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FIN 3701 Lecturer: Chainarin Srinutchasart,

Ph.D.
 Bachelor of Engineering (Industrial Engineering),
Kasetsart University
 Master of Business Administration,
Chulalongkorn University


Advanced Economic Program (Except Dissertation),
City University of New York, USA.
 Doctor of Philosophy in Business Administration
(Financial Management),
North Central University, USA.
 Certificate (Portfolio Management),
New York University, USA.
 Certificate (Value Investing),
Columbia University, USA.
 Certificate (Trading System),
New York Stock Exchange,
USA.
 Leadership Training,
Chainarin Srinutchasart, Ph.D. Harvard University, USA.

 Security Analyst: Spencer &Clarke LLC, New York


 Organizer: Hillary Clinton Presidential Campaign
 Member of New York Society of Security Analyst
 Industrial Engineer: Sirivit-Stanley Co.,Ltd.

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Office Hours

 Mon: 9:00-10:30 / 14:00-15:00


 Tue: 10:30-13:30
 Wed: 9:00-10:30 / 14:00-15:00
 Thu: 10:30-13:30
Participation is the key to
success
(3 Agreements) 1. You get an extra
point for
answering my
question during
the class.
2. Feel free to jump
in if you have any
question.
3. Follow No.1 & No.2

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Chapter 1 - An
Introduction to
Financial Management
What is Finance?

 Finance – Art and science of


managing money.

 Financial management is the process


of planning decisions in order to
maximize the owners’ wealth (long-
term approach). --- Wealth is related
to the stock’s price
You do Loan from the
You want to
not have bank (You do
own a
enough not want to
coffee shop
money have any
debt)

You go to
an
investme
nt bank to
help you You got profits and You can ask
issue the want to expand money from
common your business your friends
stock around the country (they might help
(financial
mkt- but you need a lot you take care of
primary of money your business)
mkt)

No bank
loans

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Financial Markets

Stocks and Investors


Bonds
Firms
securities
Money Bob Sue
money

Primary Market

Secondary Market
New York Stock Exchange
Four Area of Finance
(you need to know all of
them)
 Money and Capital Market
 Investments
 Risk Management
(Risk is the variability of expected returns -sales, earnings,
or cash flow-and is the probability that a financial
problem will affect the company’s operational
performance or financial position)
 Financial Management (where we
are)
Financial management

 Financial management, the broadest of the


four areas, and the one with the greatest
number of job opportunities, important to
all types of businesses.
 The types of jobs one encounters in this
area range from making decisions
regarding plant expansions to choosing
what types of securities to issue when
financing an expansion. (start with
business strategy: e.g., Chang Water)
Finance Majors

 Many finance majors go to work for


financial institutions, including
commercial banks, insurance
companies, mutual funds,
investment banking firms and any
firms (Finance Department).
Finance vs. Accounting

• Accounting is the language of business (You


all need to have accounting knowledge).
• Finance uses accounting information
together with other information to make
decisions that affect the market value of the
firm. (future vs. past)
• There are three primary decision areas in
Finance that are of concern.
Corporate Finance addresses the
following
3 questions:
1. What long-term investments
should the firm engage in?
2. How can the firm raise money
for the required investments?
(Alternatives: Bonds, Stocks,
Preferred Stocks=what is the
appropriate price?)
3. How much short-term cash flow
does a company need to pay its 14
The Balance-Sheet Model of the
Firm
Total Value of Assets: Total Claims:

Current Liabilities

Current Assets

Long-Term Debt

Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity
Corporate Finance addresses the
following
3 questions:
1. What long-term investments
should the firm engage in?
2. How can the firm raise money
for the required investments?
(Alternatives: Bonds, Stocks,
Preferred Stocks=what is the
appropriate price?)
3. How much short-term cash flow
does a company need to pay its 16
The Balance-Sheet Model of the
Firm
The Capital Budgeting Decision (Ch. 9-11)
(Investment Decision)
Current Liabilities

