ADVANCE FINANCIAL MANAGEMENTnDr. R. KabirnDepartment of Finance, Tilburg University, The NetherlandsnTeaching:nCorporate Finance / Financial ManagementnEmpirical Corporate FinancenSeminar in FinancenResearch:nCorporate finance, Corporate governance, Financial market regulationnInternet address: www.tilburguniversity.nlWhat is Finance?nFinance is usually concerned with the way in which funds for a firm are raised and investednFinance consists of four interrelated areas:n Corporate Finance (Financial Management)n Investments (Asset Pricing)n Financial Markets (Money and Capital Markets)n BankingWhat is (Corporate) Financial Management?nFinancial Management primarily addresses the following three questions:n1. What long-term investments should the firm engage in?n2. How can the firm raise the money for the investments?n3. How much short-term cash flow does a company need?nWe take the perspective of a finance manager of a firm to understand these issues.Role of the Finance ManagernStands between the firms operations and the financial marketsnInvolved with the flow of cash from investors to the firm and back to the investors againnInvolved with the use of cash to invest in firms real assetsRole of the Financial ManagerFinancial managerFirms operationsFinancial markets(1) Cash raised from investors(1)(2) Cash invested in firm(2)(3) Cash generated by operations(3)(4a) Cash reinvested(4a)(4b) Cash returned to investors(4b)Different forms of firmsnFirms are usually classified according to their form of ownership:nSole proprietorshipnPartnershipnCorporationTypical Features of a CorporationBoard of DirectorsManagementAssetsDebtEquityShareholdersDebtholdersAdvantages and disadvantages of corporationsnAdvantages:nSeparate legal entitynEasy transfer of ownershipnCorporation has unlimited lifenShareholders have limited liabilitynDisadvantages:nDouble taxation: corporate and personal income taxnSeparation of ownership and control leads to agency problems between managers and shareholdersObjectives / Goals of a businessnPopular objectivesnMaximisation of (accounting) profitnMaximisation of salesnMaximisation of return on investmentnSurvivalnStabilitynGrowthWhy not profit maximization?nThere are problems in the use of accounting profit (earnings)nIgnores time value of moneynIgnores risknCalculated on the basis of accounting rules “Creative Accounting”nIgnores investment / growth opportunities of a firmObjective / Goal of a Finance ManagernMaximize Market Value / Wealth for the Owners (Shareholders)nMarket value is the value that shareholders place on their securities today. It depends on the future cash flows that they expect to receive.nMarket value is forward looking.Why focus on Market Value?nThis objective takes into account the valuable features of all other objectivesnIt may not be a perfect description of what firms seek to achievenBut, it is probably the most objective measurenMarket value of shares is calculated as the share price multiplied by the number of outstanding shares.Why we do not focus on book value?nBook Value is the value of the firm according to the balance sheetnBook value of assets suffers from same problems like earningsnBook value of assets fails to consider inflation, technological change and organizational capitalnBook value ignores intangible assets, future liabilities (off-balance sheet)nBook value is not a forward looking measure.Sources of FinancingnShort-term and Long-term sourcesnHow much short-term cash flow does a company need to pay its bills?nHow much long-term cash flow does a company need to pay for its investments?nInternal and External sourcesnHow much of the earnings should be retained?nHow much should be financed by Equity, Debt (Bank debt, Bonds), Warrants, Convertibles, etc?Ways firms can issue sharesnInitial Public Offering (IPO): It is the first public equity issue made by a company.nPublic firms (those already listed on a stock exchange) can issue shares in different ways:nPrivate placing nPublic issueGeneral Cash OfferRights Offering1. Dividend Valuation Model:nShare price equals the present value of all expected future dividends.Valuation of a common sharenIf we expect no growth of dividends, and plan to hold the share indefinitely, we will then value the share as follows:nPo=Div / rnIf dividends are expected to grow at a constant rate, we will then value the share as follows:nPo=Div1 / (r - g)nThis formula is popularly known as Gordon Growth ModelValuation of a common shareValuation of a common sharenAn Example:nCurrent forecasts are for XYZ Company to pay dividends of $3, $3.24, and $3.50 over the next three years, respectively.nAt the end of three years you anticipate selling your stock at a price of $94.48.nWhat is the price of the stock given a 12% expected return?Valuation of a common shareValuation of a common shareIf we forecast no growth of dividend of $3, and plan to hold the stock indefinitely, we wi