Principles of Managerial Finance

CHAPTER 1
LG-1 Define finance and the managerial finance function.
Finance is the science and art of how individuals and firms raise, allocate, and
invest money. It affects virtually all aspects of business.
Managerial finance is concerned with the duties of the financial manager working
in a business.
Financial managers administer the financial affairs of all types of businesses:
 private and public,
 large and small,
 Profit seeking and not for profit.
FIRM is a business organization that sells goods or services.
LG-2 Describe some goals that financial managers pursue.
There are many goals that firms can pursue including
 Maximizing market share or profits.
 In finance, a firm’s primary goal is to maximize the wealth of its owners
who provide the capital that makes the firm’s existence possible.
 Maximizing the wealth of shareholders.
LG-3 Identify the primary activities of the financial manager.
Financial managers are primarily involved in three types of decisions.
1. Investment decisions; relate to how a company invests its capital to generate
wealth for shareholders.
2. Financing decisions relate to how a company raises the capital it needs to
invest.
3. Working capital decisions: refer to the day-to-day management of a firm’s
short-term resources such as cash, receivables, inventory, and payables.

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Principles of Managerial Finance
LG-4 Explain the key principles that financial managers use
when making business decisions.
 The time value of money means timing matters in finance.
 Tradeoff exists between risk and return: Nothing ventured nothing gain
 Cash is king: cash flow and profit are not identical concepts.
 Competitive financial market: Firms compete in the financial markets to
access to capital controlled by investors.
 Incentives are important
LG 5 Describe the legal forms of business organization.
The sole proprietorship is a for-profit business owned by one person.
Unlimited liability: The liabilities of the business are the owner’s responsibility,
and creditors can make claims against the owner’s personal assets if the business
fails to pay its debts.
The partnership is a business owned by two or more people and operated for
profit.
Articles of partnership: The written contract used to formally establish a
partnership.
The corporation is a legal business entity with rights and duties similar to those of
individuals but with a legal identity distinct from its owners.
Define Stock, Cash dividends and Board of directors
Stock: A security that represents an ownership interest in a corporation.
Cash dividends: Periodic distributions of cash to the stockholders.
Board of directors: Group elected by the firm’s stockholders and typically
responsible for approving strategic goals and plans, setting general policy, guiding
corporate affairs, and approving major expenditures.

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Principles of Managerial Finance
LG-6 Describe the nature of the principal–agent relationship
between the owners and managers of a corporation, and
explain how various corporate governance mechanisms
attempt to manage agency problems.
The separation of owners and managers in a corporation gives rise to the classic
principal–agent relationship, in which shareholders are the principals and managers
are the agents.
A firm’s corporate governance structure is intended to help ensure that managers
act in the best interests of the firm’s shareholders and it is usually influenced by
both internal and external factors.

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Principles of Managerial Finance
CHAPTER 2
L G-1 Describe the role that financial institutions play in
managerial finance.
Financial institutions bring net suppliers of funds and net demanders together to
help translate the savings of individuals, businesses, and governments into loans
and other types of investments.
Define Financial institution, Commercial banks, Investment
banks and Shadow banking system
Financial institution: An intermediary that channels the savings of individuals,
businesses, and governments into loans or investments.
Commercial banks are financial institutions that provide savers with a secure
place to deposit or save funds for future use.
Investment banks: Assist companies in raising capital, advice firms on major
transactions such as mergers or financial restructurings, and engage in trading and
market-making activities.
Shadow banking system: A group of institutions that engage in lending activities,
much like traditional banks, but that do not accept deposits and therefore are not
subject to the same regulations as traditional banks.
LG 2 Describe the role that financial markets play in managerial
finance.
Financial markets help businesses raise the external financing they need to fund
new investments for growth. Financial markets provide a forum in which savers
and borrowers can transact business directly.
L G-3 Describe the differences between the money market and
the capital market.
Money market: A market where investors trade highly liquid securities with
maturities of one year or less.
Capital market: A market that enables suppliers and demanders of long-term
funds to make transactions.

