on primary issues Funds raised by existing security holders,Capital & money markets,Capital markets Markets in long-term financial instruments By convention: terms greater than one year Long-te
21、rm debt and equity markets Bonds, shares, leases, convertibles Money markets Markets in short-term financial instruments By convention: terms less than one year Treasury notes, certificates of deposit, commercial bills, promissory notes,Reviews,Introduce the history of financial management Understan
22、d the financial goal of decision-making Understand the limitations of a goal of profit maximisation Introduce risk-return trade-off of decisions Introduce market efficiency Distinguish between the forms of business organisations Understand the financial market,End of Chapter 1,Chapter 4: Mathematics
23、 of Finance,The Time Value of Money,Compounding and Discounting: Single sums,We know that receiving $1 today is worth more than $1 in the future. This is due to OPPORTUNITY COSTS. The opportunity cost of receiving $1 in the future is the interest we could have earned if we had received the $1 sooner
24、.,we can MEASURE this opportunity cost by:,Translate $1 today into its equivalent in the future (COMPOUNDING).Translate $1 in the future into its equivalent today (DISCOUNTING).,?,?,Note:,Its easiest to use your financial functions on your calculator to solve time value problems. However, you will n
25、eed a lot of practice to eliminate mistakes.,Future Value,Future Value - single sums If you deposit $100 in an account earning 6%, how much would you have in the account after 1 year?,Mathematical Solution: FV1= PV (1 + i)1= 100 (1.06)1 = $106,0 1,PV = -100 FV = ?,Future Value - single sums If you d
26、eposit $100 in an account earning 6%, how much would you have in the account after 2 year?,Mathematical Solution: FV2= FV1 (1+i) 1=PV (1 + i)2= 100 (1.06)2 = $112.4,0 2,PV = -100 FV = ?,Future Value - single sums If you deposit $100 in an account earning 6%, how much would you have in the account af
27、ter 3 year?,Mathematical Solution: FV3= FV2 (1+i) 1=PV (1 + i)3= 100 (1.06)3 = $119.1,0 3,PV = -100 FV = ?,Future Value - single sums If you deposit $100 in an account earning 6%, how much would you have in the account after 4 year?,Mathematical Solution: FV4= FV3 (1+i) 1=PV (1 + i)4= 100 (1.06)4 =
28、$126.2,0 4,PV = -100 FV = ?,Future Value - single sums If you deposit $100 in an account earning 6%, how much would you have in the account after 5 years?,Mathematical Solution: FV5= FV4 (1+i) 1=PV (1 + i)5=100 (1.06)5 = $133.82,0 5,PV = -100 FV = ?,Future Value - single sums If you deposit $100 in
29、an account earning i, how much would you have in the account after n years?,Mathematical Solution: FVn=PV (1 + i)n= PV (FVIF i, n ),0 n,PV = -100 FV = ?,Example 4.1 Example 4.2 Example 4.3 Example 4.4,Until now it has assumed that the compounding period is always annual. But interest can be compound
30、ed on a quarterly, monthly or daily basis, and even continuously. Example 4.5,Future Value - single sums If you deposit $100 in an account earning 6% with quarterly compounding, how much would you have in the account after 5 years?,Mathematical Solution: FV = PV (FVIF i, n ) FV = 100 (FVIF .015, 20
31、) (cant use FVIF table) FV = PV (1 + I/m) m x N FV = 100 (1.015)20 = $134.68,0 20,PV = -100 FV = ?,Present Value,In compounding we talked about the compound interest rate and initial investment; In determining the present value we will talk about the discount rate and present value. The discount rat
32、e is simply the interest rate that converts a future value to the present value.,Example 4.7 Example 4.8,Present Value - single sums If you will receive $100 5 years from now, what is the PV of that $100 if your opportunity cost is 6%?,Mathematical Solution: PV = FV / (1 + i)n= 100 / (1.06)5 = $74.7
33、3 PV = FV (PVIF i, n )= 100 (PVIF .06, 5 ) (use PVIF table)= $74.73,0 5,PV = ? FV = 100,Present Value - single sums If you sold land for $11,933 that you bought 5 years ago for $5,000, what is your annual rate of return?,Mathematical Solution:PV = FV (PVIF i, n )5,000 = 11,933 (PVIF ?, 5 ) PV = FV /
34、 (1 + i)n5,000 = 11,933 / (1+ i)5 .419 = (1/ (1+i)5)2.3866 = (1+i)5(2.3866)1/5 = (1+i) i = 0 .19,Example 4.9,The Time Value of Money,Compounding and Discounting Cash Flow Streams,Annuities,Annuity: a sequence of equal cash flows, occurring at the end of each period.,Examples of Annuities:,If you buy
