10/10/23, 6:55 PM Foundations of Financial Management - Lectures 1-10 notes
Foundation to Financial
Management
What is Corporate
Finance?
Cash invested in assets must be
matched by an equal amount of cash
raised by financing.
A corporation can raise cash from lenders or from shareholders. If it
chooses to borrow, the lenders contribute the cash and the firm promises
to pay back this debt plus a fixed rate of interest (debt financing). If the
corporation has shareholders putting up cash (equity investors), they get
no fixed return but instead hold shares of stock and therefore get a
fraction of future profits and cash flow (equity financing).
Capital Budgeting and Structure
Capital Budgeting Decision (also called Investment Decision or Capital
Expenditure Decision (CAPEX) decision to invest in tangible or
intangible assets
Financing decision decision on the sources and amounts of financing
Capital structure the mix of long-term debt and equity financing
Capital Structure
The choice between debt and equity financing is called the capital
structure decision. Capital firm’s source of long-term financing.
Value of a firm = Value of bonds + value of shares
Firms can raise equity financing in two ways issuing new shares of
stock where cash is put up in exchange for a fraction of the company’s
future cash flow and profits take cash flow generated by existing
assets and reinvest cash in new assets.
What is a Corporation?
A business organised as a separate legal entity owned by stockholders.
Types include public, private and Limited Liability Corporations (LLC). (This
course mainly focuses on public limited-liability companies)
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,10/10/23, 6:55 PM Foundations of Financial Management - Lectures 1-10 notes
assets and reinvest cash in new assets.
What is a Corporation?
A business organised as a separate legal entity owned by stockholders.
Types include public, private and Limited Liability Corporations (LLC). (This
course mainly focuses on public limited-liability companies)
Limited liability owners of a corporation are not personally liable for its
obligations
Goal of the Corporation
Shareholders desire wealth maximisation questions include: which
year’s profits? Hard to defining profits? focus on cash flow instead. Also
issue of earning manipulation.
Opportunity cost of capital minimum acceptable rate of return on
capital investment set by the investment opportunities available to
shareholders in financial markets. I.e. what can we earn in similar projects.
Agency Problem
Do managers maximise shareholder wealth or manager wealth?
The agency problem refers to managers, as agents for stockholders, being
tempted to act in their own interests rather than maximising value.
Therefore, agency cost refers to value lost from agency problems or from
the cost of mitigating agency problems.
What is Financial Management?
Financial management studies how companies fund their operations.
Questions include:
Is it worth investing in a project?
Should we consider the risk of the project?
Where does funding come from and at what rate?
What is the best funding mix?
How do you value a company?
Should companies pay dividends to their shareholders?
Time Value of Money
Money can be invested in earn interest “a dollar today is worth more
than a dollar tomorrow”. Thus, financial managers make the same point
when they say that money has a time value.
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,10/10/23, 6:55 PM Foundations of Financial Management - Lectures 1-10 notes
Time Value of Money
Money can be invested in earn interest “a dollar today is worth more
than a dollar tomorrow”. Thus, financial managers make the same point
when they say that money has a time value.
Future value amount to which an investment will grow after earning
interest
Compound interest interest earned on interest
Simple interest interest earned only on the original investment
Compound Growth
£1 invested today, for a period of T years at interest rate R, compounded
annually:
£1 X (1 + R)T
If compounded M times per year at regular intervals:
£1 X (1 + R/M)M x T
If compounded continuously:
£1 X eR x T
Discount Factors and Present Values
Conversely, in order to end up with £1 at the end of T years, today we
need to invest only:
PV = Future Value after t periods / (1 + R)T
This equates to the present value (PV) of £1 that we expect to receive T
years from now.
(1 + R)T discount factor reflects time value of money (see slide 5
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, 10/10/23, 6:55 PM Foundations of Financial Management - Lectures 1-10 notes
Conversely, in order to end up with £1 at the end of T years, today we
need to invest only:
PV = Future Value after t periods / (1 + R)T
This equates to the present value (PV) of £1 that we expect to receive T
years from now.
(1 + R)T discount factor reflects time value of money (see slide 5
of lecture 2)
Why do we invest in risky projects?
There is a trade-off between risk and return investors prefer more
wealth to less wealth but are also risk averse. Hence, the return required
by investors is:
Risk-free return + risk premium
Opportunity cost depends on amount of risk
Discounted Cash Flows
Let’s say a company invests £1,000 today in machinery that is expected
to generate incremental cash flows of £300 at the end of each year 1-5.
Net Present Value
In return for some initial investment I, a typical capital project is
expected to generate a stream of future cash flows Ct (t = 1,2…T)
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Foundation to Financial
Management
What is Corporate
Finance?
