fhbm 1224 ch_01
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FHBM 1224Financial Management
Foundation in Arts
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Subject Information
3 hours lecture + 1 hour tutorial
Text book: Ross, S. A., Westerfield, R. W.,and Jordan, B. D. (2010). Fundamentals ofcorporate finance.(9th ed.). New York:McGraw-Hill.
Lecturer:Ms. Liu / Ms. Leong
Tutor:Pn. Liu / Ms. LeongEmail:Liusy@utar.edu.my /leongxy@utar.edu.my
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Methods of Evaluation1. Assignment 25%
2. Mid-term Test 15%
3. Final exam 60%
Total 100%
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Teaching Materials Students are expected to download own
lecture notes or any other materials via the
website provided by Web Based Learning
Environment: http://wble.utar.edu.my
It is essential that each student has accessto this website.
Active subject-related discussion among
students in WBLE forum is strongly
encouraged.
http://wble.utar.edu.my/http://wble.utar.edu.my/ -
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UTAR Student Dress Code
Proper Attire
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Third week of the trimester onwards
Full implementation as follow:
1sttime offenders: details of students taken downand submitted to the academic advisor for further action
2ndtime offenders: details of students submitted to the
Dean/Deputy Dean for further action.
3rdtime offenders: Warning letter issued to the student
4thtime offenders: Student to be sent for counseling
5thtime offenders: Barredfrom entering the campus
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Learning Objectives Know the goal of financial management
Understand the conflicts of interestthatcan arise between owners and managers
Know the basic types of financial
management decisionsand the roleofthe financial manager
Know the financial implications of thedifferent forms of business
organization
Understand the various types of
financial markets
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What is
Financestudies andaddresses the ways in which
individuals, businesses andorganizations raise, allocateand usemonetary
resourcesover time, takinginto account the risksentailed in their projects.
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Lets say you earn RM3,000 per month, how
do you allocate the income?
Example
RM 3,000
5% for insurance
30% for installment
20% for retirement plan
45% for monthly expenditure
Car loan
House loan
Back
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Problems with these Goals
Each of these goals presentsproblems.
These goals are either associated
with increasing profitabilityorreducing risk.
They are not consistent with the
long-term interests of shareholders. It is necessary to find a goal that
can encompass both profitabilityand risk.
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The Firms Objective
The goal of financialmanagement is tomaximize shareholderswealth.
Shareholders wealth can be measured as
the current value per share of existingshares.
This goal overcomes the problemsencountered with the goals outlined
above.
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Agency problem: Conflict of interest between
principal and agent
Principalsdelegateauthority to
agents tomanage firms
Principals hire agents
Principals
(shareholders)
Agents(managers)
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Example: Agency Problem
You hire someone to sell yourhouse and agree to pay that person
a flat fee when he sells the house. The agents incentive is to make the
sale, notnecessarily to get you thebest price.
Hence, the agent may not be actingin your best interest.
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Management may maximize own welfare (job
securities) instead of owners wealth (higher profit)
Ownership (shareholders)Problem created
by separation of
Agency Relationships/Problems
Control (Management& Employees)
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Do Managers Act in Shareholders Interests?
The answer to this willdepend on two factors:
how closely management goals are alignedwith shareholder goals
the ease with which management can bereplacedif it does not act in shareholders
best interests.
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Example: Aligning goals
aligningyour agents interestwith yours,since you want your house to be sold at the
highest possible price, so does your agent.
From the previous example, if,you offer a commissionof,
say, 10% of the sales priceinstead of a flat fee, you are
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Ways to Overcome Agency Problem
management compensation schemes(ESOS)
monitoring of management (Board ofDirectors)
the threat of takeover
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Employee Stock Option Scheme
a plan through which a company awardsStock Options to the employees basedon their performance
employees have the right to buy theshares of the company on a
predetermined date at apredetermined price.
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Example: ESOS
An employee is granted the option to purchase 1,000sharesof the companysstock at a price of RM5 pershare(the "grant" price). The employee can exercise theoption at RM5 per share.
Plans allow employees to exercise their options after acertain number of years or when the companysstockreaches a certain price.
If the price of the stock increases to RM20 per share,for example, the employee may exercise his or her
option to buy 1,000 shares at RM5 and then sell thestock at the current market price of RM20.
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Board of Directors
Board of Directors (BoD) should have a majorityof independentdirectors.
Independent directors are individuals who are
not current or former employees of the companyand must not have any business dealings withthe company.
The BoD has the ultimate authority to hire andfiretop management so a strong board woulddeter management from engaging in actions thatare detrimental to shareholders.
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Threat of Takeover
Poorly-managed firms are more attractive asacquisitionsthan well-managed firms becauseof greater profit potential.
A hostile takeover is usually associated withjob-
loss. Hence, it gives management another incentive
to act in the shareholders interests.
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Responsibility of Financial Managers
To acquire funds (cash) needed by a firm
To direct those funds into profitable
activities To maximize value of a firm
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Financial Management Decisions1. Investment Decisions (Capital Budgeting)
What long-term investments or projects should thebusiness take on?
2. LT Financing Decisions (Capital Structure)
Should we use debt or equity?
3. ST Financial Decisions (Working CapitalManagement)
How do we manage the day-to-day finances of thefirm?
4. Dividend Decisions (Dividend Distribution Policy)
How much dividends should we pay to ourshareholders?
How much earnings should we retain forreinvestment?
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1. The Investment Decision
Capital budgetingis the planning andcontrol of cash outflows in the expectationof deriving future cash inflows from
investments in non-current assets.