35、 a bond, you will receive equal coupon interest payments over the life of the bond. If you borrow money to buy a house or a car, you will pay a stream of equal payments.,Future Value - annuity If you invest $1,000 at the end of the next 3 years, at 8%, how much would you have after 3 years?,1000 100
36、0 1000,Mathematical Solution: FV = PMT (FVIFA i, n ) FV = 1,000 (FVIFA .08, 3 ) (use FVIFA table, or)FV = PMT (1 + i)n - 1 iFV = 1,000 (1.08)3 - 1 = $3246.400.08,Example 4.11,Present Value - annuity What is the PV of $1,000 at the end of each of the next 3 years, if the opportunity cost is 8%?,1000
37、1000 1000,Mathematical Solution: PV = PMT (PVIFA i, n ) PV = 1,000 (PVIFA .08, 3 ) (use PVIFA table, or)1 PV = PMT 1 - (1 + i)n i1 PV = 1000 1 - (1.08 )3 = $2,577.10.08,Example 4.12,Interpolation within financial tables: finding missing table values,Example 1:PV=1000(PVIFA2.5%,6)Example 2:1000=100(P
38、VIFA?%,12 months),Perpetuities,Suppose you will receive a fixed payment every period (month, year, etc.) forever. This is an example of a perpetuity. You can think of a perpetuity as an annuity that goes on forever.,Present Value of a Perpetuity,When we find the PV of an annuity, we think of the fol
39、lowing relationship:,PV = PMT (PVIFA i, n ),Mathematically, (PVIFA i, n ) = We said that a perpetuity is an annuity where n = infinity. What happens to this formula when n gets very, very large?,When n gets very large, 1 were left with PVIFA = i,So, the PV of a perpetuity is very simple to find:PV =
40、 PMT/i,Present Value of a Perpetuity,What should you be willing to pay in order to receive $10,000 annually forever, if you require 8% per year on the investment?,= $125,000,Example 4.13,Other Cash Flow Patterns,Ordinary Annuity versus Due Annuity,Earlier, we examined this “ordinary” annuity:,Using
41、an interest rate of 8%, we find that:The Future Value (at 3) is $3,246.40. The Present Value (at 0) is $2,577.10.,1000 1000 1000,What about this annuity?,Same 3-year time line, Same 3 $1000 cash flows, but The cash flows occur at the beginning of each year, rather than at the end of each year. This
42、is an “annuity due.”,1000 1000 1000,0 1 2 3,-1000 -1000 -1000,Future Value - annuity due If you invest $1,000 at the beginning of each of the next 3 years at 8%, how much would you have at the end of year 3?,Mathematical Solution: Simply compound the FV of the ordinary annuity one more period:FV = P
43、MT (FVIFA i, n ) (1 + i)FV = 1,000 (FVIFA .08, 3 ) (1.08) (use FVIFA table, or)FV = PMT (1 + i)n 1 (1+i)iFV = 1,000 (1.08)3 - 1 (1.08) = $3,506.110.08,0 1 2 3,1000 1000 1000,Present Value - annuity due What is the PV of $1,000 at the beginning of each of the next 3 years, if your opportunity cost is
44、 8%?,Mathematical Solution: Simply compound the FV of the ordinary annuity one more period:PV = PMT (PVIFA i, n ) (1 + i)PV = 1,000 (PVIFA .08, 3 ) (1.08) (use PVIFA table, or)1 PV = PMT 1 - (1 + i)n (1+i) i1 PV = 1000 1 - (1.08 )3 (1.08) = 2,783.260.08,Is this an annuity? How do we find the PV of a
45、 cash flow stream when all of the cash flows are different? (Use a 10% discount rate).,Uneven Cash Flows,Uneven Cash Flows,Sorry! Theres no quickie for this one. We have to discount each cash flow back separately.,period CF PV (CF)0 -10,000 -10,000.001 2,000 1,818.182 4,000 3,305.793 6,000 4,507.894
46、 7,000 4,781.09 PV of Cash Flow Stream: $ 4,412.95,Retirement Example,After graduation, you plan to invest $400 per month in the stock market. If you earn 12% per year on your stocks, how much will you have accumulated when you retire in 30 years?,Mathematical Solution:FV = PMT (FVIFA i, n ) FV = 40
47、0 (FVIFA .01, 360 ) (cant use FVIFA table)FV = PMT (1 + i)n - 1iFV = 400 (1.01)360 - 1 = $1,397,985.65.01,House Payment Example,If you borrow $100,000 at 7% fixed interest for 30 years in order to buy a house, what will be your monthly house payment?,Mathematical Solution:PV = PMT (PVIFA i, n ) 100,
48、000 = PMT (PVIFA .005833, 360 ) (cant use PVIFA table)1 PV = PMT 1 - (1 + i)n i1 100,000 = PMT 1 - (1.005833 )360 PMT=$665.300.005833,Calculating Present and Future Values for single cash flows for an uneven stream of cash flows for annuities and perpetuities For each problem identify:i, n, PMT, PV
49、and FV,Summary,chapter 9 Risk and rates of return,In financial markets, firms seek financing for their investments and shareholders of a company achieve much of their wealth through share price movements. Involvement with financial markets is risky. The degree of risk varies from one financial security to another.,
