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Finance 2 NHL Trenden summary with formula list

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Finance Summary with Formula List

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  • January 18, 2023
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  • 2022/2023
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Summary Finance
Chapter 1: introduction to the foundations of financial management

Goal of the firm:
 Create value for firm owners (shareholders)
o In other words,  maximize shareholders wealth
 Maximize the price of the current stocks
 Good financial decisions  increasing stock prices
 Bad/poor financial decisions  decline stock prices

Five principles that form foundations of finance
1. Cashflow is what matters
2. Money has a time value
3. Risk requires a reward
4. Market prices are generally right
5. Conflicts of interest cause agency problems.

Principle 1: cashflow is what matters
 Accounting profits = the cashflows
o Generate accounting profits without cash or the possibility to generate cashflows
 Cashflow drive the value of the business not the PROFIT
 Determine incremental or marginal cashflow by taking a financial decision
o Incremental  difference between the expected cash flow if the project is selected
and the cash flow the project will have if it is not selected.

Principle 2: money has a time value
 Dollar received today  more worth than in the future
o Earn interest on received money of today  better receiver sooner rather than later
 Opportunity costs  cost of making a choice in terms of next best alternative that
forgone
o Lending money to a friend at zero interest  opportunity cost 1%  potentially be
earned by depositing the money in a savings account in a bank
 Benefits or cashflows outweigh the costs  project creates wealth and should be
accepted
o Costs or outflows outweigh benefits or cash inflows  project destroys wealth and
should be rejected

Principle 3: risk requires a reward
 Investors don’t take additional risk unless expect compensated with additional reward or
return
 Investors  expect be compensated for ‘delaying consumption’ and ‘taking on a risk’
o Investors expect return when deposit their savings in a bank (delayed consumption)
o Expect earn relatively higher rate or return on stocks compared to bank savings
account (taking on risk)


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, Look at figure 1.1  investor’s rate of return should equal a rate of return of delaying
consumption + additional return van assuming risk

Principle 4: market prices are generally right
 Efficient market  market prices of all traded assets (stocks/bonds) fully reflect all
available information at any moment in time
 Stock prices are a useful indicator of the value of the firm
 Price changes  reflect changes in expected future cashflows
 Good decisions  tend to increase stock price and visa versa
 Note  inefficiencies in the market  may distort market prices from value of assets
o Often caused by behavioral biases

Principle 5: conflicts of interest are agency problems
 Separation of management and ownership of the firm creates agency problems
 Managers can make decisions which not consistent with the goal of maximizing
shareholder wealth
 Agency conflict is reduced through monitoring (annual reports), compensation schemes
(stock options) and market mechanisms (takeovers)

Essential elements of ethics and trust
 Missing out of ethics and trust  nothing works
 Everything we do  involves some dependence on others
 Ethical behavior  right thing
 Ethical dilemma  every person has his or her own set of values  form the basis for
personal judgments about what’s the right thing
 Sound ethical standards are important for business and personal success
 Unethical decisions  destroy shareholder wealth (Enron scandal)

Role of finance in business
 Basic issues addressed by study of finance
o What long-term investments should the firm undertake (capital budgeting decision)
o How should the firm raise money to fund these investments (capital structure
decision)
o How should cash flows arising from day-to-day operations be managed (working
capital decision)
 Knowledge financial tools is relevant for decision making in all areas of business (
marketing, production etc.) also in managing personal finances

Why study finance
 Not planning a career in finance  working knowledge of finance will take you far in
both personal and professional life
 Finance is primarily about management of money, a key component of finance is the
management and the interpretation of information
 Persue carreer in management information systems of accounting  finance managers
are likely most important clients
 Student with entrepreneurial asportations  understanding finance is essential
 If you can’t manage your finances  won’t be in business very long

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,The role of the financial manager
 Firm can assume many different organizational structures  figure 1.2 = typical
presentation of how the finance area fits into a firm
 CFO serves under the firm’s CEO  responsible for overseeing financial planning,
strategic planning and controlling the firm’s cashflow
 Treasurer and controller under the CFO  in a small firm  same person fill both roles

Legal forms of business organization
 Fall into 3 categories
o The sole proprietorship, the partnership, and the corporation

Sole proprietorship
 Business owned by an individual
 Owner retains title of business’s assets and is responsible, general without limitation for
liabilities incurred
 Proprietor is entitling to profits from the business, but must also absorb any losses

Partnership
 Association of 2 or more persons coming together  co-owners for purpose of operating
a business for profit into two types
o General partnership  each partner is fully responsible for liabilities incurred by the
partnership
o Limited partnership  state statutes permit one or more of the partners to have
limited liability, restricted to the amount of capital invested in the partnership
Corporations
 Corporation legally functions separate and apart from its owners
 Individually sue and be sued and purchase or own property  personnel are subject to
criminal punishment for crimes
 Ownership reflected in common stock certificates
o Each designated the number of shares outstanding determines the stockholder’s
proportionate ownership in the business

Organizational form and taxes: double taxation on dividends and passthrough entitles
 Occurs when a corporation earns a profit, pays taxes on those profits and pays some of
those profits back to shareholders in form of dividends  the same shareholders pay
personal income taxes on those dividends
 Current law  qualified dividends from domestic corporation and qualified foreign
corporations are now taxed at maximum rate of 20%
 New tax law  impact pass-through entities
o Products from the business flow through the business owner’s personal tax return a
then are taxed ordinary income tax rates

S-corporations and limited liability companies (LLCs)
 Limited liability while allowing business’s owners to be taxed as if they were a
partnership
 Cross between partnership en corporation

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,  Difference with S-corporation  runs and taxed like a partnership
o More flexibility than the S-corporation
 2 variants because business owners face the problem, they need benefits of the
corporate from the expand  double taxation or earnings come with corporate makes it
difficult to accumulate the necessary wealth of expansion
LOOK AT TABLE 1.1

Finance and multinational firm: new role
 Coca cola  significant profits from overseas sales
 U.S.  going abroad  many foreign firms making their mark in the United States
o Think of the car industry dominated by Toyota, BMW, and Nissan
 Risks and challenges of going abroad:
o Country risk  changes in government regulations, unstable government, economic
changes in foreign country
o Currency risk  fluctuations in exchange rates
o Cultural risk  differences in language, traditions, ethical standards etc.

Developing skills for your career
 Finance skill needed regardless of career choice here we learn:
o Excel skills
o Data analysis skills
o Collaboration and communication skills

Chapter 2: financial markets and interest rates
Financing of business: the movement of funds through the economy
 Financial markets  critical role capitalist economies
o Help facilitate transfer of funds from ‘saving surplus’ units ‘saving deficit’  transfer
money from those who have the money to those who need it
 Look at figure 2.1  3 ways to transfer capital in the economy
o Direct transfer
 Firm seeking’s cash sells it securities directly to savers (investors) who are willing
the purchase them in hopes of earning a large return
 New business  directly to wealthy private investor called an angel investor or
business angel for funds, or may go to a venture capitalist for early funding
o Indirect transfer using the investment banker
 Financial institution helps companies raise capital, trades in securities and provides
advice advice on transactions such as mergers en acquisitions
o Indirect transfer using the financially intermediary
 Type of system in which life insurance companies, mutual funds and pension funds
operate

Public offerings versus private placements
 Corporation decides to raise external capital  can be obtained by making public
offering or private placement
 Both individual and institutional investors  opportunity to purchase securities
 Private placement (direct placement)  securities offered and sold directly to a limited
number of investors

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