Involves evaluating the:
size of future cash flows
timing of future cash flows
risk of future cash flows.
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Cash Flow Size
Accounting income does not mean cashflow.
For example, a sale is recorded at the timeof sale and a cost is recorded when it isincurred, not when the cash is exchanged.
Vs.
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Cash Flow Timing
A dollar today is worth more than a dollarat some future date.
There is a trade-offbetween the size ofan investments cash flow and when the
cash flow is received.
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Cash Flow Timing
Which is the better project?
Future Cash FlowsYear Project A Project B
1 $0 $20 000
2 $10 000 $10 0003 $20 000 $0
Total $30 000 $30 000
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Cash Flow Risk
The role of the financial manager is to dealwith the uncertaintyassociated withinvestment decisions.
Assessing the risk associated with thesize and timingof expected future cash
flows is critical to investment decisions.
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2. Long Term Financing Decisions
A firms capital structureis the specificmix of debt and equity used to finance thefirms operations.
Decisions need to be made on both thefinancing mix and how and where to raise
the money.
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3. Short Term Financial Decisions
- working capital management
How much cash and inventory should be
kept on hand?
Should credit terms be extended? If so,
what are the conditions?
How is short-term financing acquired?
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4. Dividend Decision
Involves the decision of whether to pay adividendto shareholders or maintain thefundswithin the firm for internal growth.
Factors important to this decision includegrowth opportunities, taxation and
shareholders preferences.
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Forms of Business Organization
Three major forms in Malaysia
1. Sole proprietorship
2. Partnership General
Limited
3. Corporation Private Limited Company ( Sdn Bhd )
Public Limited Company ( Bhd )
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Sole Proprietorship
The business is owned by one person. The least regulated form of organization.
Owner keeps all the profits but assumes
unlimited liability for the businesssdebts.
Amount of equity raised is limited
to owners personal wealth.
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Partnership
The business is formed by two or more owners.
All partners share in profits and losses of thebusiness and have unlimited liability for debts.
Partnership dissolves if one partner sells out ordies.
More capital available but amount is limited tothe combined personal wealth of the partners.
Income is taxed as personal income to partners.
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Liability of Partners
General Partner- Has unlimited liability for all obligationsof the business disadvantage
Limited Partner
-Liability limited to the partnershipagreement advantage
- Limited partnership involves at leastone general partner and one or morelimited partners
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Corporation
A business created as a distinctlegal entity composed of one or
more individuals or entities.
Easy to raise capital. Shareholders and management are usually
separated.
Ownership can be readily transferred. Owners (shareholders) have limited liability.
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Private vs. Public Companies
Private Limited Company (Sdn Bhd)- cannot offer its shares for sale to the public
- shares normally held by one shareholder or a
small group of shareholders Public Limited Company (Bhd)
- offers its shares for sale to the public through astock exchange (e.g. Bursa Malaysia)
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Structure of Financial Markets
Primary Market Secondary Market
Money Market
Primary Market Secondary Market
Capital Market
Financial Markets
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Financial Market Components
Money markets Market for short-termsecurities ( 1 year)
Less risk, low return (Fixed Deposits, CommercialPaper)
Capital markets
Market for long-termsecurities
(> 1 year)
High risk, higher return
(Shares and Bonds )
P i S d M k t
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Primary vs. Secondary Markets
1. Primary- new securities or primary claims
are issued, resulting in cash inflow to the issuer.
- firms issuing common shares to public for the1sttime is known as Initial Public Offering
(IPO).2. Secondary - already existing financial claims
such as stocks and bonds are bought and sold,no resulting cash inflow to the issuer.
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The Corporation and Financial Markets
Corporation Investors
Government
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The Corporation and Financial Markets
Corporation Investors
Capital
Securities
Government
Primary Market
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The Corporation and Financial Markets
Corporation Investors
Secondary
market
Capital
Securities
Government
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The Corporation and Financial Markets
Corporation Investors
Secondary
market
Capital
Securities
Government
Cash Flow
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The Corporation and Financial Markets
Corporation Investors
Secondary
market
Capital
Securities
Government
Cash Flow
tax
Reinvest
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The Corporation and Financial Markets
Corporation Investors
Secondary
market
Capital
Securities
Government
Cash Flow (dividends)
tax
Reinvest
M t f S i 1 Th di t
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Movement of Savings: 1.The direct
transfer of funds
cash
securities
saver
firm
Movement of Savings: 2 Indirect
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Movement of Savings: 2. Indirect
transfer with investment banker
securities
fundsfunds
securities
saver
investment
banker firm
M t f S i 3 I di t
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Movement of Savings: 3. Indirect
transfer with financial intermediary
funds
intermediarysecurities
funds
firmsecurities
financial
intermediary firmsaver
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Lecture Exercise
Match the following with the questions below:(a.) restructuring(b.) capital market(c.) money market(d.) inflation(e.) primary market(f.) secondary market
(g.) financial capital
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1.______This form of capital is found on the Statement ofFinancial Position under long-term liabilities and equity.
2.______The purchasing power of the dollar shrinks over
time.3.______A market where the securities being traded are
new public offerings.
4.______Securities with a maturity of less than 1 year.
5.______Redeploying the asset and liability structure of thefirm.
6.______Market composed of common stock, preferredstock, commercial and government bonds and otherlong-term securities.
7.______This market trades previously issued securities.
Answer: (1.) g (2.) d (3.) e (4.) c (5.) a (6.) b (7.) f
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"I hear and I forget.
I see and I remember.
I do and I understand."
-- Confucius
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