Lecture 1 - Introduction To Business Finance

Question 1

Accounting versus Finance

Answer 1

Accounting goal:

• create a set of statements that represent accurately the financial standing of a company at a specific point in time
• accounting is historical-looking & static

Finance goal:

• make business decisions based on accounting statements and assumptions about what is going to happen in the future
• finance is forward looking and dynamic

Question 2

Accounting view of the firm

Answer 2

The balance sheet

Assets:

• long lived real assets
• short lived assets
• investment in securities
• assets which are not physical

Liabilities:

• short term liabilities
• debt obligations of the firm
• other long term obligations
• equity investment in the firm

Question 3

Financial view of the firm

Answer 3

Assets:

• existing investments that generate cash flows today
• expected value that will be created by future investments

Liabilities:

• fixes claim on cash flows
• residual claim on cash flows

Question 4

What is business finance

Answer 4

Every decision made in a business has financial implications, & any decision that involves the use of money is a corporate finance decision. Defined broadly, everything that a business does fits under the rubric of corporate finance

Question 5

Three examples

Answer 5

Marketing:
- launching a new advertising campaign

Operations:
- introducing a new production line in a factory

Strategy:
- merging with another firm

Question 6

Maximising the value of a business (firm)

Answer 6

The investment decision - invest in assets that earn a return greater than the minimum acceptable hurdle rate

• The hurdle rate should reflect the riskiness of the investment and the mix of debt & equity used to fund it
• the return should reflect the magnitude & the timing of the cash flows as well as all side effects

The financing decision - find the right kind of debt for your firm & the right mix of debt & equity to fund your operations

• the optimal mix of debt & equity maximises firm value
• the right kind of debt matches the tenor of your assets

The Dividend Decision - if you cannot find investments that make your minimum acceptable rate, return the cash to the owners of the business

• how much cash you return depends upon current & potential investment opportunities
• how you choose to return cash to the owners will depends on whether they prefer dividends or buybacks