1. Financial Management BUSS207 (Present Value)

Volatility

A Tendency to change quickly and unpredictably

Rate of Return

Profit/Investment

YTM (Yield to Maturity)

(√Fv/P) - 1

Or

(Fv/P)^1/n - 1

PV of t-year Annuity

C [ (1/r) - 1/(r(1+r))^t ]

What is a Firm?

A firm is an entity that uses capital raised from shareholders and debt holders to pursue projects that maximizes shareholder value/wealth.

According to the shareholder value maximization perspective, what is the primary objective of a firm?

Maximizing shareholder wealth

• we want CFO and CEO to maximize the interest of Shareholders

Patents

Protects intellectual property for a certain amount of time - legal way to exchange ideas

Financing and payout Decisions

how the firm raises money (as debt or equity) and disburses of excess money (as dividends or share repurchase)

Investments Decisions

How the firm spends its money (on tangible, intangible, or financial assets) - Future growth

Firms and Financial Market

1. Cash raised from investors by selling stocks and bonds to investors in the primary market

2. Cash Invested in the firm’s operation and used to purchase real assets

3. Cash generated by the firm’s operation

4. 1. Cash reinvested

   2. Cash distributed to investors in the form of dividends, coupons, principal, and repurchases

5. Stocks and bonds sold to investors in the primary market are being constantly traded amongst the investors in the secondary market

Financial Market

Leaves this to the investing public, who trades stocks to determine the firm’s market value

• Easier to communicate the value

Central Panning

The government has to figure this out - Harder to know

• The gov. makes decisions about goods and services

Sole proprietor ship

Easy to form ; unlimited liability to the owners; usually the owners manage the business directly

obligated to use own funds, no need to report to anyone

HIGHER RISK - Smaller businesses

Corporation

Legal fees to form and maintain; limited liability to owners (shareholders)

usually a separation of ownership and management (control)

Lower risk - Larger businesses

Corporate Governance

a set of rules and processes by which corporation operate and are controlled

Should you choose $100 today or $105 today?

Obviously $105

Present Value Formula

PV = C/ (1+r)

C = Cash Flow

r = Discount rate

n = number of periods/years

PV = C₁/ (1+r) + C₂ / (1+r)² + ... + C_t / (1+r)^t

NPV (Net present Value) Formula

(PV - Investment) / (1 + r)

C₀ - C₁ / (1 + r)

Expected Return is also ____________

Discount rate

Components of Interest Rate

Which component is common to all assets (Risk-Free Rate)

Which component is unique to each asset (Risk Premium)

Risk Premium

The investment return an asset is expected to yield in excess of the risk-free rate of return

• a form of compensation for investors

Discount Rate

Represents the rate of return or the rate at which future cash flows are discounted back to their present value