Está en la página 1de 34

PowerPoint Presentation

prepared by

Traven Reed Canadore College

Chapter 1
An Overview of Financial Management and the Financial Environment

Topics in Chapter
CH1

Attributes of successful companies Forms of business organization Objective of the firm: maximize wealth Determinants of fundamental value Financial securities, financial institutions, and financial markets

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-3

Attributes of Successful Companies


CH1

Like a stool needs all three legs to stand, a successful business relies on:
Skilled people Strong external relationship Sufficient capital

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-4

The Corporate Life Cycle


CH1

No two companies will develop in exactly the same way A business usually begins as a small potato and hopefully finishes up as a major giant Structures of business organizations:
Sole proprietorship Partnership Corporation Income trust
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-5

Starting as a Proprietorship
CH1

Advantages:
Ease of formation Subject to few regulations No corporate income taxes

Disadvantages:
Difficult to raise capital to support growth Unlimited liability Limited life span
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-6

Starting as or Growing into a Partnership


CH1

A partnership involves two or more entities with various privileges and responsibilities
General vs. limited partner Limited liability partnership

A partnership has roughly the same advantages and disadvantages as a sole proprietorship.
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-7

Becoming a Corporation
CH1

A corporation is a legal entity separate from its owners and managers. File papers and prepare reports with Corporation Canada.
Articles of incorporation Bylaws

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-8

Advantages and Disadvantages of a Corporation


CH1

Advantages:
Unlimited life Easy transfer of ownership Limited liability Ease of raising capital

Disadvantages:
Double taxation Higher setup cost Endless report filing
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-9

A Unique Twist: Income Trusts


CH1

Expand 100 times to a market capitalization of $192 billion from 1994 to 2007 Growth ends as government has announced plans in 2006 to tax trusts at the same rate as corporations In the past, income trust cash distributions are only taxed in the hands of investors, not at the firm level Investors see trusts as tax-efficient and are willing to pay more for a company converted to a trust
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-10

What should be managements primary objective?


CH1

The primary objective should be shareholder wealth maximization, which translates to maximizing the fundamental share price, not just the current market price. Should firms behave ethically? YES! Business ethics are a companys attitude and conduct toward its employees, customers, community and shareholders
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-11

CH1

Stock Price Maximization and Social Welfare


Do firms have any responsibilities to society at large? Yes! Unethical behavior destroys public trust and confidence. Maximizing share price is good for society. Why? Shareholders are also members of society.
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-12

CH1

Is Maximizing stock price good for consumers?


Consumer welfare is higher in capitalist free market economies than in communist or socialist economies due to competition Consumers can improve quality of life by the direct or the indirect investments in the stock market

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-13

Is maximizing stock price good for employees?


CH1

Employment growth is higher in firms that try to maximize stock price. On average, employment goes up in:
firms that make managers into owners (such as LBO firms) firms that were owned by the government but that have been sold to private investors
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-14

How do managers affect shareholder wealth?


CH1

Improve a firms ability to generate cash flows now and in the future by focusing on:
Amount of expected cash flows (bigger is better) Timing of the cash flow stream (sooner is better) Risk of the cash flows (less risk is better)
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-15

Free Cash Flows (FCF)


CH1

There are many ways firms can increase free cash flows FCF are cash flows available (or free) for distribution to all investors (stockholders and creditors). FCF = sales revenues - operating costs - operating taxes - required investments in operating capital.
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-16

What is the weighted average cost of capital (WACC)?


CH1

WACC is the average rate of return required by all of the companys investors. WACC is affected by:
Capital structure (the firms relative amounts of debt and equity) Interest rates Risk of the firm Investors overall attitude toward risk
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-17

Determinants of a Firms Value


CH1

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-18

Who are the providers (savers) and users (borrowers) of capital?


CH1

Households: Net savers Non-financial corporations: Net users (borrowers) Governments: Net borrowers Financial corporations: Slightly net borrowers, but almost breakeven

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-19

Capital Allocation Process


CH1

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-20

Transfer of Capital from Savers to Borrowers


CH1

Direct transfer (e.g., corporation issues commercial paper to insurance company) Indirect transfer through an investment banker (e.g., IPO, seasoned equity offering, or debt placement) Indirect transfer through a financial intermediary (e.g., individual deposits money in bank, bank loans to a firm)
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-21

Cost of Money
CH1

Supply and demand of funds determine the price of money. What do we call the price (or cost) of debt capital? Of equity capital?
Interest rate Cost of equity = required return = dividend yield + capital gain

Both are the rate fund users pay to fund providers


Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-22

What four fundamental factors affect the cost of money?


CH1

Production opportunities Time preferences for consumption Risk Expected inflation

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-23

What economic conditions affect the cost of money?


CH1

Bank of Canada policies Budget deficits/surpluses Level of business activity (recession or boom) International trade deficits/surpluses Country risk depending on its economic, political, and social environment Exchange rate risk
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-24

Financial Securities
CH1

Financial securities are contracts granting owners specific rights and claims on specific values Vary in risk and maturity Nature of claims: debt, equity, and derivatives Money market instrument (T<1), and capital market instrument (T1)
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-25

Financial Securities
CH1

Debt Money Market


T-Bills Bankers Acceptances Commercial papers MMMFs EuroCanadian dollars
Canadian

Equity

Derivatives
Options Futures Forward contract

Capital Market

Government-Bonds Mortgages Corporate bonds

Common stock Preferred stock

LEAPS Swaps

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-26

Typical Rates of Return


CH1

Instrument Govt of Canada T-bills Bankers acceptances Commercial paper Money Market mutual funds EuroCanadian market time Commercial loans: Tied to prime or LIBOR

Rate (April 2009) 2.05% 3.57 5.39 3.50 3.45

5.25 + 3.05 +
1-27

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Typical Rates (contd)


CH1

Instrument Govt of Canada bonds Mortgages Corporate bonds Leases Common Stock

Rate (April 2009) 3.56% 6.50 5.11 5.11 10.9

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-28

What are some financial institutions?


CH1

Investment banks Commercial banks Trust companies Credit unions Life insurance companies Mutual funds
Money Market Funds (MMMFs) Exchanged Traded Funds (ETFs)

Pension funds Hedge funds


Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-29

Types of Financial Markets


CH1

A financial market brings together savers and borrowers. Physical asset vs. financial asset markets Spot versus future markets Money versus capital markets Primary versus secondary markets Private versus public markets
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-30

CH1

Physical- vs. Financial-asset Markets


Physical (a.k.a. tangible or real) asset markets
Products as wheat, autos and real estates

Financial asset markets


Primitive securities and derivative securities

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-31

Spot vs. Futures Markets


CH1

Spot (a.k.a. cash) markets


Assets are bought or sold for on-thespot delivery

Futures markets
Assets are bought or sold for delivery at some future date

Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-32

Primary vs. Secondary Markets


CH1

Primary
New issue (IPO or seasoned) Key factor: issuer receives the proceeds from the sale.

Secondary
Existing owner sells to another party. Issuing firm doesnt receive proceeds and is not directly involved.
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-33

Private vs. Public Markets


CH1

Private markets
Transactions are worked out directly between two parties Lack of liquidity

Public markets
Standardized contracts are traded on an organized More liquid and transparent
Copyright 2011 by Nelson Education Ltd. All rights reserved.

1-34