Principles of Finance - Lecture 1

Class Structure & Delivery

• One 2-hour lecture per week (four on-campus streams: Wed 11–1, Wed 2–4, Thu 12–2, Thu 3–5)
• Tutorials begin week 2
– Attempt questions before class
– Tutors prioritise “priority questions”; full solutions released end-week
• Peer Assisted Study Sessions (PASS)
– Free, voluntary, student-led weekly review sessions—scan QR code on slide for timetable

Assessment Summary

• Assessment 1 ExamBuddy! (peer-review problem sets) – 15 %
– Four tasks; best 3 count (5 marks each)
– Marks awarded purely for participation:
• Submission = 60 %
• Self-review = 20 %
• Peer-review = 20 %
– Strict deadlines; late = 0 because system instantly re-allocates papers
• Assessment 2 Mid-semester MCQ test – 25 %
– 60 min, in-person, week beginning Mon 1 Sept
• Assessment 3 Final exam – 60 %
– 2 hr, closed book, exam period
• No hurdle requirements
• Time-commitment rule: ≈3 × weekly contact hours for private study

Required Readings & Resources

• Primary text (tool, not gospel): Graham, Adam & Gunasingham, Corporate Finance (Asia-Pac 3e, Cengage 2020)
– Discount code: WOW10
• Supplement: Lamba (2025) Teaching Note 1 after reading GRAH
• Lecture slides, teaching notes & links on Canvas
• Habit: read financial press regularly to contextualise theory

1. Finance Discipline – Big Picture

• Finance studies how individuals, firms & institutions acquire, spend & manage money
• Three broad sub-fields and matching UoM electives:
– Corporate finance (FNCE20005, FNCE30006, FNCE30011)
– Investment analysis & management (FNCE30001, 30003, 30010, 30013, 30014)
– Risk management (FNCE30007 Derivatives)

Finance vs Accounting

• Accounting = identifying, recording & reporting economic info; backward-looking; profit focused:
$\text{Profit}=\text{Revenues} - \text{Expenses}$
• Finance = forward-looking cash-flow management:
$E[\text{Net Cash Flow}]=E[\text{Cash In}] - E[\text{Cash Out}]$
• Cash flow statement is the bridge between the disciplines

1.2 Business Structures – Focus on Listed Corporations

• Separate legal entity; ownership via shares
• Key roles: Board (strategic control), CEO (day-to-day), CFO (investment, financing, cash management)
• Shares issued in IPO; dividends discretionary
• Other forms exist (sole traders, partnerships, trusts etc.) but subject centres on listed firms

Financial Markets: Primary vs Secondary

• Primary market: firm receives funds (IPO, placements, bond issues)
– Example: Reddit IPO (March 2024)
– Example: Goodman Group $4 bn placement (Feb 2025)
• Secondary market: trading of existing securities; investors exchange ownership; provides liquidity; supports primary issuance
– Eg. RDDT trading data on Google Finance

Key Takeaways (Section 1.2)

1. What finance is

2. Distinction from accounting

3. Characteristics of listed firms

4. Difference between primary & secondary markets

1.3 Four Fundamental Concepts in Finance

1 Cash is King (Cash-flow Focus)

• Only cash can be reinvested or consumed; profits alone cannot buy a $15 beer
• Valuation aims to quantify future cash benefits/costs in common units

2 Time Value of Money (TVM)

• $1 today ≠ $1 in one year (reasons: inflation, opportunity cost, risk)
• Cannot simply add cash flows across time; must discount/compound to a common date
• Classroom TAPPS warm-up: three reasons to prefer $100 now vs $100 in a year:
1. Immediate consumption/utility
2. Investment opportunity (earn interest)
3. Uncertainty that promise will be honoured

3 Risk & Return Trade-off

• Investors assumed risk-averse → higher dispersion of outcomes demands higher expected return
• Example comparison: Asset 1 (σ 30 %, E[R] 10 %) vs Asset 2 (σ 50 %, E[R] 10 %)—risk-averse investor chooses Asset 1
• Expected Return can be decomposed:
$E[R]=R_{\text{f}}+\text{Risk-Premium}$
• Government bonds approximate risk-free benchmark (see RBA data)

4 Objective of the Firm: Maximise Firm Value

• Market value of assets $V$ equals debt value $D$ plus equity value $E$:
$V = D + E$
• Shareholders have residual claim—dividends paid after operating expenses, interest, taxes & reinvestment
• Aligning managers (agents) with shareholder value leads to Agency Problem discussions

