Lecture 1 intro
- 1. Introduction FINS1613: Business Finance School of Banking and Finance Australian School of Business UNSW Robert Tumarkin r.tumarkin@unsw.edu.au 1
- 2. Business Finance World View 2
- 3. Our world view In which companies should I What projects should I fund? own stock? Companies Owners 3
- 4. Our world view Project Cash Flows Risk Project Funding Decision Discount Rate 4
- 5. Our world view Key assumptions Firm with professional management that does not own the firm Firm has many owners, each is invested in many firms 5
- 6. Types of Firms 6
- 7. Terminology Ownership have shares in a firm The right to share in a firm’s profits decide who Control manage the The right to directly manage or elect management of a firm firm/himself Personal liability or others The responsibility to pay a firm’s financial obligations using personal assets when the firm cannot Limited liability use his money to repay firm's debt A limit that the owner can only lose the value of their investment when the firm cannot pay its financial obligations loose a part of his assets (investments) money already shared in the firm but no obligation to use his personal money to 7 repay firm's debt
- 8. CONTROL/OWNERSHIP/ Sole trader PERSONAL LIABILITY Business owned and controlled by a single person Sole trader is personally liable for firm’s debts Business ceases existence with death or withdrawal of the sole trader Profits taxed at personal level Also known as sole proprietorships = sole trader 8
- 9. Partnership Business owned by several partners • General partners: act as a sole proprietor Ownership, control and personal liability • Limited partners: Ownership, no control and limited liability general Profits taxed at personal level partners are very Business ceases to exist with death or withdrawal of a single general partner unless other important provisions are made control/limited liability=good ; no control/personal liability=bad 9
- 10. Comparison Sole trader Partnership Limited Partnership Type of owner N/A General partner General partner Limited partner Number One Several One or more Several Control Yes Yes Yes No Liability Personal Personal Personal Limited Taxation Personal Personal Personal Person 10
- 11. Big organisation/ mgt Corporations and owners different control Organizational structure Board of directors • Each director is A B C D elected by the firm’s owners • Hires the Chief hires CEO Executive Officer CEO • Monitors firm and sets high level strategy CFO • Objective is to maximize firm value 11
- 12. Corporations Organizational structure Chief Executive Officer (CEO) A B C D • Everyday manager of the firm • Implements rules and policies set by board of CEO director • Advised by high level executives CFO • Objective is to maximize firm value 12
- 13. Corporations Organizational structure Chief Financial Officer A B C D (CFO) • Evaluates investment decisions for the firm CEO • Evaluates financing decisions for the firm • Objective is to maximize firm value CFO 13
- 14. The Financial Manager We will focus on two primary responsibilities of the financial manager: CFO Investment decisions Where to put • Which projects should the firm pursue? money? which Financing decisions projects • How should the firm raise capital to finance How raise these projects? funds/capital? • How should the firm distribute profits to investors? Is it beneficial to distribute money/ beneficial to put in dividends to shareholders or the common stock 14 reinveste it? or publick stock?
