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ADMS 3530 Chapter Notes -Discounted Cash Flow, Effective Interest Rate, Real Interest Rate

Administrative Studies
Course Code
ADMS 3530
Kwok Ho

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ADMS 3530 Finance Notes
Ch 1- Goals and Governance of the Firm
Investment and Financing Decisions
-the financial manager is to make good investment and financing decisions
Investment or Capital Budgeting Decision
Def’n- decision about which real assets the firm should acquire
-the financial manager identifies projects and decides how much to invest in each project
-some investments are in tangible assets, while some are intangible (trademark, patents)
Financing Decision
Def’n- how to raise the money to pay for investments
When deciding how to raise money, a company can:
1) invite investors to put up cash in exchange for a share of future profits
-investors thus receive stock shares, becoming shareholders and known as equity investors
2) promise to pay back the investors’ cash along with a fixed rate of interest
-investors are lenders, aka debt investors
Capital structure- the choice between debt and equity financing
-the financial manager has to identify risks and make sure they’re managed properly
*Fig 1.1 for how money flows from investors to the firm and back to investors
-the financial manager is b/n the firm and investors because they help manage the firm’s
operations in making good investment decisions, as well as deal with investors
Real assets- assets used to produce goods and services
-tangible and intangible
Financial assets- claims to the income generated by real assets; aka securities
Eg. Share of stock, bank loans
What is a Corporation?
Public companies- corp whose shares are listed for trading on a stock exchange
-they have a lot of flexibility; can sell shares to any investor
-thus they’re required to provide detailed financial info
Private companies- corp whose shares are privately owned
-shares can’t be freely traded, and don’t raise money in the stock market
Corporation- business owned by shareholders who aren’t liable for the business’s liabilities
Limited liability- owners of the corp aren’t responsible for its obligations
-to incorporate a firm, it can be done under the Canadian Business Corp Act (fed) or under prov laws
-all corps have a board of directors that’s selected by shareholders
-they oversee the activities of the corporation
-shareholders can sell out to new investors without affecting the corp’s business
-shareholders of private corporations can also sell, but the process takes up more time
-public corps must pay stock exchanges for listing their shares, and abide by the rules of stock
exchanges, accounting standards, securities laws
-they have to engage in proper auditing, abide by guidelines for ensuring board independence

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-disadv of corps in taxing; corps have to pay tax on their profits, and shareholders are taxed again when
they receive dividends from the company
-income generated by businesses that aren’t incorporated are taxed just once as personal income
Adv of corporationslimited liability, ease with ownership and management
-financial flexibility of publicly traded shares
Disadvdouble taxation
Other Forms of Business Organizations
Sole Proprietorship
Def’n- sole owner of a business; personally liable for all the firm’s obligations
Adv; easy to establish, lack of regulations to govern it
Def’n- business owned by 2+ people who are responsible for all its liabilities
-partners then pay personal income tax on their share of the profits
-partners also have unlimited liability, like sole proprietorship
Hybrid Forms of Business Organization
-some bus forms don’t fit into one specific category, so they are a combo of others
-limited liability partnerships (LLP) or limited liability companies (LLC)
-professional corporation (PC) commonly used by doctors, lawyers
-business has limited liability and taxed as a corp, but professionals can be sued personally
-income trust; which is an investment fund aka mutual fund trust
-they sell units to investors to raise money to purchase shares and debt of operating businesses
Who is the Financial Manager?
-financial manager is anybody responsible for a significant corporate investment or financing decision
Treasurer- manager responsible for financing, cash management, relationships with financial markets,
raising new capital, most directly responsible for looking after the firm’s cash
-likely to be the only financial exec for small firms
-focus is on obtaining and managing the firm’s capital
Controller- responsible for budgeting, auditing, preparing financial statements, accounting
-ensures money is used efficiently
Chief Financial Officer (CFO)- oversees the treasurer and controller, sets overall financial strategy
-those 3 are usually responsible for organizing and supervising capital budgeting process
-since projects likely include other business areas, managers from those departments also engage
-ultimate decisions often rest by law or by custom with the board of directors
Goals of the Corporation
Shareholders want Managers to Maximize Market Value
-maximize the current value of their interest
-increased wealth can either be saved or spent
Do Managers really Maximize Firm Value?
-in most large public companies the managers aren’t the owners and they might be tempted to act in
ways that aren't in the best interests of the owners

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Agency problems- conflict of interest between the firm’s owners and managers
-can sometimes lead to outrageous behaviour; charging large amounts towards a company
Stakeholders- anybody with a financial interest in the firm
There are diff arrangements to help ensure shareholders and managers work toward a common goal:
Compensation Plansincentive schemes that provide big returns if shareholders gain but are valueless
if they don’t
-if employee compensation plans aren’t properly designed, they can create incentives for straying
behaviour by management
-some criticize exec stock options for being too favourable for managers, distorting mgmt’s incentives
-backdating is when the date on the options isn’t the actual date of the option grant, but a date in the
past when the stock price was lower
Board of DirectorsSarbanes-Oxley Act requires corps place more independent directors on the board;
more directors who aren’t managers not affiliated with management
-they meet in sessions without the CEO present
-if shareholders believe that the corp is underperforming, they can try to replace the board
-shareholders convince others to vote for their candidates to the board
Takeoverstaken over by another firm
Specialist Monitoringmanagers’ actions are monitored by security analysts who advice investors to
buy, hold, sell the company’s shares
Legal and Regulatory Requirementslegal duty to act responsibly and in the interests of investors
-sets accounting and reporting standards for public companies
-Ontario securities Commission prohibits insider trading
Ch 5- Time Value of Money
Future Values and Compound Interest
Future value- amount to which an investment will grow after earning interest
Compound interest- interest earned on interest
Simple interest- interest earned only on the original investment
Future Value of $I interest = I x (1 + r) ^t
To do it on a calculator:
With a 6% interest rate and 10yr investment,
Enter [1.06], press [yx], press [10], and [=], press [10], and [=]
Future value interest factor- future value of a current cash flow of $1
FVIF(r, t) = (1 + r) ^t
Future value of an investment:
FV = I x (1 + r) ^t
Eg. If you invest $1 for 20 years at 10% without withdrawing anything:
$1 x [1.10]20 = $6.73
Eg. If you invested $50, then it would be $50 x [1.10]20 = $336.375
Eg. If a bank is paying 1% per month on deposits, and you invest $500 for 20 months, then the FV is
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