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INTRO, RISK&RETURN, MPT (Fundamental concepts in Corporate Finance…
INTRO, RISK&RETURN, MPT
Role of a financial manager?
opportunities to create wealth
Finance from capital markets
long term financing
equity vs debt financing depends on risk preference of the investor
3 types of markets
Secondary market
trading in:
previously issued shares and bonds
of established public companies
outstanding
Over the counter (OTC) market
if not traded on an organised exchange
its said to trade in the OTC market
Primary market
new public offerings
by privately held firms
the inital public offering (IPO) market
additional
sold by established public Co's
e.g. rights issues
shares/bonds.debentures
Issue of shares
equity shares
high risk but high expected return
Working capital investments
accounts receivable
inventory
cash
Issue of debt
debenture/bonds
low risk
Non-current assets
PPE
intangible assets (e.g. patents, trademarks)
Finance from creditors
working capital financing
Investing in financial assets
Loans
Derivatives
Bonds or preference shares
Investments in non-operating assets
Finance from retained earnings
use of accumulated profits of prior years
retain or distribute profits through dividends
Finance from money markets
short term financing
based on cyclical nature of business
Investing in operating assets
Relationship of corporate finance to accounting an economics?
Why is the objective of financial management to maximise the value of the firm?
because shareholders desire value maximisation
maximization of firm's value
What is financial management?
how should Co pay (finance) these investments?
when should dividends be paid and how much?
which assets should Co invest in?
Issues with profit maximisation?
does not reflect cash flows
accounting profits does not account for the cost of equity capital
timing of returns
risk - if higher profits come with much higher risk, then the share price may fall
manipulation of accounting profits
Financing decision
Selecting the optimal finance mix
cost of financing is linked to the risk associated with the investment
risk depends on
type of project undertaken
length of time for which funds are provided
cost and risk of financing
sources of finance
Fundamental concepts in Corporate Finance
Risk and return
expected return of an asset is determined by its level of risk
risk is measure ito risk of loss and variability of cash flows
Efficient market hypothesis
and without bias
to all publicly available info
hypothesis asserts that securities markets react immediately
TVOM
value of any investment is determined by:
timing of cash flows
use of a risk adjusted discount rate
size of future cash flows
Portfolio theory
theme of diversification
PV
value today of expected future cash flows
CAPM
used to calculate a risk adjusted required rate of return
Capital asset pricing model
focus is on risk that can't be diversified away i.e. market risk
FV
value that an investment will grow over a stated period at a specified interest rate
Effective rate
Nominal rate vs Real interest rate
Future Value
single sum
FV=PV(1+r)
annuity
FV=PV(1+r)^n
PV=FV/(1+r)^n
Effective rate=[1+(Rn/m)]^m-1
Important
Nominal vs real interest rate
Apply compounding and discounting to complex cash flow streams
Define and calculate an effective rate
Apply TVOM principles to real world problems
Present Value
perpetuity
PV= CF/r
growing perpetuity
PV= pmt(1+g)/r-g
annuity
uneven cash flow stream
single sum