Current Assets

Long-Term Debt

Fixed Assets What long-


1 Tangible term
Shareholders’
2 Intangible investments Equity
should the
firm engage
in?
Corporate Finance addresses the
following
3 questions:
1. What long-term investments
should the firm engage in?
2. How can the firm raise money
for the required investments?
(Alternatives: Bonds, Stocks,
Preferred Stocks=what is the
appropriate price?)
3. How much short-term cash flow
does a company need to pay its 18
The Balance-Sheet Model of the
FirmThe Capital Structure Decision (Ch. 12)
(Financing Decision)
Current Liabilities

Current Assets

Long-Term Debt

How can the


firm raise the
Fixed Assets money for the
1 Tangible
required
investments? Shareholders’
2 Intangible Equity
Corporate Finance addresses the
following
3 questions:
1. What long-term investments
should the firm engage in?
2. How can the firm raise money
for the required investments?
(Alternatives: Bonds, Stocks,
Preferred Stocks=what is the
appropriate price?)
3. How much short-term cash flow
does a company need to pay its 20
The Balance-Sheet Model of the
The Net Working Capital Investment Decision
Firm
(Ch. 18)
Current Liabilities

Current Assets Net Working


Capital
Long-Term Debt

Fixed Assets How much


short-term cash
1 Tangible
flow does a Shareholders’
2 Intangible company need Equity
to pay its bills?
Capital Structure (What about Financial
Structure?)
>The value (Market 30%
Equity
Value) of the firm can 70%
be thought of as a pie. Debt

>The goal of the


50% Debt
manager is to increase
the size of the pie
(Market Value). 50%
Equity
>The Capital Structure
decision can be viewed
as how best to slice up 25%
a the pie. Debt
75%
>If how you slice the pie affects the size Equity
of the pie, then the capital structure
decision matters.
•What should be the goal
of the firm?
•Many people think the
goal is to maximize
profits.
• Would this mean short-term profit, or
long-term profit?
• Businesses are sometimes criticized
for being overly concerned about
short-term profits results rather than
the long-term strategic positioning of
the company.
Goal of the Firm

Profit Maximization? (Finance or


Microeconomics Approaches?)
this goal (Economics approach) has problems with:

Timing of returns
 Profit NOW or LATER??

Uncertainty of returns (Risks)


 2M profit 1st yr = 2M profit 2nd yr
•What about risk? Isn’t
risk important as well
as profits?
• How would the stockholders of a small business
react if they were told that their manager canceled
all casualty and liability insurance policies so that
the money spent on premiums could go to profit
instead.(ex. Central World)
• Even though the expected profits increased by this
action, it is likely that stockholders would be
dissatisfied because of the increased risk they
would bear.
• You should trade-off between risk and return.
•The common stockholders
are the owners of the
corporation!
• Stockholders elect a board of
directors who in turn hire managers
to maximize the stockholders’ well
being.
• When stockholders perceive that
management is not doing this, they
might attempt to remove and
replace the management, but this
can be very difficult in a large
corporation with many stockholders.
•This action by
stockholders will cause
the market price of the
company’s stock to fall.
•Management is failing in
their job to increase the
welfare (or wealth) of the
stockholders (the owners).
•Management is
accomplishing their goal of
increasing the welfare (or
wealth) of the stockholders
(the owners).
•The goal of the firm
should be to maximize
the stock price!
• This is equivalent to saying the goal is to
maximize owners’ wealth.
• Note that the stock price is affected by
management’s decisions affecting both
risk and future cash flows (in the long
run).
• Stock price can be maintained or
increased only when stockholders
perceive that they are receiving profits
that fully compensate them for bearing
•Important focal points
in the study of finance:

• Accounting and Finance often focus


on different things
• Finance is more focused on market
values rather than book values
(future vs past).
• Finance is more focused on cash
flows rather than accounting income.
•Why is market value
more important than book
value?
• Book values are often based on dated
values. They consist of the original cost of
the asset from some past time, minus
accumulated depreciation (which may not
represent the actual decline in the assets’
value).
• Maximization of market value of the
stockholders’ shares is the goal of the firm.
Why is cash flow more
important than
accounting income?
• You can earn the interest by
reinvesting received cash (TVM)
•Examples of when
accounting income is
different from cash
flow:
• Credit sales are recognized as
accounting income, yet cash has not
been received.
• Depreciation expense is a legitimate
accounting expense when calculating
income, yet depreciation expense is
not a cash outlay.
Legal Forms of
Business
1) Sole Proprietorship
 A business owned by a single individual.
 Profits and control not shared with others.
 Owner has unlimited liability.
 Less regulation.
 Significant tax savings.
 Limited life, limited to the life of the owner.
 No tax deductions for personal and employees’ health, life, or
disability insurance.

2) Partnership
 Similar to a sole proprietorship, except that
there are two or more owners.
Legal Forms of
Business
2a) General Partnership
 All partners have unlimited liability.

2b) Limited Partnership


 Consists of one or more general partners,
who have unlimited liability.
 One or more limited partners (investors)
whose liability is limited to the amount of
their investment in the business.
Legal Forms of
Business
2c) Limited Liability
Company (LLC)
 Cross between a partnership and
a corporation.
 Owners have limited liability,
but the firm runs and is taxed
like a partnership.
Legal Forms of
Business
3) Corporation
 A business entity that legally
functions separate and apart from its
owners.
 Owners’ liability is limited to the
amount of their investment in the
firm.
 Owners hold common stock
certificates, and ownership can be
transferred by selling the certificates.
Stockholders

elect

Board of
Directors

appoint

R& Chief Executive HR


D Officer (CEO) VP
VP

Finance
Marketing Productio VP Controller
VP n VP (CFO)
Treasurer
Responsibilities of Controller and
Treasurer
Controller Treasurer
 Accounting  Obtain financing
 Reporting financial info
 Maintaining banking relationships
 Custody of records
 Investing funds
 Interpreting financial data
 Investor relations
 Budgeting
 Managing cash
 Controlling operations
 Insuring assets
 Appraising results and making
recommendations
 Fostering relationships with creditors
and investors
 Preparing taxes
 Appraising credit and collecting funds
 Managing assets
 Deciding on the financing mix
 Internal auditing
 Disbursing dividends
 Protecting assets
 Managing pension funds
 Reporting to government bodies
 Payroll
The Corporation and
Financial Markets
The Corporation and
Financial Markets

Corporation
The Corporation and
Financial Markets

Corporation Investors
The Corporation and
Financial Markets

Corporation Investors

Government
The Corporation and
Financial Markets

Corporation cash Investors

Government
The Corporation and
Financial Markets

Corporation cash Investors


securities

Government
The Corporation and
Financial Markets

Corporation cash Investors


securities

Secondary
markets

Government
The Corporation and
Financial Markets

Corporation cash Investors


securities

Secondary
markets

Government
The Corporation and
Financial Markets

Corporation cash Investors


securities

Secondary
markets

Government
The Corporation and
Financial Markets

Corporation cash Investors


securities

Secondary
markets
Cash flow

Government
The Corporation and
Financial Markets

Corporation cash Investors


securities

Secondary
markets
Cash flow

tax

Government
The Corporation and
Financial Markets

Corporation cash Investors


securities
reinvest
Secondary
markets
Cash flow

tax

Government
The Corporation and
Financial Markets

Corporation cash Investors


securities
reinvest
Secondary
markets
dividends,
Cash flow
etc.

tax

Government
Structure of Financial
Market

F i n a n c i a l M a r k e t s

M o n e y M a r k e t C a p i t a l M a r k e t

P r i m a r y SM e a c r ok ne td a r Py r Mi m a a r kr y e StM e a c r ok ne dt a r y
Financial Markets