Cash invested in assets must be
matched by an equal amount of cash
raised by financing.
A corporation can raise cash from lenders or from shareholders. If it
chooses to borrow, the lenders contribute the cash and the firm promises
to pay back this debt plus a fixed rate of interest (debt financing). If the
corporation has shareholders putting up cash (equity investors), they get
no fixed return but instead hold shares of stock and therefore get a
fraction of future profits and cash flow (equity financing).
Capital Budgeting and Structure
Capital Budgeting Decision (also called Investment Decision or Capital
Expenditure Decision (CAPEX) decision to invest in tangible or
intangible assets
Financing decision decision on the sources and amounts of financing
Capital structure the mix of long-term debt and equity financing
Capital Structure
The choice between debt and equity financing is called the capital
structure decision. Capital firm’s source of long-term financing.
Value of a firm = Value of bonds + value of shares
Firms can raise equity financing in two ways issuing new shares of
stock where cash is put up in exchange for a fraction of the company’s
future cash flow and profits take cash flow generated by existing
assets and reinvest cash in new assets.
What is a Corporation?
A business organised as a separate legal entity owned by stockholders.
Types include public, private and Limited Liability Corporations (LLC). (This
course mainly focuses on public limited-liability companies)
about:blank 1/59
,10/10/23, 6:55 PM Foundations of Financial Management - Lectures 1-10 notes
assets and reinvest cash in new assets.
What is a Corporation?
A business organised as a separate legal entity owned by stockholders.
Types include public, private and Limited Liability Corporations (LLC). (This
course mainly focuses on public limited-liability companies)
Limited liability owners of a corporation are not personally liable for its
obligations
Goal of the Corporation
Shareholders desire wealth maximisation questions include: which
year’s profits? Hard to defining profits? focus on cash flow instead. Also
issue of earning manipulation.
Opportunity cost of capital minimum acceptable rate of return on
capital investment set by the investment opportunities available to
shareholders in financial markets. I.e. what can we earn in similar projects.
Agency Problem
Do managers maximise shareholder wealth or manager wealth?
The agency problem refers to managers, as agents for stockholders, being
tempted to act in their own interests rather than maximising value.
Therefore, agency cost refers to value lost from agency problems or from
the cost of mitigating agency problems.
What is Financial Management?
Financial management studies how companies fund their operations.
Questions include:
Is it worth investing in a project?
Should we consider the risk of the project?
Where does funding come from and at what rate?
What is the best funding mix?
How do you value a company?
Should companies pay dividends to their shareholders?
Time Value of Money
Money can be invested in earn interest “a dollar today is worth more
than a dollar tomorrow”. Thus, financial managers make the same point
when they say that money has a time value.
about:blank 2/59
,10/10/23, 6:55 PM Foundations of Financial Management - Lectures 1-10 notes
Time Value of Money
Money can be invested in earn interest “a dollar today is worth more
than a dollar tomorrow”. Thus, financial managers make the same point
when they say that money has a time value.
Future value amount to which an investment will grow after earning
interest
Compound interest interest earned on interest
Simple interest interest earned only on the original investment
Compound Growth
£1 invested today, for a period of T years at interest rate R, compounded
annually:
£1 X (1 + R)T
If compounded M times per year at regular intervals:
£1 X (1 + R/M)M x T
If compounded continuously:
£1 X eR x T
Discount Factors and Present Values
Conversely, in order to end up with £1 at the end of T years, today we
need to invest only:
PV = Future Value after t periods / (1 + R)T
This equates to the present value (PV) of £1 that we expect to receive T
years from now.
(1 + R)T discount factor reflects time value of money (see slide 5
about:blank 3/59
, 10/10/23, 6:55 PM Foundations of Financial Management - Lectures 1-10 notes
Conversely, in order to end up with £1 at the end of T years, today we
need to invest only:
PV = Future Value after t periods / (1 + R)T
This equates to the present value (PV) of £1 that we expect to receive T
years from now.
(1 + R)T discount factor reflects time value of money (see slide 5
of lecture 2)
Why do we invest in risky projects?
There is a trade-off between risk and return investors prefer more
wealth to less wealth but are also risk averse. Hence, the return required
by investors is:
Risk-free return + risk premium
Opportunity cost depends on amount of risk
Discounted Cash Flows
Let’s say a company invests £1,000 today in machinery that is expected
to generate incremental cash flows of £300 at the end of each year 1-5.
Net Present Value
In return for some initial investment I, a typical capital project is
expected to generate a stream of future cash flows Ct (t = 1,2…T)
about:blank 4/59