Section 1.3 Mini-Summary

1. Cash priority

2. TVM

3. Risk–return linkage

4. Value maximisation goal

1.4 Financial Mathematics Foundations

1.4.1 Simple Interest

• Interest calculated solely on original principal
• Future Value: $FV = PV<em>0\,(1 + r \times n)$ • Present Value: $PV</em>0 = \dfrac{FV}{1 + r \times n}$
• Example: $1,000 @ 8 % p.a. for 5 years → $FV=1{,}000(1+0.08\times5)=1{,}400$

1.4.2 Compound Interest

• Interest accrues on both principal and accumulated interest (“interest on interest”)
• General formula:
$FV = PV<em>0 (1+r)^n \qquad \text{and} \qquad PV</em>0 = \dfrac{FV}{(1+r)^n}$
• 8 % example: $1,000 for 5 years → $FV=1{,}000(1.08)^5=1{,}469.33$
• Table on slide 47 shows exponential divergence vs simple interest over long horizons (e.g., 100 yrs: $9 k vs $2.2 m)

1.4.3 Stated vs Effective Rates of Return

• Nominal (stated) rate quoted with compounding frequency, effective rate converts to single-period equivalent
• Conversion formula:
$r<em>e = \left(1+\dfrac{r}{m}\right)^m - 1$ • $1 m @ 6 % p.a.: – Annual compounding $FV=1.06^1=1.0600$ m – Monthly compounding: $FV=\left(1+0.06/12\right)^{12}=1.061678$ m → $r</em>e=6.1678\%$
– Daily compounding: $FV=1.061831$ m → $r_e=6.1831\%$
– Continuous: $FV=e^{0.06}=1.061836$ m

Section 1.4 Takeaways

1. Simple interest linear growth

2. Compound interest exponential growth

3. Always translate stated rates to effective for apples-to-apples comparison

1.5 Present & Future Values of Single Cash Flows

1.5.1 Future Value (Compounding)

• $FV<em>n = PV</em>0 (1+r)^n$
• Illustration: $1,000 for 5, 20, 100 yrs at 6 % vs 8 %

1.5.2 Present Value (Discounting)

• $PV<em>0 = \dfrac{FV</em>n}{(1+r)^n}$
• Example: Need $10,000 in 5 or 20 years → invest $7,472.58 (6 %, 5 yrs) or $2,145.48 (8 %, 20 yrs)

1.5.3 Key Drivers

• For constant r: ↑n ⇒ ↑FV, ↓PV
• For constant n: ↑r ⇒ ↑FV, ↓PV
• Non-linear PV curve emphasises early cash-flow importance

1.5.4 Application Example – Choosing Between Two Projects

• Cash-inflows:
– Project A: single $376,451 in year 3
– Project B: single $393,768 in year 4
• Required return r = 8.5 %
• Method 1 (PV today):
– $PV<em>A = \dfrac{376{,}451}{1.085^3}=294{,}726$ – $PV</em>B = \dfrac{393{,}768}{1.085^4}=284{,}132$
→ Choose Project A (higher PV)
• Method 2 (common future date FV4):
– $FV<em>{A,4}=376{,}451(1.085)=408{,}449$ – $FV</em>{B,4}=393{,}768$
→ Again Project A dominates
• Demonstrates necessity of time-alignment before comparison

Master Formula Sheet (slide 73)

• Simple interest PV: $PV<em>0 = \dfrac{FV}{1+r\,n}$ • Simple interest FV: $FV = PV</em>0\,(1+r\,n)$
• Compound interest PV: $PV<em>0 = \dfrac{FV}{(1+r)^n}$ • Compound interest FV: $FV = PV</em>0(1+r)^n$
• Stated → Effective conversion: $r_e = \left(1+\dfrac{r}{m}\right)^m -1$

Ethical, Practical & Pedagogical Notes

• Agency problems highlight ethical duties of managers to investors
• Regular reading of financial press equips students to connect formulas to real markets (placements, IPOs, interest-rate changes)
• TAPPS pedagogy fosters metacognition—explain reasoning, probe logic, not merely answer

Comprehensive Takeaways for Topic 1 Exam Prep

1. Understand finance’s cash-flow, forward-looking nature vs accounting’s profit-reporting focus

2. Master TVM mechanics—discounting & compounding, simple vs compound

3. Always convert quoted rates to effective rates before valuation

4. Risk drives required return; risk-free + premium framing underpins asset pricing

5. Firm value maximisation equates to maximising $V=D+E$; cash available to shareholders is residual

6. Comparison of projects or securities demands aligning cash flows on a common date using PV or FV

7. Remember and be able to manipulate the five core formulas under exam conditions

8. Practise with worked numerical examples (as in slides) to reinforce concept-formula linkage