Money markets Capital markets


 The markets for short-  The markets for long-
term debt securities term debt (that with a
(those with maturities maturity of more than
of less than one year) one year) and
such as treasury bills, corporate stocks.
commercial paper,
and certificates of
deposit.
Financial Institutions
(Intermediaries)
 Commercial Banks
 Pension Funds
 Life Insurance Companies
 Credit Unions
 Investment Banking Houses
(Brokerage Houses)
 Others
The Corporation and
Financial Markets
 Primary Market
The Corporation and
Financial Markets
 Primary Market
 Market in which new
issues of a security are
sold to initial buyers.
The Corporation and
Financial Markets
 Primary Market
 Market in which new
issues of a security are
sold to initial buyers.
 Secondary Market
The Corporation and
Financial Markets
 Primary Market
 Market in which new issues
of a security are sold to
initial buyers.
 Secondary Market
 Market in which previously
issued securities are traded.
Financial Markets

Stocks and Investors


Bonds
Firms
securities
Money Bob Sue
money

Primary Market

Secondary Market
The Corporation and
Financial Markets
 Initial Public Offering
(IPO)
The Corporation and
Financial Markets
 Initial Public Offering
(IPO)
 The first time the firm’s
stock is sold to the
general public.
The Corporation and
Financial Markets
 Initial Public Offering
(IPO)
 The first time the firm’s
stock is sold to the
general public.
 Seasoned New Issue
The Corporation and
Financial Markets
 Initial Public Offering (IPO)
 The first time the firm’s stock is
sold to the general public.
 Seasoned New Issue
 A new stock offering by a firm that
already has stock that is traded in
the secondary market.
11 Principles of Finance
1. Higher Returns Require Taking More Risk
2. Efficient Capital Markets Are Tough to Beat
3. Supply and Demand Drive Stock Prices in the Short Run
4. Transaction Costs, Taxes, and Inflation Are Your Enemies
5. Time and the Value of Money Are Closely Related
6. Asset Allocation Is a Very Important Decision
7. Incremental Cash Flows- It’s only what changes that
counts
8. Cash-not profits-is the king
9. The curse of competitive markets
10. The agency problem
11. Ethical dilemmas are everywhere in finance.
Principle 1: Higher Returns
Require Taking More Risk
 The Risk-Return Trade-Off= You don’t want to take on
additional risk unless you expect to be compensated with
additional return.
 People invest some money now in order to consume in
the future (earn some interest)
 A rational investor favors a higher return on a his
investment over a lower return, and prefers to take less
risk rather than more risk. Unfortunately, there is no free
lunch in the world of finance. A trade-off exists between
higher expected return on an investment and greater
risk. Safe investments (i.e., Treasury securities) have low
returns. High returns require investors to take big risks.
 Risk reflects the uncertainty associated with the
expected returns of an asset. Risk is the part of an
asset’s price movement that is caused by a surprise or
an unexpected event measured by standard deviation
of the return on the asset.
Principle 1 (cont.)
 Unsystematic risk is the risk caused by a surprise
event that affects only one company, such as an
accounting irregularity, new drug or new technology
discovery (e.g., Blu-ray), or a patent expiration.
Unsystematic risk is unique to a stock or industry
and can be reduced by proper diversification.
 Systematic risk is the risk caused by a surprise event
that affects the entire economy and all assets to
some degree, such as an increase in interest rates, a
terrorist attack, or the political risk. The level of
systematic risk for an asset is not reduced by
diversification.
Expected Return

ks k
oc ris
St h-
ig
H
Corporate
Bonds
Govt
Bond St
s
ris ock
Lo k
w
T- -
Bills

Risk

Security Market Line


Principle 2: Efficient
Market
Hypothesis (EMH)

Securities are normally in


equilibrium and are “fairly priced.”
One cannot “beat the market”
except through good luck or inside
information.
1. Weak-form EMH:
Can’t profit by looking at past trends. A
recent decline is no reason to think
stocks will go up (or down) in the future.
Evidence supports weak-form EMH, but
“technical analysis” is still used.
2. Semistrong-form EMH:
All publicly available information is
reflected in stock prices, so it doesn’t pay
to pore over annual reports looking for
undervalued stocks. Largely true.
Principle 3: Supply and
Demand Drive Financial
Asset Prices in the Short
Run
 Stock Prices in the short run are
driven by greed and fear of traders
(it’s so true in the real world).

