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Chapter 1

FIN 3715 Chapter Notes - Chapter 1: Barometer, Capital Structure, General Partnership


Department
Finance
Course Code
FIN 3715
Professor
A L L
Chapter
1

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Chapter 1 - An Introduction to the Foundations of Financial Management
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Chapter 1 An Introduction to the Foundations of Financial Management
Learning objectives
The goal of the firm
Five principles that form the foundations of finance
The role of finance in business
Distinguish between the legal forms of business
Finance and the multinational firm: the new role
The goal of the firm
The main goal of a business is to create value for the shareholders: maximize the market value of
the existing shareholders’ common stock. Consequently, the stock price is the result of different
financial decisions.
According to the reaction of the investors, good and bad financial decisions will bring respectively
the price of the stock up or down. The good ones are those that create wealth for shareholders.
In practice is impossible to identify a reaction to a particular financial decision, because many
factors affect stock prices. To apply this goal in practice we should assume that everything remain
constant and focus on the effect of the management decision.
The five principles that form the foundations of finance
The five principles that form the foundations of Finance are the following:
1. Cash flow is what matters: it is cash flow, not profits, that determines the value of a
business.
2. Money has a time value: to measure value, we bring the future benefits and costs of a
project, measured by its cash flows, back to the present. If the cash inflows outweigh the
costs, the project creates wealth and should be accepted, otherwise should be rejected.
3. Risk requires reward: any risky investment decision must have its relative reward;
otherwise investors are not attracted to it. The main problem is that sometimes the returns
are not certain as expected through a rational decision and cannot be realized in the future.
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