CHAPTER 1

 The nature and goals of financial

management.
 Introduction to Corporate Finance & it
purpose.
 Stakeholders and key decisions of financial
management.
 Introduction on types of securities traded on
Bursa Malaysia.

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 DIVIDEND
INVESTMENT FINANCING
POLICY

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 Maximize the value of the business (firm)

The Investment Decision The Financing Decision The Dividend Decision

Invest in assets that earn a Find the right kind of debt If you cannot find investments
return greater than the for your firm and the right that make your minimum
minimum acceptable hurdle mix of debt and equity to acceptable rate, return the cash
rate fund your operations to owners of your business

The hurdle rate The return How much How you choose
should reflect the The optimal The right kind
should reflect the cash you can to return cash to
riskiness of the mix of debt of debt
magnitude and return the owners will
investment and and equity matches the
the timing of the depends upon depend on
the mix of debt maximizes firm tenor of your
cashflows as welll current & whether they
and equity used value assets
as all side effects. potential prefer dividends
to fund it. investment or buybacks
opportunities

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 Financial management or business finance is
concerned with managing an entity’s money
 Functions:
◦ Allocate funds to current and fixed assets
◦ Obtain the best mix of financing alternatives
◦ Develop an appropriate dividend policy within the
context of the firm’s objectives

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 In traditional corporate finance, the objective in decision
making is to maximize the value of the firm.
 A narrower objective is to maximize stockholder wealth.
When the stock is traded and markets are viewed to be
efficient, the objective is to maximize the stock price.
Maximize equity Maximize market
Maximize
value estimate of equity
firm value
value
Assets Liabilities
Existing Investments Fixed Claim on cash flows
Generate cashflows today Assets in Place Debt Little or No role in management
Includes long lived (fixed) and Fixed Maturity
short-lived(working Tax Deductible
capital) assets

Expected Value that will be Growth Assets Equity Residual Claim on cash flows
created by future investments Significant Role in management
Perpetual Lives

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 Maximizing stock price is not incompatible with
meeting employee needs/objectives. In
particular:
 Employees are often stockholders in many firms
 Firms that maximize stock price generally are
profitable firms that can afford to treat employees well.
 Maximizing stock price does not mean that
customers are not critical to success. In most
businesses, keeping customers happy is the
route to stock price maximization.
 Maximizing stock price does not imply that a
company has to be a social outlaw.

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 Stock price is easily observable and constantly
updated (unlike other measures of performance,
which may not be as easily observable, and
certainly not updated as frequently).
 If investors are rational (are they?), stock prices
reflect the wisdom of decisions, short term and
long term, instantaneously.
 The objective of stock price performance
provides some very elegant theory on:
 Allocating resources across scarce uses (which
investments to take and which ones to reject)
 how to finance these investments
 how much to pay in dividends

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 STOCKHOLDERS

Hire & fire Maximize

managers stockholder
- Board wealth
- Annual Meeting

Lend Money No Social Costs

BONDHOLDERS/ Managers SOCIETY
LENDERS Protect All costs can be
bondholder traced to firm
Interests
Reveal Markets are
information efficient and
honestly and assess effect on
on time value

FINANCIAL MARKETS

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 STOCKHOLDERS

Have little control Managers put

over managers their interests
above stockholders

Lend Money Significant Social Costs

BONDHOLDERS Managers SOCIETY
Bondholders can Some costs cannot be
get ripped off traced to firm
Delay bad
news or Markets make
provide mistakes and
misleading can over react
information

