Feb 27 – Introduction to Finance
– Under what terms is money allocated b/w lenders and borrowers?
Role of Management
– Management serves as a sort of intermediary for the best interest of the
shareholder. Manager's role is to ensure conflicting interests are satisfied
– Contractual claims – eg. Salary owed for working for two weeks. Under
contract that these claims will be satisfied
Function of Financial Manager
– Finance function: investing funds in the right places and getting returns
back to investors. Look at longer-term decisions.
Day to day decisions: looks at current assets and liabilities – short term
investments critical to the company eg. Having the right amount of
– Financing a business: short term debt, liability. eg. Is it wiser to sell shares?
– Manager must generate money by going to outside financial markets.
– Investors: anyone that lends or gives a company money.
Maximizing Shareholder Wealth
– Investors have expectations on return – either dividends or reselling at a
– *Shareholder – shares. Stockholder – owns stocks. Both mean the same
– *Stakeholder – anyone who invests in a company – creditor, employee,
– *Not all stakeholder are shareholders/stockholders
Profits must be considered in relation to the investment. eg. Company makes
$1000. 1000 shares outstanding. $1000/outstanding shares = $1. Profit is $1500,
but shares are doubled. $1500/2000 = $0.75. Must consider the amount of shares
to the amount of profit – often better to issue debt.
– Also must consider timing
– Consider risk as well – some projects are riskier than others.
Six Principles of Finance
1. Time Value of Money
– Money is more valuable now because it has higher purchasing power than
later if it is the same amount
Net Present Value Method – *if it's zero, it's still acceptable – promises return
equal to required rate of return
2. Risk-Return Tradeoff
– More risk = more chance of a good return
3. Diversification of Investments – Impossible to have a risk-free portfolio
– Fully diversified portfolio – always will be stuck with the market or
4. Efficient Financial Markets
– Information can be through anything - financial media reports, press
releases, accounting info. Information gets processed by investors.
– No one is at an advantage – all known information is processed. However,
doesn't mean everything is correct eg. Something can be over-valued
5. Management vs. Owner Objectives
– Manager works on behalf of the shareholders
– Owners want maximization of their returns, but managers are looking
towards their own personal objectives. This may create bias eg. Company
owners may want to buy companies to be in charge of a large company
even if it may not be in the best interest of the shareholders. Tying manager
compensation to performance measures beneficial to owners – can be
costly. Creates information asymmetry.