LAMP MOS 1023 Study Sheets

LAMP MOS 1023 Study Sheets - Lecture 6 Introduction to...

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1 Lecture 6 - Introduction to Finance Finance The science or study of the management of funds Firm’s Goal - Create value for shareholders By maximizing price of common stock Good financial decisions that increase stock price Management Arbitrator and moderator between conflicting interest groups, stakeholders, objective Contractual Claims - creditors, managers, employees, customers hold against the company Residual Claims - shareholders have against the company Role of Finance Capital budgeting decision - long term investments Capital structure decision - raising money to fund long term investments Operating decision - managing cash flow Financial manager Raise funds, obligations (stocks, debt securities); Investments; Cash from operating activities; Reinvesting; Dividends or interest payments Principles of Finance Principle 1: Cash flow is what matters Profits are not equal to cash flows; cash flow drives the business Principle 2: Money has time value A dollar today is worth more than a dollar received in the future due to interest LEARN present value calculations - NPV Positive and zero NPV is acceptable but not a negative NPV Cash outflows - initial investment, incremental operating costs, repairs, inventory Cash inflows - incremental revenues, reduction in operating costs, salvage value Discount rate - costs of capital is the minimum required rate of return Cost of capital is the average rate of return the company must pay its long-term creditors and stockholders for the use of their funds Principle 3: Diversification of Investment All investment risk is not the same Some risk can be removed or diversified by investing in different securities - firm specific (unsystematic), market (systematic) Principle 4: Market Prices Are Generally Right Information efficiency - prices of securities reflect all info available to public at any point in time Prices should reflect new information made publicly available Inefficiencies in market may distort market prices (behavioural biases) Principle 5: Conflicts of Interest and Agency Problems Agency problem = separation of management & ownership of firm Owner objective: maximize equity Management objective: firm sales, assets, other perks Principal agent problem = managers making decisions not in best interest of shareholders Agency conflict can be reduced through monitoring & compensation plans Corporate governance functions: Oversight board of directors to oversee management
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2 Managerial run company Compliance laws, regulations, standards Internal Audit assurance & consulting activity Legal and advisory advice External audit lend credibility Monitoring elect/remove directors and management Principle 6: Ethics/Trust in Business Firms must have standards of ethics to minimize subjectivity of “ethical behaviour” Unethical decisions can negatively impact shareholder wealth Real vs. Financial Assets Real assets = tangible things owned by people/businesses (ex. Property, equipment)
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