- 15. Corporations Capital structure • Describes how firm value is split among different types of financial securities Total firm value (e.g. $100 million) • Common securities include • Equity common stocks • Debt • Preference shares = different common financial securities 15
- 16. Capital structure Total Firm Value = Market Value of Equity + Market Value of Debt Equity value Equity value (e.g. $20 million) (e.g. $60 million) or Debt value Debt value (e.g. $80 million) (e.g. $40 million) 16
- 17. Capital structure common stock=stock E+stock D Equity owners of +stock Prefer Shares • Ownership of a company is divided into common stock the • Stock owners, called shareholders, elect the Board of company Directors have also • Stock owners share in firm profits, which are uncertain and control and may be zero liability • Public stock is traded on stock exchanges Debt firms have to • Lender of capital to a firm hold bonds Bond holders repay bonds • Bond holders have no role in electing directors have no control after; repay • Bond holders receive prescribed payments when firms debt generate profits 17
- 18. Capital structure before paying dividends, have to Absolute priority repay debt/bonds Requires a firm to make payment on debt before distributing money to equity holders Administration (bankruptcy) and liquidation Occurs when a firm cannot pay its prescribed payments to debt holders, an event called default Control of the firm is given to the debt holders firms take control when firms bankruptcy=default have done shit! 18
- 19. Capital structure Example Imagine a firm that has promised to pay bond holders $90 million in one year. Assume the firm will either earn $80, $100, or $120 million in one year. Equity Value 30 10 Debt Value 80 90 90 repay debt before putting19money in the common stock (equity)/and public stock for new exchange/new investment
- 20. Capital structure depends of Equity Debt how much they have to Elects Board of Seizes firm on Control Directors default reimburse. if they prefer Payment amount Uncertain Prescribed to reinvest instead Payment order Last First Risk High Low I think risk must depends on debt; because of the payment order; and the uncertained payment amount 20
- 21. Corporations! Key features of a corporation It is its own legal entity, distinct from the owners There is a separation between ownership and management 21
- 22. Corporations Advantages over partnerships and sole traders Limited liability for the owners Business continues operation when ownership changes personal liability for the ceo?? 22
- 23. Agency costs Definition We assume that employees have their own personal objectives These personal objectives may not always agree with the value maximizing objective of the firm’s owners An agency cost arises when an employee takes an action that serves their own interests instead of maximizing firm value Examples A CEO may not invest in a profitable, but risky project if they are afraid of getting fired should the project fail An employee may arrive late and leave early due to lack of interest and no managerial oversight 23
- 24. Taxation Firm profits generate different after-tax values to owners depending on firm structure and the tax system Firm owner Limited partner Shareholder Tax System Imputation Classical credit Firm profits $100 $100 $100 compensate income Distribution method Dividends Dividends the Corporate Tax (30%) - -30 -30 corporate Distributed Profits 100 70 70 tax! Personal tax basis distributed profits Firm profits distributed profits Personal tax (45%) -45 -45 -31.5 Franking credit (equal - 30 - to corporate tax) After-tax to owner $55 $55 $38.5 classical: tax previous amount 24 imputation: tax first amount=amount before being distributed
- 25. Corporations Advantages over partnerships and sole traders Limited liability for the owners Business continues operation when ownership changes Disadvantages compared to partnerships and sole traders Agency costs between owners and management Taxation (in jurisdictions with “classical” tax systems) with the previous slide, the after tax value of the imputation is bigger than the classical. 25
- 26. Ownership comparison Sole trader Partnership Limited Partnership Corporation General General Limited Type of owner N/A Shareholder partner partner partner Number One Several One or more Several Many Control Yes Yes Yes No Yes Liability Personal Personal Personal Limited Limited Corporate and Personal Taxation Personal Personal Personal Personal (depending on tax system) 26
- 27. Review Firm structures • Characteristics of sole trader, partnerships, corporations Corporations • Responsibilities of the financial manager • Difference between equity and debt • Advantages and disadvantages versus sole traders and partnerships 27
- 28. Administrative 28
- 29. Staff Lecturers Robert Tumarkin • Weeks 1 -8 • Consultation: Thursday 2-4 Gloria Tian • Weeks 9 - 12 • Consultation: Monday 3-5 Tutor Peter Andersen (Tutor-in-charge) Ning Ding,Yan Su, Bobby Wang, Howie Zhang 29
- 30. Resources Blackboard Lecture slides Tutorial assignments Announcements MyFinanceLab 30
- 31. Assessments 31
- 32. Assessments Stock Weight Tutorial Participation 15% Attendance 5 Quizzes (Lowest of the 4 quizzes dropped) 40 Final Exam 40 100% 32
- 33. How to succeed Tutorials Attend Participate Quizzes and final exam Practice • Questions in tutorials and the text • MyFinanceLab Know strategies for Multiple Choice Questions 33
- 34. Next week 34
- 35. Next week Project Cash Flows Risk Project Funding Decision Discount Rate 35