Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 1 Chapter1 FinancialEconomics ObjectiveToDefineFinanceTheValueofFinanceIntroductiontothePlayers Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 2 Chapter1Contents 1 1DefiningFinance1 2WhyStudyFinance1 3FinancialDecisionsofHouseholds1 4FinancialDecisionsofFirms1 5FormsofBusinessOrganization1 6SeparationofOwnershipandManagement 1 7TheGoalofManagement1 8MarketDiscipline Takeovers1 9TheRoleoftheFinancialSpecialistinaCorporation Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 3 Introduction I msavingforretirement ShouldIuseabankCD mutualfund directstockmarketinvestment Iwantthatnewcar ShouldIusesavedcash lease borrow I mthinkingaboutstartinganewbusinesswillitrewardmeadequately Thecompanyislookingtoexpandintotelecommunications howshouldyouadvisetheCFO ALatinAmericancountryhasaskedformajorprojectfinancingshouldmyorganizationprovidethefunds Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 4 1 1DefiningFinance FinanceisthestudyofhowpeopleallocatescarceresourcesovertimecostsandbenefitsaredistributedovertimebuttheactualtimingandsizeoffuturecashflowsareoftenknownonlyprobabilisticallyUnderstandingfinancehelpsyouevaluatetheseuncertaincashflows Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 5 DefiningFinance Whenimplementingdecisions peoplemakeuseoftheFinancialSystemdefinedasthesetofmarketsandotherinstitutionsusedforfinancialcontractingandexchangeofassetsandrisks Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 6 DefiningFinance Financialtheoryconsistsof thesetofconceptsthathelptoorganizeone sthinkingabouthowtoallocateresourcesovertimethesetofquantitativemodelsusedtohelpevaluatealternatives makedecisions andimplementthemTheseconceptsandmodelsapplyatalllevelsandscalesofdecisionmaking Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 7 DefiningFinance Abasictenetoffinanceisthattheexistenceofeconomicorganizations e g firmsandgovernments facilitatethesatisfactionofpeople sconsumptionpreferences Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 8 1 2WhyStudyFinance TomanageyourpersonalresourcesTodealwiththeworldofbusinessTopursueinterestingandrewardingcareeropportunitiesTomakeinformedpublicchoicesasacitizenTheintellectualchallenge Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 9 1 3FinancialDecisionsofHouseholds ConsumptionandsavingdecisionsInvestmentDecisionsFinancingDecisionsRisk managementdecisions Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 10 ImportantTerms AssetsPersonalinvesting AssetallocationLiability DebtNetWorth Assets LiabilitiesExogenousandendogenouselements Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 11 1 4FinancialDecisionsofFirms BusinessFirmsentitieswhoseprimaryfunctionistoproducegoodsandservicestheyvarywidelyinsizefrompart timebusinessesrunfromaspareroom togiantcorporations e g MitsubishiorGeneralMotors withhundredsofthousandsofemployees andanevenlargerownership Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 12 FinancialDecisionsofFirms Strategicplansspecifythebusinessthefirmisinstrategicplansmaychangeradicallyovertimethefirm sbusinessmaybedefinedintermsofagroupofproducts technologiesorcustomers Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 13 FinancialDecisionsofFirms TheCapitalBudgetingProcessThepreparationofaplanforacquiringfactories machinery researchlaboratories showrooms warehouses andhumanassetstoimplementthestrategicplanThebasicunitofanalysisistheinvestmentproject Investmentprojectsareidentified triaged andimplementedinthecapitalbudgetingprocess Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 14 FinancialDecisionsofFirms TheFinancingProcessOnceanewsetofapprovedprojectshasbeenidentified itmustbefinancedwithretainedearnings stock bonds etceteraCapitalstructureistheamountofthefirm smarketvalueallocatedtoeachcategoryofissuedsecurities ItdeterminesownershipandrisklevelofthefirmsfuturecashflowsCapitalstructure sunitofanalysisisthefirmasawhole notaninvestmentproject Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 15 FinancialDecisionsofFirms ThecapitalstructurealsodetermineswhocontrolsthefirmunderdifferentcontingenciesCommonstockholdersusuallydeterminethemembershipoftheboardofdirectorsPreferredstockholdersusuallygainsomecontrolifpreferreddividendsarenotpaidBondholdercovenantsrestrictdecisionsthatcouldadverselyaffectbondvalues Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 16 FinancialDecisionsofFirms WorkingCapitalallfirms includinghighlyprofitableones thatdonotpaysufficientattentiontoworkingcapitalmanagementmaybeseriouslydamagedbytheresultinglossofinvestorandcreditorconfidencedelayedininvestmentschedulessub optimaltemporaryfinanceunscheduledsaleofthefirmsassets Copyright 2009PearsonEducation Inc PublishingasPrenticeHall 17 1 5FormsofBusinessOperation SoleProprietorshipafirmownedbyanindividualorfamilytheassetsandliabilitiesarethepersonalassetsandliabilitiesofthepro