u Finance and the Financial Manager Principles of Corporate Finance Brealey and Myers Sixth Edition Chapter 1 2 Topics Covered w What Is A Corporation? w The Role of The Financial Manager w Who Is The Financial Manager? w Separation of Ownership and Management w Financial Markets 3 Corporate Structure Sole Proprietorships Corporations Partnerships Unlimited Liability Personal tax on profits Limited Liability Corporate tax on profits + Personal tax on dividends 4 Role of The Financial Manager Financial manager Firm's operations Financial markets (1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors (1)(2) (3) (4a) (4b) 5 Who is The Financial Manager? Chief Financial Officer Comptroller Treasurer 6 Ownership vs. Management Difference in Information w Stock prices and returns w Issues of shares and other securities w Dividends w Financing Different Objectives w Managers vs. stockholders w Top mgmt vs. operating mgmt w Stockholders vs. banks and lenders 7 Financial Markets Primary Markets Secondary Markets OTC Markets Money 8 Financial Institutions Company Intermediaries Banks Insurance Cos. Brokerage Firms Obligations Funds 9 Financial Institutions Intermediaries Investors Depositors Policyholders Investors Obligations Funds u Present Value and The Opportunity Cost of Capital Principles of Corporate Finance Brealey and Myers Sixth Edition Chapter 2 [...]... Opportunity Cost of Capital Example You may invest $100,000 today Depending on the state of the economy, you may get one of three possible cash payoffs: Economy Payoff Slump Normal Boom $80,000 110,000 140,000 80,000 + 100,000 + 140,000 Expected payoff = C1 = = $110,000 3 23 Opportunity Cost of Capital Example - continued The stock is trading for $95.65 Depending on the state of the economy, the value of the... Discount Factors can be used to compute the present value of any cash flow 15 Valuing an Office Building Step 1: Forecast cash flows Cost of building = C0 = 350 Sale price in Year 1 = C1 = 400 Step 2: Estimate opportunity cost of capital If equally risky investments in the capital market offer a return of 7%, then Cost of capital = r = 7% 16 Valuing an Office Building Step 3: Discount future cash flows PV... 4: Go ahead if PV of payoff exceeds investment NPV = −350+ 374= 24 17 Net Present Value NPV = PV - required investment C1 NPV = C0 + 1+ r 18 Risk and Present Value w Higher risk projects require a higher rate of return w Higher required rates of return cause lower PVs PV of C1 = $400 at 7% 400 PV = = 374 1 + 07 19 Risk and Present Value PV of C1 = $400 at 12% 400 PV = = 357 1 + 12 PV of C1 = $400 at... value of the stock at the end of the year is one of three possibilities: Economy Slump Normal Boom Stock Pric e $80 110 140 24 Opportunity Cost of Capital Example - continued The stocks expected payoff leads to an expected return 80 + 100 + 140 Expected payoff = C1 = = $110 3 expected profit 110 − 95.65 Expected return = = = 15 or 15% investment 95.65 25 Opportunity Cost of Capital Example - continued... Rule w Opportunity Cost of Capital w Managers and the Interests of Shareholders 12 Present Value Present Value Discount Factor Value today of a future cash flow Present value of a $1 future payment Discount Rate Interest rate used to compute present values of future cash flows 13 Present Value Present Value = PV PV = discount factor × C1 14 Present Value Discount Factor = DF = PV of $1 DF = 1 t (1+ r... C1 = $400 at 12% 400 PV = = 357 1 + 12 PV of C1 = $400 at 7% 400 PV = = 374 1 + 07 20 Rate of Return Rule w Accept investments that offer rates of return in excess of their opportunity cost of capital Example In the project listed below, the foregone investment opportunity is 12% Should we do the project? profit 400,000 − 350,000 Return = = = 14 or 14% investment 350,000 21 Net Present Value Rule w... appointed by the board of directors è Financial incentives such as stock options è Principles of Corporate Finance Brealey and Myers u Sixth Edition How to Calculate Present Values Chapter 3 32 Topics Covered w Valuing Long-Lived Assets w PV Calculation Short Cuts w Compound Interest w Interest Rates and Inflation w Example: Present Values and Bonds 33 Present Values Discount Factor = DF = PV of $1 DF = 1 t... invest A prefers to invest 14%, moving up the red arrow, rather than at the 7% interest rate G invests and then borrows at 7%, thereby transforming $100 into $106.54 of immediate consumption Because of the investment, G has $114 next year to pay off the loan The investment’s NPV is $106.54100 = +6.54 G invests $100 now, borrows $106.54 and consumes now 100 106.54 Dollars Now 30 Managers and Shareholder Interests... invest A prefers to invest 14%, moving up the red arrow, rather than at the 7% interest rate G invests and then borrows at 7%, thereby transforming $100 into $106.54 of immediate consumption Because of the investment, G has $114 next year to pay off the loan The investment’s NPV is $106.54-100 = +6.54 29 Investment vs Consumption w Dollars Later A invests $100 now and consumes $114 next year 114 107 The... payoff = C1 = = $110 3 expected profit 110 − 95.65 Expected return = = = 15 or 15% investment 95.65 25 Opportunity Cost of Capital Example - continued Discounting the expected payoff at the expected return leads to the PV of the project 110,000 PV = = $95,650 1.15 26 Investment vs Consumption w Some people prefer to consume now Some prefer to invest now and consume later Borrowing and lending allows . u Finance and the Financial Manager Principles of Corporate Finance Brealey and Myers Sixth Edition Chapter 1 2 Topics Covered w What Is A Corporation? w The Role of The Financial. Cost of Capital Principles of Corporate Finance Brealey and Myers Sixth Edition Chapter 2 11 Topics Covered w Present Value w Net Present Value w NPV Rule w ROR Rule w Opportunity Cost of Capital w. in the capital market offer a return of 7%, then Cost of capital = r = 7% 16 Valuing an Office Building Step 3: Discount future cash flows Step 4: Go ahead if PV of payoff exceeds investment 374 )07.1( 400 )1( 1 === ++r C PV 24374350 = + − = NPV 17 Net