 For the long run, stock prices will be


valued by the long-term company’s
competitive advantages.
Principle 4: Transaction
Costs, Taxes, and Inflation
Are Your Enemies
 Transaction cost comes in many forms:
brokerage commissions when you execute a
trade; sales loads, etc…

 The higher inflation, the lower return we have


 If the future payment will be diminished in
value because of inflation, then the investor
will demand an interest rate higher than the
pure time value of money to also cover the
expected inflation expense (loss of purchasing
power).
Taxes bias business
decisions.
 Concern about tax before making
decision

 After-tax cash flow is more important


 Investment tax credit
 BOI industrialize zone

 Government use tax incentive to


help increase investment
Principle 5: Time and the
Value of Money Are Closely
Related
 The basic idea underlying finance
theory is that a dollar today is worth
more than a dollar tomorrow.

FV = PV x 1
PVt =0 = Ct =i ×
(1+r)^n (1 + rt =i )i
Time Value of Money

 If we can earn interest rate:


 $1 Now > $1 Tomorrow

 Apply to investment decision


 1M now vs. 1M 1-yr from now

 If earn 3% interest rate


 1M now = 1.03M 1-yr from now
Principle 6: Asset
Allocation Is a Very
Important
 Some risk can beDecision
diversified away

 Diversify: A risk management technique that


mixes a wide variety of investments to reduce risk.
the positive performance of some investments will 
neutralize the negative performance of others.

 To reduce your Unsystematic risk. “Don’t put all of


your eggs in one basket”

 Gov’t Bonds + Corp Bonds + Large Stocks + Small


Stocks + Internationals + etc…
Principle 7: Incremental Cash
Flow Count
 Cash flows = The actual cash in and cash out of
the firm.
 Free cash flows: This cash is available to
distribute to the firm’s creditors and owners.
 Incremental cash flow: Only what
change that matter
 Current machine created $1Million profit
 New machine will create $3 Million profit
 With incremental concept,
 New machine create only additional or
incremental $2 million profit (not $3 million)
Principle 8: Cash is
King
 Cash is more important!
Why?
 Cash pays employees and
creditors, profit don’t
 Accounting profit can be
manipulated
 Cash can be reinvest right away
and start earning interest on it.

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Principle 9:Curse of Competitive Market-
Why it’s hard to find exceptionally
profitable projects.
 New competitor – always
*In competitive markets, extremely large
profits simply cannot exist for very long.

 Identify good profitable (value


creating) projects
Imperfect market
Differentiate (Starbucks), cost advantage,
etc.
Patents (R&D)

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Principle 10:The Agency
Problem
 Manager is the agent for owners
 They have conflict of Interest
 Work for his/her benefit
 Bigger conflict, bigger agency
problem
 Hurt the firm value

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A potential agency problem arises
whenever a manager of a firm owns less
than 100 percent of the firm’s common
stock
 Since the firm’s earnings do not go
solely to the manager, he or she may
not concentrate exclusively on
maximizing shareholder wealth.

 In most large corporations, potential


agency conflicts are important,
because large firms’ managers
generally own only a small percentage
of the stock.
Ways to motivate managers to act in
shareholders’ best interests

 Managerial compensation (stock


options)
 Direct intervention by shareholders
 The threat of firing
 The threat of takeovers (a hostile
takeover)
Principle 11: Ethical
dilemmas
 Doing the right thing
 Code of ethics
 Why concerning ethics?

“Although business errors can be forgiven, ethical errors tend to end


careers and terminate future opportunities because unethical behavior
eliminates trust”

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