1. A F T 0 4 1 0 2
F O U N D AT I O N O F F I N A N C E
N z u n g u , R
2. Learning outcomes
i. Describe fundamental concept of Finance
ii. Identify different financial environment
iii. Describe financial markets
iv. Use Time value of money for compounding and discounting cash
flows
v. Assess firm performance using financial ratios
vi. Describe market efficiency
vii. Describe valuation of long term securities
viii. Describe risk and return
3. METHODS OF ASSESSMENT
i) Course work 40%
ii) Semester Exam 60%
Coursework Assessment
– Test 1 = 15
– Test 2 = 15
– Tutorial = 10.
5. What is Finance?
• Finance can be defined as the art and science of
managing money. Practically, individuals and
organizations earn or raise money and spend or
invest money.
• Finance is the study of how people and businesses
evaluate investments and raise capital to fund them.
6. The role of Finance in a Business
• A Financial Manager performs the following roles;
–Investment decisions
–Financing decisions
–Dividend decisions.
7. Investment Decision
• Investing decisions are sometimes referred to as
capital budgeting decisions
–The financial manager is required to identify profitable
investments to undertake.
–firm has to select the most appropriate assets for
investment which will bring maximum benefit for the firm.
8. Financing Decision
• Financial manager are required to identify various
sources of raising capital to finance profitable
investment. This include
–Internal Financing, and
–External Financing.
• Financing decision is referred to as financing mix or
capital structure (Equity plus borrowings).
• Find the least expensive sources of fund.
9. Dividend Decision
• This decision relates to the distribution of profits back
to investors who supplied capital to the firm.
• The term dividend refers to that part of profits of a
company which is distributed by it among its
shareholders.
• Should the company:-
– Distribute all the profits?
– Retain all the profits in business?
– Keep part of profits in the business and distribute
others among shareholders?
10. Objectives of Finance
• To ensure regular and adequate supply of funds to the
concern
• To ensure adequate returns to the shareholders
(Maximize shareholder wealth)
• To ensure optimum funds utilization
• To ensure safety on investment
• To plan a sound capital structure
11. Legal forms of business organization
• There are three most common legal forms of business
organization
–the sole proprietorship,
–the partnership, and
–the corporation.
12. Sole proprietorship
• A sole proprietorship is a business owned by one
person who operates it for his or her own profit.
• About 75% of all business firms are sole
proprietorships.
• There is no separation between the business and the
owner when it comes to debts or being sued.
• Sole proprietorships are generally financed by personal
loans from family and friends and business loans from
banks.
13. Sole proprietorship…
• Advantages:
–Easy to start
–No need to consult others while making decisions
–Taxed at the personal tax rate
–There is no minimum or maximum limit of capital
–It is subjected to few Government regulations
• Disadvantages:
–Personally liable for the business debts
–Ceases on the death of the proprietor
14. Partnership
• A partnership consists of two or more owners doing
business together for profit.
• There is no separation between the partnership and the
owners with respect to debts or being sued.
• Partnerships account for about 10 percent of all
businesses, and they are typically larger than sole
proprietorships.
–Finance, insurance, and real estate firms are the most
common types of partnership.
• Most partnerships are established by a written contract
known as articles of partnership.
15. Partnership
• Advantages:
–Relatively easy to start
–Taxed at the personal tax rate
–Access to funds from multiple sources or partners
• Disadvantages:
–Partners jointly share unlimited liability
–Short life of business
16. Partnership
• There are two classes of partners:
–general or unlimited partnership and limited partnership.
• The general partners runs the business and face
unlimited liability for the firm’s debts, while the limited
partners are only liable on the amount invested.
• One of the drawback of limited partners is that it is
difficult to transfer the ownership of the general partner.
17. Corporation
• A corporation is wholly owned by the shareholders, who
entrust the task of management to managers.
• It is legal entity, and thus, there is separation between
the owners and the managers.
• Being a legal entity:
–It can own assets, incur liabilities, enter into contracts,
sue and be sued in its name.
18. Corporation
• Advantages
–limited liability,
–easy transfer of ownership,
– unlimited life, and an
– ability to raise large sums of capital
• Disadvantages
–Double taxation:
• Company pays taxes on its profits
• The dividend received by shareholders is also taxed
–Must file financial statement
–Greater regulations
19. Corporation
• A company can be categorized as a public limited
company (plc) or private limited company (Ltd.)
• The main differences are:-
–A public company has shares quoted at stock Exchange
(eg. DSE, NSE)
–A public company invites members of the public to
subscribe shares whereas a private limited company can
not do so
–A public limited company permits free transfers of shares
whereas a private limited company usually imposes
restrictions on such transfers
20. The goal of the Financial Manager
• The goal of the financial manager must be consistent
with the mission of the corporation.
• To maximize value of the shareholder’s wealth (as
measured by share prices)
• If managers fail to pursue shareholder wealth
maximization:
• they will lose the support of investors and lenders. The
business may cease to exist and ultimately, the
managers will lose their jobs!
21. Agency Theory
• Agency relationship exists when one or more persons
(known as the principal) contracts with one or more
persons (the agent) to make decisions on their behalf.
• In a corporation, the managers are the agents and the
stockholders are the principals.
• Agency problems arise when there is conflict of interest
between the stockholders and the managers.
–Such problems are likely to arise more when the
managers have little or no ownership in the firm
• All else equal, agency problems will reduce the firm
22. How to reduce Agency problems?
• Monitoring
–(Examples: Reports, Meetings, Auditors, board of
directors, financial markets, bankers, credit agencies)
• Compensation plans
–(Examples: Performance based bonus, salary, stock
options, benefits)
• Others
–(Examples: Threat of being fired, Threat of takeovers,
Stock market, regulations)
23. The basic principles of finance
• PRINCIPLE 1: Money Has a Time Value.
• PRINCIPLE 2: There is a Risk-Return Trade-off.
• PRINCIPLE 3: Cash Flows Are The Source of Value.
• PRINCIPLE 4: Market Prices Reflect Information.
