Lecture 1: Intro to Finance

Question 1

what is a company?

Answer 1

A business organised as a separate legal entity owned by shareholders

Question 2

what does owning a share entitle a shareholder to?

Answer 2

A proportional claim on the company’s assets (they own a fractional part of the company and its net worth)

Question 3

what are residual claimers

Answer 3

In the event of the company’s liquidation, after all
creditors are paid, the shareholders have the right to claim what remains
of the company’s assets

Question 4

what are public companies

Answer 4

ownership (shares) traded in public markets such as stock exchanges
- e.g. Woolworths, Apple, Alibaba

Question 5

what are private companies

Answer 5

ownership (shares) NOT traded in public markets
- e.g. Meriton, Aldi, Huawei

Question 6

what are alternative business structures

Answer 6

1. Sole trader (e.g. most cafes and restaurants)
2. Partnership (Law firms, “Big Four” acct firms)

Question 7

what is the goal of the financial manager

Answer 7

consistent with the corporate objective of a public company, which is to maximise the wealth of shareholders

Question 8

what is shareholder wealth

Answer 8

the current market value of a shareholder’s investment

Question 9

who are shareholders

Answer 9

owners of public companies who provide risk capital and residual claimers

Question 10

profit formula

Answer 10

profit = revenue - cost

Question 11

what does the market value of shareholder wealth reflect

Answer 11

the sum of all expected future cash flows to shareholders after adjusting for time value of money

Question 12

what are investment decisions

Answer 12

activities that aim at generate revenues or to save costs

Question 13

what are financing decisions

Answer 13

How should a firm raise money to fund
investments?

Question 14

what are dividend decisions

Answer 14

How should a firm return cash to
shareholders?
– Two types: buybacks or dividends

Question 15

what is debt

Answer 15

borrowed funds, e.g. loans and bonds.

Question 16

what is equity

Answer 16

ownership (shares of profit), i.e., shares/stocks

Question 17

investment decision examples

Answer 17

• Disney’s spent $14-16 bil in a new streaming platform Disney+
  – Apple decided to develop Apple Watch in 2015

Question 18

Financing decisions examples

Answer 18

– Tesla’s initial public offering (IPO) in 2010
– Apple issues $14B of corporate bonds in Feb 2021

Question 19

dividend decisions examples

Answer 19

• CBA announced an interim dividend of $1.50 per share for the six months ended 31 Dec 2020
  – Macquarie Group announced a $2B on-market share buyback program in 2024

Question 20

how do financial managers max shareholder wealth

Answer 20

take every opportunity to
make corporate finance decisions that increase shareholder
wealth

Question 21

valuation

Answer 21

financial manages should only invest in a project when
the project’s return > minimum return required by
investors in financial markets

Question 22

key players in corporations

Answer 22

1. Shareholders
   - legal owners and they elect directors
2. Directors
   - on behalf of shareholders, hire/fire top executives to manage the corporation
3. Directors
   - on behalf of shareholders, are supposed to advise and to monitor top managers;
4. Managers
   - responsible for the company’s strategic directions & day-to-day operations

Question 23

agency problem

Answer 23

Managers, acting as agents for shareholders, may act in
their own interests rather than maximising value

Question 24

when are agency costs incurred

Answer 24

when:
- there’s is a separation of ownership and control
– Shareholders face constraints in monitoring the managers and discipline their actions

Question 25

examples of agency problems

Answer 25

Reduction of managerial effort Inefficient investment policies – Over-investment – Under-investment Extraction of resources: – Excessive monetary rewards & perks Earnings manipulation / “creative” accounting

Question 26

what corporate governance policies help mitigate agency problems

Answer 26

– Executive compensation – Board of directors – Large shareholders – Lenders – Market mechanisms: e.g. Hostile takeovers – Auditors

Question 27

executive composition

Answer 27

includes base salary; bonuses; stocks & stock options grants – Equity-based pay gives executives intrinsic incentives to maximise share value and thus their own wealth

Question 28

pros of equity-based management compensation

Answer 28

- Alignment of interests with shareholders – Reduce managers’ tendency to focus on short-term goals

Question 29

cons of equity-based management compensation

Answer 29

May provide incentives for managers to manipulate stock prices, - e.g. earnings management, news announcements Stock option grants may encourage excessive risk-taking: - E.g. Many believe jumps in stock option grants to bank executives pre-crisis encouraged excessive risk-taking

Question 30

what is the function of board of directors

Answer 30

monitor and advise the management on behalf of shareholders

Question 31

executive directors

Answer 31

company’s top executives

Question 32

non-executive directors

Answer 32

outside directors who are not part of the companies day-to-day operations

Question 33

what makes a good director

Answer 33

- They have the “right” incentives: independent and not affiliated to the management – They have the “right” expertise/skills: Knowledge of the company’s operations and/or financial expertise

Question 34

retail investors

Answer 34

These are individual “mum and dad” investors who can directly buy and sell securities for their personal accounts, and not for another company or organization.

Question 35

institutional/professional investors

Answer 35

These are entities such as funds, investment banks, and insurance companies that directly invest large sums of money, typically for others.

Question 36

indirect investment

Answer 36

a fund is an organisation that invests funds on behalf of investors (their clients)

Question 37

what is superannuation

Answer 37

provide retirement benefits for their members

Question 38

mutual fund

Answer 38

pools money from many investors (retail and institutional clients) and deliver returns

Question 39

hedge fund

Answer 39

investment funds that employ customised and often aggressive strategies deemed riskier than typical investments.

Question 40

substantial investors

Answer 40

a shareholder with a relevant interest in at least 5% of the company’s voting shares