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1、Introduction to FinanceLecture 1Tashfeen HussainWhat is Finance“We have a great business idea but no money”“We have lots of money but no business ideas”Without Finance: The Dark AgesWith Finance: Better TimesFinancing The role of the financial system is to transfer funds in the most efficient manner

2、 possible. It can be done via:5Indirect FinancingDirect FinancingSaversBorrowersor You need finance literacy to: Make more informed real-life decisions regarding your savings, consumption and investments According to a 2007 survey:Four in ten American credit card holders do not pay the full amount d

3、ue every month A third said that had no idea what the interest rate on their card was Distinguish yourself in the job market Develop a more comprehensive and more efficient business acumen Gain a better understanding of the world around E.g. financial crisis Why Finance is Important (for non-finance

4、 majors)? Time value of money Risk-return tradeoffFinance Core Ideas:78Important Aspects of Cash Flow: TimingYour generous Uncle Gary offers you Offer A: $1000 that you can collect in 1 year Offer B: $1500 but that you cant collect for 2 years Offer C: $1000 todayWhich do you prefer? 9Important Aspe

5、cts of Cash Flow: RiskYour generous but possibly sadistic Uncle Larry offers you Offer D: $100,000 Offer E: A roll of the die Odds you get $90,000 Evens you get $110,000 Offer F: A coin flip: Heads you get $50 Tails you get $300,000Which do you prefer? In finance we care about the timing (and risk)

6、of cash flows. Finance versus Accounting10Net Income (Accounting):Sales- Costs- DepreciationEBIT- Interest Taxable Income (EBT)- TaxNIOperating Cash Flow (Finance):Sales- Costs- DepreciationEBIT- TaxesNOPAT+ DepreciationOCF11Firm Financial Decisions Most financial decisions that we will study are re

7、lated to two broad questions: What investments should the firm undertake? Capital Budgeting: The process of making and managing expenditures on long-lived assets. How should the firm finance these investments? Capital Structure: The mixture of debt and equity capital maintained by the firm and used

8、to finance its investment activities. The Balance-Sheet Model of the FirmThe Capital Budgeting Decision12Current AssetsFixed Assets1. Tangible2. IntangibleShareholders EquityCurrent LiabilitiesLong-Term DebtWhat long-term investments should the firm engage in?The Balance-Sheet Model of the FirmThe C

9、apital Structure Decision13Current AssetsFixed Assets1. Tangible2. IntangibleShareholders EquityCurrent LiabilitiesLong-Term DebtHow can the firm raise the money for the required investments?Cash flowfrom firm (C)The Firm and the Financial Markets14Taxes (E)FirmGovernmentFirm issues securities (A)Re

10、tained cash flows (D)Investsin assets(B)Dividends anddebt payments (F)Current assetsFixed assetsFinancialmarketsShort-term debtLong-term debtEquity sharesUltimately, the firm must be a cash generating activity.The cash flows from the firm must exceed the cash flows from the financial markets.There a

11、re two major categories of financial securities:Equity InstrumentsCommon stock (represent ownership in firm)Preferred stock (less prevalent)Debt Short Term Debt InstrumentsCommercial papersTreasury bills and notes Long Term Debt InstrumentsBondsMortgage loansFinancial Instruments15Overview of Global

12、 Financial Assets1617Separation of Ownership and Control Agency relationship Principal hires an agent to represent his/her interests. e.g. Shareholders (principals) hire managers (agents) to run the company (on their behalf). Analogous to a real estate agent. Agency problem Conflicts of interest can

13、 exist between the principal and the agent. The agents interests/goals may not be aligned with the principals.The Agency Problem Will managers work in the shareholders best interests?In 2008 John Thain spent $1.22 million of Merrills money to refurbish his office.:Interior Designer = $800,000Persian

14、 Area Rug =$87,000Egyptian Silk Curtains = $28,000Mink Guest Chairs = $87,000Roman Shade Fabric = $11,000 Mahogany Pedestal Table = $25,00019th Century Credenza = $68,000Hand-Stitched Polynesian Sofa = $28,000George IV Desk = $18,000 Wall Sconces = $2,7006 Antique Chairs = $37,000Private Dining Room

15、 Mirror = $5,000Dining Room Chandelier = $13,000Commode On Legs = $35,000 Regency Chairs = $24,000 40 yards of Fabric For Wall Panels $5,000 Parchment Waste Can = $1,400Additional designer Expenses = $30,000The Agency Problem Will managers work in the shareholders best interests? Agency costs (costs associated with the conflict of interests):Direct agency costs (e.g. job perks, monitoring e

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