Financial Economics, FUIEMS, 2009 Engineering Economics Financial Economics, Accounting & Corporate...

Financial Economics, FUIEMS, 2009

Engineering EconomicsEngineering Economics

Financial Economics, Accounting Financial Economics, Accounting & Corporate Finance& Corporate Finance


Financial economicsFinancial economics• Branch of economics studying the interrelation of financial

variables, such as shares, bonds and securities, and economics such as price, interest, inflation, tax. Financial economics concentrates on influences of real economic variables on financial ones.

• It includes

– Valuation

– Financial markets

– Financial institutions and regulations

Finance is the science of funds management Finance is the science of funds management


AccountingAccounting• Accounting is the art of communicating financial Accounting is the art of communicating financial

information about a information about a business entity to users. The

communication is generally in the form of

financial statements that show the economic resources

under the control of management.

• Accounting is thousands of years old. The earliest

accounting records were found in the Middle East which

date back more than 7,000 years

http://en.wikipedia.org/wiki/Business_entity

http://en.wikipedia.org/wiki/Communication

http://en.wikipedia.org/wiki/Financial_statements

http://en.wikipedia.org/wiki/Factors_of_production

http://en.wikipedia.org/wiki/Middle_East


AccountingAccounting

• Accounting is a set of concepts and techniques that are Accounting is a set of concepts and techniques that are

used to measure and report financial information about used to measure and report financial information about

an economic unit. an economic unit.

• The information is potentially reported to a variety of The information is potentially reported to a variety of

different types of interested parties. These include different types of interested parties. These include

business managers, owners, creditors, governmental business managers, owners, creditors, governmental

units, financial analysts, and even employees. units, financial analysts, and even employees.


Users of Accounting InformationUsers of Accounting Information

• OwnersOwners

• LendersLenders

• Labor OrganizationsLabor Organizations

• CustomersCustomers

• Society groupsSociety groups

• Government Regulatory AgenciesGovernment Regulatory Agencies


Types of AccountingTypes of Accounting• Financial accountingFinancial accounting is concerned with reporting of is concerned with reporting of

information to parties outside the firm. In contrast, information to parties outside the firm. In contrast,

managerial accountingmanagerial accounting is primarily concerned with providing is primarily concerned with providing

information for internal management. information for internal management.

• Both financial accounting and managerial accounting Both financial accounting and managerial accounting

depend upon a strong information system to reliably depend upon a strong information system to reliably

capture and summarize economic data. capture and summarize economic data.

• Information technology has solved this problem during the Information technology has solved this problem during the

past 50 years. past 50 years.

• Now, accounting is more of a dynamic, decision-making Now, accounting is more of a dynamic, decision-making

discipline, rather than a bookkeeping task.discipline, rather than a bookkeeping task.


Accounting - LimitationsAccounting - Limitations

• Accounting data is not absolute or concrete. Accounting data is not absolute or concrete.

• Considerable amounts of judgment and estimation are Considerable amounts of judgment and estimation are

necessary to develop the specific accounting necessary to develop the specific accounting

measurements that are reported during a particular month, measurements that are reported during a particular month,

quarter, or year. quarter, or year.

• Accounting has not yet advanced to value a business (or a Accounting has not yet advanced to value a business (or a

business's assets). business's assets).

• The "reliability" of reported data, can pose a limitation on its The "reliability" of reported data, can pose a limitation on its

"relevance." "relevance."


TerminologiesTerminologies• Assets are the economic resources, and include such items as

cash, accounts receivable, inventories, land, buildings,

equipment.

• Liabilities are expenditures such as loans, and other obligations

arising in the course of business

• Owners' equity is the owner's "interest or profit " in the business.

It is equivalent to assets minus liabilities for a particular business.

• Fundamental Accounting Equation Assets = Liabilities +

Owners' Equity

• Balance Sheet is the key financial statement (sometimes called

the statement of financial position).


Major Financial StatementsMajor Financial Statements• Financial accounting information is conveyed through a Financial accounting information is conveyed through a

standardized set of reports. standardized set of reports.

