Ch01 Ppt Brighamfm1ce
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Transcript of Ch01 Ppt Brighamfm1ce
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PowerPoint Presentationprepared by
Traven ReedCanadore College
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Chapter1An Overview of Financial
Management and theFinancial Environment
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-3
Topics in Chapter
Attributes of successful companies
Forms of business organization
Objective of the firm: maximizewealth
Determinants of fundamental value
Financial securities, financialinstitutions, and financial markets
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-4
Attributes of SuccessfulCompanies
Like a stool needs all three legs tostand, a successful business relieson:
Skilled people
Strong external relationship
Sufficient capital
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-5
The Corporate Life Cycle
No two companies will develop in exactlythe same way
A business usually begins as a smallpotato and hopefully finishes up as amajor giant
Structures of business organizations: Sole proprietorship
Partnership
Corporation
Income trust
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-6
Starting as a Proprietorship
Advantages: Ease of formation
Subject to few regulations No corporate income taxes
Disadvantages:
Difficult to raise capital to supportgrowth
Unlimited liability
Limited life span
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-7
Starting as or Growing into aPartnership
A partnership involves two or moreentities with various privileges and
responsibilities General vs. limited partner
Limited liability partnership
A partnership has roughly the sameadvantages and disadvantages asa sole proprietorship.
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-8
Becoming a Corporation
A corporation is a legal entityseparate from its owners and
managers.
File papers and prepare reportswith Corporation Canada.
Articles of incorporation Bylaws
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-9
Advantages and Disadvantagesof a Corporation
Advantages: Unlimited life
Easy transfer of ownership Limited liability
Ease of raising capital
Disadvantages: Double taxation Higher setup cost
Endless report filing
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-10
A Unique Twist: Income Trusts
Expand 100 times to a market capitalization of$192 billion from 1994 to 2007
Growth ends as government has announcedplans in 2006 to tax trusts at the same rate ascorporations
In the past, income trust cash distributions areonly taxed in the hands of investors, not at thefirm level
Investors see trusts as tax-efficient and arewilling to pay more for a company converted toa trust
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-11
What should be managementsprimary objective?
The primary objective should beshareholder wealth maximization, which
translates to maximizing the fundamentalshare price, not just the current marketprice.
Should firms behave ethically? YES!
Business ethics are a companys attitudeand conduct toward its employees,customers, community and shareholders
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Stock Price Maximization and
Social Welfare Do firms have any responsibilities
to society at large? Yes!
Unethical behavior destroys publictrust and confidence.
Maximizing share price is good for
society. Why?
Shareholders are also members ofsociety.
Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-12
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Is Maximizing stock price
good for consumers? Consumer welfare is higher in
capitalist free market economies
than in communist or socialisteconomies due to competition
Consumers can improve quality of
life by the direct or the indirectinvestments in the stock market
Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-13
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-14
Is maximizing stock price good foremployees?
Employment growth is higher infirms that try to maximize stock
price. On average, employmentgoes up in:
firms that make managers into owners
(such as LBO firms) firms that were owned by the
government but that have been sold toprivate investors
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-16
Free Cash Flows (FCF)
There are many ways firms canincrease free cash flows
FCF are cash flows available (orfree) for distribution to all investors(stockholders and creditors).
FCF = sales revenues - operatingcosts - operating taxes - requiredinvestments in operating capital.
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-17
What is the weighted averagecost of capital (WACC)?
WACC is the average rate of returnrequired by all of the companys
investors. WACC is affected by:
Capital structure (the firms relative amountsof debt and equity)
Interest rates
Risk of the firm
Investors overall attitude toward risk
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-18
Determinants of a Firms Value
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-19
Who are the providers (savers) andusers (borrowers) of capital?
Households: Net savers
Non-financial corporations: Netusers (borrowers)
Governments: Net borrowers
Financial corporations: Slightly netborrowers, but almost breakeven
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-20
Capital Allocation Process
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-21
Transfer of Capital fromSavers to Borrowers
Direct transfer (e.g., corporation issuescommercial paper to insurance
company) Indirect transfer through an investment
banker (e.g., IPO, seasoned equityoffering, or debt placement)
Indirect transfer through a financialintermediary (e.g., individual depositsmoney in bank, bank loans to a firm)
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-22
Cost of Money
Supply and demand of fundsdetermine 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 = dividendyield + capital gain
Both are the rate fund users pay tofund providers
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-23
What four fundamental factorsaffect the cost of money?
Production opportunities
Time preferences for consumption
Risk
Expected inflation
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What economic conditions affectthe cost of money?
Bank of Canada policies
Budget deficits/surpluses
Level of business activity (recession orboom)
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
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Financial Securities
Financial securities are contractsgranting owners specific rights and
claims on specific values
Vary in risk and maturity
Nature of claims: debt, equity, and
derivatives Money market instrument (T
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-26
Financial Securities
Debt Equity Derivatives
MoneyMarket
T-BillsBankers AcceptancesCommercial papersMMMFsEuroCanadian dollars
OptionsFuturesForwardcontract
CapitalMarket
CanadianGovernment-BondsMortgagesCorporate bonds
Common stockPreferred stock
LEAPSSwaps
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Typical Rates of Return
Instrument Rate (April 2009)
Govt of Canada T-bills 2.05%
Bankers acceptances 3.57
Commercial paper 5.39
Money Market mutual funds 3.50
EuroCanadian market time 3.45
Commercial loans:
Tied to prime 5.25 +
or LIBOR 3.05 +
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-28
Typical Rates (contd)
Instrument Rate (April 2009)
Govt of Canada bonds 3.56%
Mortgages 6.50
Corporate bonds 5.11
Leases 5.11
Common Stock 10.9
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-29
What are some financialinstitutions?
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
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Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-30
Types of Financial Markets
A financial market brings togethersavers and borrowers.
Physical asset vs. financial assetmarkets
Spot versus future markets
Money versus capital markets
Primary versus secondary markets
Private versus public markets
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Physical- vs. Financial-asset
Markets Physical (a.k.a. tangible or real)
asset markets
Products as wheat, autos and realestates
Financial asset markets
Primitive securities and derivativesecurities
Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-31
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Spot vs. Futures Markets
Spot (a.k.a. cash) markets
Assets are bought or sold for on-the-
spot 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
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Primary vs. SecondaryMarkets
Primary
New issue (IPO or seasoned)
Key factor: issuer receives theproceeds from the sale.
Secondary
Existing owner sells to another party. Issuing firm doesnt receive proceeds
and is not directly involved.
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Private vs. Public Markets
Private markets
Transactions are worked out directly
between two parties
Lack of liquidity
Public markets
Standardized contracts are traded onan organized
More liquid and transparent
Copyright 2011 by Nelson Education Ltd. All rights reserved. 1-34