FINANCIAL MARKETS

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 With this type of business organization, you would be fully
responsible for all debts and obligations related to your business
and all profits would be yours alone to keep. As a sole owner of the
business, a creditor can make a claim against your personal or
business assets to pay off any debt.
 Advantages:
◦ Easy and inexpensive to form a sole proprietorship
◦ Lowest amount of regulatory burden
◦ Direct control of decision making
◦ Low organizational and operational costs
 Disadvantages
◦ Unlimited liability to the owner
◦ Profits and losses are taxed as though they belong to the
individual owner
◦ Lack of continuity for your business, if you need to be absent
◦ Difficulty raising capital on your own
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 A partnership is a good business structure if you want to carry on a
business with a partner and you do not wish to incorporate your
business. With a partnership, financial resources are combined and
put into the business. You can establish the terms of your business
with your partner and protect yourself in case of a disagreement or
dissolution by drawing up a specific business agreement. As
partners, you would share in the profits of your business according
to the terms of your agreement.
 You may also be interested in a limited liability partnership in the
business. This means that you would not take part in the control or
management of the business, but would be liable for debts to a
specified extent only.
 When establishing a partnership, you should have a partnership
agreement drawn up with the assistance of a lawyer, to ensure that:
◦ You are protecting your interests
◦ That you have clearly established the terms of the partnership with
regards to issues like profit sharing, dissolving the partnership, and more
◦ That you meet the legal requirements for a limited partnership (if
applicable)

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Advantages:
 Easy to start up a partnership

 Start-up costs would be shared equally with you and your partner

 Equal share in the management, profits and assets

 Tax advantage, if income from the partnership is low or loses money

(you and your partner include your share of the partnership in your
individual tax return)
Disadvantages:
 Similar to sole proprietorship, as there is no legal difference
between you and your business
 Unlimited liability (if you have business debts, personal assets would
be used to pay off the debt)
 Hard to find a suitable partner

 Possible development of conflict between you and your partner

 You are held financially responsible for business decisions made by

your partner (for example, contracts that are broken)

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 When you incorporate your business, it is considered to be a legal
entity that is separate from the shareholders. As a shareholder of a
corporation, you will not be personally liable for the debts,
obligations or acts of the corporation. When making such decisions,
it is always wise to seek legal advice before incorporating.
Advantages:
 Limited liability

 Ownership is transferable

 Continuous existence

 Separate legal entity

 Easier to raise capital

 Possible tax advantage as taxes may be lower for an incorporated

business

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Disadvantages:
 A corporation is closely regulated

 More expensive to incorporate than a partnership or sole

proprietorship
 Extensive corporate records required, including shareholder and
director meetings, and documentation filed annually with the
government
 Possible conflict between shareholders and directors

 Possible problem with residency of directors

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 Valuation approach
 Maximizing shareholder wealth
 Management and stockholder wealth
− Retention of position of power in long run is by
becoming sensitized to shareholder concerns
− Sufficient stock option incentives to motivate
achievement of market value maximization
− Powerful institutional investors are making
management more responsive to shareholders

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 Adopting policies that:
◦ Maximize values in the market
◦ Attracts capital
◦ Provides employment
◦ Offers benefits to the society
 Certain cost-increasing activities may have to
be mandatory rather than voluntary initially,
to ensure burden falls equally over all
business firms

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 A financial market is a broad term describing any marketplace
where buyers and sellers participate in the trade of assets
such as equities, bonds, currencies and derivatives. Financial
markets are typically defined by having transparent pricing,
basic regulations on trading, costs and fees, and market
forces determining the prices of securities that trade.

Financial markets can be found in nearly every nation in the

world. Some are very small, with only a few participants, while
others - like the New York Stock Exchange (NYSE) and the
forex markets - trade trillions of dollars daily.

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1. Borrowers: Individuals and businesses that
need money to finance their purchases or
investments.
2. Savers (Investors): Those who have money
to invest. These are principally individuals
although firms also save when they have
excess cash.
3. Financial Institutions (Intermediaries): The
financial institutions and markets help
bring borrowers and savers together.
 Financial institutions like commercial banks,
finance companies, insurance companies,
investment banks, and investment companies
are called financial intermediaries as they
help bring together those who have money
(savers) and those who need money
(borrowers).
 A security is a negotiable instrument that
represents a financial claim and can take the
form of ownership (such as stocks) or debt
agreement (such as bonds).

 The securities market allow businesses and

individual investors to trade the securities
issued by public corporations.
 A primary market is a market in which
securities are bought and sold for the first
time. In this market, the firm selling
securities actually receives the money raised.
For example, securities sold by a corporation
to investment bank.
 A secondary market is where all subsequent
trading of previously issued securities takes
place. In this market, the issuing firm does
not receive any new financing. The securities
are simply transferred from one investor to
another. Thus secondary markets provide
liquidity to the investor. For example, the
New York Stock Exchange.