RMIT Business Finance lecture 1

8/19/2019 RMIT Business Finance lecture 1

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Topic 1

Introduction ToBusiness/Corporate Finance


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Overview

In this lecture we will discuss

The nature of business/corporate finance;

The nature of financial markets;

The corporate objective;

Corporate financial decisions;

Critical factors in financial decision-making;

Valuation of a firm and real and financial

assets; &

inance vs! accounting

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Business/Corporate Finance

What Is Business/Corporate Finance?

Corporate inance is a bod% of knowledge which

focuses on e.plaining and interpreting financial markets! It

provides an anal%tical framework to guide managers of

firms and to assist them to evaluate corporate financial

decisions”.

*ishop0 Crapp0 aff and Twite 0 ,1123

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Financial Markets

4hat is a inancial #arket5

+ medium for the issue and e.change offinancial assets!

+ustralian financial market includes6

The big four7 banks and all otherbanks/building societies/savings & loansoperating in +ustralia3

The +ustralian 8tock 9.change +8:3 The +ustralian government bond market

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Financial Markets

inancial markets - bring together the bu%ers and sellers of debtand e


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Corporate Financial #ecisions$The %oal o& The Firm

'The Corporate O()ective*

The Corporate O()ective

*efore we discuss corporate financial decisions we should know what isthe main goal/objective of a firm from a corporate/business financeperspective6

#ain corporate objective6 obvious answer - #a.imise =rofit + Wrong!!!

The corporate objective can be stated in two different0 but e


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The Corporate O()ective

+ compan% should make decisions that increase

the wealth of its owners!This is s%non%mous with increasing the value ofthe firm!

>wner wealth is measured b% the marketcapitalisation o& securities for shares this is thetotal market value of all of the shares of a compan%on issue!

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,n -.ample o& Market Capitalisation

9.ample6 *B=-*illiton as at ()th ul% '(,2

8ecurit%6 >rdinar% 8haresDo! on issue E ?!2) billion,

Fast sale price - G2,!(('

#arket capitalisation of ordinar% sharesE

?!2) billion shares . G2,!(( H G,@@!((' billion, http6//www!bhpbilliton!com/home/investors/reports/ocuments/'(,'/*B=*illiton+nnual"eport'(,'!pdf *B=* +nnual "eport une '(,' p! @0 ()/(A/,2 26((pm!

' http6//www!as.!com!au/as./research/compan%Info!do5b%Has.Code&as.CodeH*B=0 +8: price0 ()/(A/,2 '6??pm!

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Why "hould , Company ,im To Ma.imise Its Market alue? 0

The "tandard -conomic Model -conomics )usti&ication$

The standard economic model 89#3 states6

Individuals are utilit% satisfaction/happiness3 ma.imisers

$tilit% is a function of consumption

Consumption is a function of wealth$tilit% ma.imising individuals wish to ma.imise their wealth

+nd we know that6

Individuals hold part of their wealth in the form of shares in companies0 and

The market value of a compan% is represented b% its share price multiplied b% the number of shareson issue

Therefore0

The greater the market value of a compan%Js shares0 the greater the compan%Ks market value0 andthe greater will be the wealth of its shareholders and therefore the greater will be their utilit%

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Corporate Financial #ecisions$,chievin The Corporate O()ective

2ey #ecisions In Business Finance

The two ke% decisions faced b% corporatefinance managers in achieving the corporate

objective are6

,! The investment decision

'! The financing decision

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The Investment #ecisionThe wa% in which funds that have been raised areused in productive activities!

The objective is to generate a return to investors!

This is dealt with under the topic of capitalbudgeting7 or project evaluation7 Topic 3

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The Investment/Capital Budetin #ecisionThe investment decision deals with the evaluation of investmentopportunities!

Involves evaluating the6 siLe of future cash flows;

timing of future cash flows; and risk of future cash flows!

The


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The Financin #ecision

The mi. of funding obtained from capital markets!

The proportional holdings of debt and e


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The Financin #ecision

The financing decision deals with the determination of the firmJs capitalstructure

The


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Critical Factors In Financial #ecisionMakin

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Cash Time Risk

Three Critical Factors


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Critical Factors In Financial #ecisionMakin

CashFlow ,nalysis

ocus is alwa%s on cash-flows0 not accounting earnings!CashFlow Timin

#one% has a time value; ecision-making in finance must take account of the timing ofthe cash-flows!

+ dollar toda% is worth more than a dollar at some future date!

There is a trade-off between the siLe of an investmentKs cash-flow and when the cash-flow is received!

CashFlow 4isk

"isk refers to variabilit% of a cash-flow stream; +djustments must be made to takeaccount of differing degrees of variabilit% - the risk-return relationship must alwa%s be

kept in mind!The role of the financial manager is to deal with the uncertaint% associated withinvestment decisions!

+ssessing the risk associated with e.pected future cash-flows is critical to investmentdecisions

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aluation o& The Firm ,nd ,ssets

The corporate objective6 #a.imise the valuation market value3 of the

compan%/ wealth of the owners shareholders3!8o0 we need to ma.imise the market value of the firmKs assets!

+ssets can be classified as either6

4eal ,ssets$ +ssets that can be put to productive use to generate areturn e!g! machiner% and e


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aluation o& , Firm

+ firm is a collection of real assets e!g! plant0 ene approach is to value the real assets of the firm!

: =roblem6=roblem6 ""eal assets are not fre


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Financial ,ssets

9.amples of inancial +ssets68hares e


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Balance "heet Woolworths 5td 'WOW* 6une 78 98191

, http6//www!woolworthslimited!com!au/annualreport/'(,'/pdf/44N+",'Nin"eport!pdf0 4oolworths +nnual "eport '(,' p! 110 ()/(A/,2 26()pm!

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Current ,ssets :;(Total ,ssets :91


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Finance vs< ,ccountin

*oth disciplines are concerned with a firmKs assets and liabilities!

+ccounting0 with its emphasis on review and compliance0 generall%has an historical outlook!

inance0 with its emphasis on valuation and decision-making0generall% has a focus on the future!

The primar% focus of accounting is stewardship/compliance!

+ccounting standards give discretion in the selection of accountingprocedures which can6

a3 cause comparabilit% problems when anal%sing reports of differentcompanies0 and

b3 enable deliberate manipulation of financial reports creativeaccounting or window dressing0 e!g! 9nron & +rthur +nderson '((,3

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Finance vs< ,ccountin

!ro(lems With ,ccountin !ro&it From , Corporate Finance !erspective$

,< What pro&it? ,! G amount or O return5 Is a G,(m profit better than a G,m profit5

9.ample =roject + Cost G,b0 profit G,(m0 O return ,O

=roject * Cost G,m0 profit G,m0 O return ,((O

'! *efore-ta. v! after-ta.!

B< elect o& time E Ignores time value of mone% concept! 9.ample G,(m overeight %ears vs! G2m over two %ears E which is better5

C< elect o& risk E =rofit streams are not adjusted for risk!

Is a G,(m profit better than a G,m profit5

G,(m E high risk project; could lose all our mone%! G,m E low risk project; ver% little chance of losing our mone%!

#< elect o& cash&lows E accounting earnings/profits are calculated on anaccrual basis0 not cash-flow basis!

-< ,r(itrary allocations E e!g! depreciation0 provisions!

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RMIT Business Finance lecture 1

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