• BALANCE SHEETBALANCE SHEET

• INCOME STATEMENTINCOME STATEMENT: It provides information about revenues : It provides information about revenues

generated and expenses incurred. generated and expenses incurred.

• THE STATEMENT OF RETAINED EARNINGSTHE STATEMENT OF RETAINED EARNINGS: It shows how : It shows how

retained earnings increased and decreased in response to retained earnings increased and decreased in response to

events that impacted income. Retained earnings is reduced by events that impacted income. Retained earnings is reduced by

dividends paid to shareholders. dividends paid to shareholders.

• STATEMENT OF CASH FLOWSSTATEMENT OF CASH FLOWS: The statement of enterprise's : The statement of enterprise's

cash flow. This statement reveals how cash is generated and cash flow. This statement reveals how cash is generated and

expended during a specific period of time.expended during a specific period of time.


Corporate FinanceCorporate Finance

Corporate finance is an area of finance dealing with

financial decisions made by business enterprises and the

tools and analysis used to make these decisions. The

primary goal of corporate finance is to maximize

corporate value while managing the firm's financial risks.

Finance is the science of funds management

http://en.wikipedia.org/wiki/Finance

http://en.wikipedia.org/wiki/Business

http://en.wikipedia.org/wiki/Maximization

http://en.wikipedia.org/wiki/Valuation_(finance)


What is Corporate Finance?What is Corporate Finance?

• Every decision that a business makes has financial

implications, and any decision which affects the finances

of a business is a corporate finance decision.

• Defined broadly, everything that a business does fits

under the corporate finance.

• Regardless of your job, understanding and being able to

analyze corporate decisions is important


Corporate FinanceCorporate Finance

Corporate Finance addresses the following three questions:Corporate Finance addresses the following three questions:

1.1. What long-term investments should the firm engage What long-term investments should the firm engage

in?in?

2.2. How can the firm raise money for the required How can the firm raise money for the required

investments?investments?

3.3. How much short-term cash flow does a company How much short-term cash flow does a company

need to pay its bills?need to pay its bills?


Three major decision in corporate Three major decision in corporate financefinance

• The investment decision– What makes for a good investment?

• The financing decision– Where do firms raise/acquire the funds for value-

creating investments?– What mix of owner’s money (equity) or borrowed

money (debt) should the firm use?• The dividend decision

– How much of a firm’s funds should be reinvested in the business and how much should be returned to the owners?


First Principle of Corporate FinanceFirst Principle of Corporate Finance

• Invest in projects that yield a return greater than the

minimum acceptable rate

• If there are not enough investments that earn the MARR,

return the cash to stockholders.

• These decision criteria will be consistent with the

objective of the firm: Maximize the Value of the

Firm


Corporate Governance and Managerial Corporate Governance and Managerial DecisionsDecisions

• Managers making decisions that are consistent with the

firm objective of firm value maximization is predicated on

the assumption that managers will act in the best interest

of shareholders

• Corporate governance addresses the relationships

between the various stakeholders in the firm


Finance is not a science…

• Often times, decision inputs are subjective

• Experience allows us to become more confident about our inputs


Corporate finance - Key functionsCorporate finance - Key functions

• Planning for future funding• Manage bank relationships• Ensure corporate profit• Proportion the liabilities• Risk and valuation analysis • Commercial input to negotiations with partners• Rating agency liaison


Financial Markets Financial Institutions Financial Instruments

Financial Institutions

(Banks)

Primary market

Secondary market

Consumers (Savers)

Firms (Spenders)

Financial Markets

CD’s $

$ $

$

exchange ownership

Short term Long term

Stocks & Bonds

Stocks & Bonds

real investment

Loans

$

Investment Environment


ValuationValuation• Determination of the fair value of an asset

– How risky is the asset? (identification of the asset-

appropriate discount rate)

– What cash flows will it produce? (discounting of

relevant cash flows)

– How does the market price compare to similar assets?

(relative valuation)

– Are the cash flows dependent on some other asset or

event? (derivatives, contingent claim valuation)

Financial Economics, FUIEMS, 2009 Engineering Economics Financial Economics, Accounting & Corporate...

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