Four basic areas of finance
Corporate finance: Basic theories and ideas of finance such as sources of funding being debt
and equity
Investments: Financial assets such as shares and bonds
Financial institutions: Firms dealing in financial matters
International finance: covers an area above in a global context
Goals of Financial Management
Maximise shareholder wealth by maximising share price
Investment decisions- what assets to buy
Capital structure decisions
Working capital decisions
Factors in any financial decision
Dollar amount: the actual cash flow received or paid out
Time: When the cash flow is received or paid out (Time value of money)
Risk: Amount of uncertainty
The Working Capital Decision
Managing short-term assets and liabilities which forms part of the investment decision
Inventory management: what is the optimal level of inventory
Receivables management: should credit sales be allowed
Accounts Payable management: How long should suppliers have to wait before being paid
Cash: how much cash should a company hold
Principal and Agent law
A contractual relationship between a person (the agent_ who is authorised to act on behalf
of another (the principal)
Agents can create legal relationship with a third party
Not all employees are agents for the employer, sales people are agents for the employer as
they are arranging sales and managers as well as they enter into contracts for the employer
Interaction between firms and financial markets
Primary Market
Security or instrument issued to an investor for the first time directly
Funds are raised by the firm and flow to it
Public offering or private replacement
Can be debt or equity funding
Fund raising between investors and firms
Secondary Market
Financial securities that are already issued are bought and sold
Way of transferring ownership e.g. securities exchange
No additional funds are raised by the firm
Market values and book values
Balance sheet is historic accounting
Real or productive assets: produce the cash flows over time
Financial or paper assets: claim on cash flows of productive assets
Income statements
Revenue- COGS= Gross profit – expenses – net income
Time Value of Money 1 (Examples throughout lecture 2)
The financial manager makes decisions about proposals with cash flow over long periods of
time
It is based on the fact that a dollar today is worth more than a dollar tomorrow
PV= present value I= interest rate n=number of periods FV= future value PMT= periodic
payment
Simple interest
Used in the valuation of short-term financial instruments traded in the money market e.g.
term in under 12 months, bills of exchange
Interest= PV x I x N
FV= PV + INT
FV = PV + PV × i × n = PV(i × n)
PV= FV/(1 + I x n)
What is the future value of $100,000 invested for 180 days at 10% pa simple interest?
FV = PV(1 + i × n) FV = 100,000(1 + 10%×180/365) = 100,000(1 + 0.0493) = 104,930
Compound interest
FV = PV(1 + i)n (to the power of n)
PV= FV/(1+I)n (to the power of n)
When compounded quarterly divide the annual interest rate by 4.
What is the compounding rate for each time period for a 18% nominal annual interest rate
with monthly compounding? The number of compounding periods each year is 12 Rate
per period = 18% ‚ 12 = 1.5%
Effective annual rates (EAR)
An effective rate is an interest rate that compounds annually
EAR=( 1 + i) m – 1 (m is a power) m= number of compounding periods per year
i= interest rate per period
12.5% annual interest rate, compounded half yearly: EAR = (1+ i) m – 1 = (1+.0625)2 -1=
12.89%
Time Value of Money 2 examples in lecture 3
Annuity
An annuity is a number of equal cash flows occurring at equal time intervals ( money
deposited at the end of each period)
An ordinary annuity assumes all cash flows occur at the end of each period
In a future value calculation: First period receives interest for two periods, second payment
receives interest for only one period, third payment receives no interest
E.g. Rose deposits $10,000 into a bank account at the end of each year for the next three
years. If the interest rate is 5% p.a. how much will Rose have accumulated at the end of the
third year?
Present value of an annuity
Present value is calculated at the beginning of the period
Assumes the first payment made is at the end of the first period, (beginning of period one =
time 0, beginning of period 3= end of period 2
To find monthly payments use Present value formula and substitute to find PMT and then
divide by the Future value.
Amortisation schedule
Perpetuity
A annuity that continues forever
PV= PMT/i
There is no future value
E.g. A life insurance policy that pays $13,000 every year forever is being sold for $140,000, If
interest rates are 11% pa would you purchase the insurance policy?
Solution: PV= 13,000/0.11= $118,181.82 therefore you would not buy the policy
Debt and Valuation
Debt
An amount of money borrowed today from a lender to be repaid in the future
It is a contractual obligation which commits the borrower to interest and principal
repayments
Default is failure to meet the required payments when due
Features of Debt
Maturity: Short term or long term debt
Security: Secured or Unsecured
Ranking: Senior or subordinate
Interest rate: Fixed, variable or a combination
Repayment pattern: Interest only, principal and interest, capitalised interest
Currency: Domestic (AUD), Foreign
Source: Markets or financial institutions
Bill of exchange
Source of short-term finance, a bill must state amount payable and date payable
Bills are discount instruments; only payment made at maturity, issued at a price less than
their face value, interest is difference between security’s price and face value
Can be ‘rolled over’ at maturity
