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CHAPTER 1 GETTING STARTED --- PRINCIPLES OF FINANCE Finance is the study of how people and businesses evaluate investments and raise capital to fund these investments. Key principles guide the process of evaluating investment decisions. This chapter lays the foundation for understanding the principles that underpin financial decision making. Financial decisions permeate every aspect of the business world and of our personal lives. Understanding basic financial concepts is critical to making informed decisions concerning the use of financial resources. This chapter describes the three types of business organizations—sole proprietorships, partnerships, and corporations—and compares and contrasts the similarities and differences among these types of business organizations. Further, the role of finance is discussed relative to the overall structure of the organization. The overriding goal of finance is to maximize shareholder wealth. The separation of ownership and control within the corporate structure gives rise to agency problems between various stakeholders in the firm. Finance encompasses four basic principles: Money has a time value; there is a risk-return tradeoff; cash flows are the source of value; and market prices reflect information. LEARNING OBJECTIVES 1-1. Understand the importance of finance in your personal and professional lives and identify the three primary business decisions that financial managers make. 1-2. Identify the key differences between the three major legal forms of business. 1-3. Understand the role of the financial manager within the firm and the goal for making financial choices. 1-4. Explain the four principles of finance that form the basis of financial management for both businesses and individuals. CHAPTER ORGANIZATION 1. FINANCE: AN OVERVIEW There are three basic questions that are addressed by the study of finance: 1. What long-term investments should the firm undertake? This area of finance is generally referred to as capital budgeting . 2. How should the firm raise money to fund these investments? The firm’s funding choices are generally referred to as capital structure decisions. 3. How can the firm best manage its cash flows as they arise in its day-to-day operations? This area of finance is generally referred to as working capital management . 1
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A- 2 INTRODUCTION TO FINANCIAL MANAGEMENT The Four Basic Areas Corporate Finance: Deals with the operation of the firm (both the investment decision and the financing decision) from the firm's point of view. The application of financial principles within a corporation to create and maintain value through decision-making and proper resource management. Investments: Pricing of financial assets; risk and rewards of investing; portfolio management. Financial Institutions: An
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