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Principles of Managerial Finance
Define Primary market, Secondary market, Money market and
Eurocurrency market
Primary market: Financial market in which and securities are initially sold by the
issuing entity.
Secondary market: Financial market in which investors’ trade securities with
each other.
Eurocurrency market: International equivalent of the domestic money market.
Define Bond, Common stock, Preferred stock, Common stock,
Liquidity, Bid price and Ask price?
Bond: Long-term debt instrument used by business and government to raise large
sums of money, generally from a Preferred stock diverse group of lenders.
Common stock: A unit of ownership, or equity, in a corporation.
Preferred stock: A special form of ownership having a fixed periodic dividend
that must be paid prior to payment of any dividends to common stockholders.
Liquidity: The ability to quickly buy or sell a security without having an impact
on the security’s price.
Bid price: The highest price a buyer in the market is willing to pay for a security.
Ask price: The lowest price a seller in the market is willing to accept for a
security.

L G-4 Describe the major regulations and regulatory bodies that

affect financial institutions and markets.
 The Glass-Steagall Act,
 Federal Deposit Insurance Corporation (FDIC, soundness.
 Gramm-Leach-Bliley Act,
 Securities Act of 1933,
 Securities Exchange Act of 1934,
 Securities and Exchange Commission (SEC),
 Stop Trading on Congressional Knowledge (STOCK) Act of 2012,
 The Dodd-Frank Act
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Principles of Managerial Finance
Define Market makers, Broker market, Dealer market,
Eurobond market, foreign bond, Efficient market, and Random
walk hypothesis
Market makers: Securities dealers who “make markets” by offering to buy or sell
certain securities at stated prices.
Broker market: The securities exchanges on which the two sides of a transaction,
the buyer and seller, are brought together to trade securities.
Dealer market: The market in which the buyer and seller are not brought together
directly but instead have their orders executed by securities dealers who “make
markets” in the given security.
Eurobond market: The market in which corporations and governments typically
issue bonds denominated in dollars and sell them to investors located outside the
United States.
Foreign bond: A bond that is issued by a foreign corporation or government and is
denominated in the investor’s home currency and sold in the investor’s home
market.
Efficient market: A market that establishes security prices by rapidly
incorporating all available information.
Random walk hypothesis: The idea that in an efficient financial market, prices
should be virtually unpredictable because they move in response to new
information, which is itself unpredictable.

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Principles of Managerial Finance
L G-5 Describe the process of issuing common stock, including
venture capital, going public, and the role of the investment
bank.
The process of issuing common stock.
Private equity: External equity financing that is raised via a private placement,
typically by private early-stage firms with attractive growth prospects.
Angel investors (angels): Wealthy individual investors who make their own
investment decisions and are willing to invest in promising startups in exchange
for a portion of the firm’s equity.
venture capitalists (VCs): Formal business entities that take in private equity
capital from many individual investors, often institutional investors such as
endowments and pension funds or individuals of high net worth, and make private
equity investment decisions on their behalf.
Venture capital: Equity financing provided by a firm that specializes in financing
young, rapidly growing firms.

Going Public
(1) Private placement: The firm sells new securities directly to an investor or
group of investors.
(2) Rights offering: Firm sells new shares to existing stockholders.
(3) Public offering: Firm sells new shares to the general public.

The role of the investment bank

The lead investment bank may form a selling syndicate with other investment
banks. The IPO process includes getting SEC approval, promoting the offering to
investors, and pricing the issue.

Originating investment bank

Underwriting syndicate
Tombstone.
Selling group

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Yassein Mohamud Abdirahman
Principles of Managerial Finance
The Selling Process for a Large Security Issue
Total proceeds: The IPO offer price times the number of shares issued.
Market price: The price of the firm’s shares as determined by the interaction of
buyers and sellers in the secondary market.
Market capitalization: The total market value of a publicly traded firm’s
outstanding stock.
IPO market price: The final trading price on the first day in the secondary
market.
IPO underpricing: The percentage change from the final IPO offer price to the
IPO market price, which is the final trading price on the first day in the secondary
market; this is also called the IPO initial return.

The initial external financing for business startups with attractive growth prospects
typically comes in the form of private equity raised via a private equity placement.

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Principles of Managerial Finance
CHAPTER 3
LG 1 Review the contents of a company’s financial statements.
Mandatory Financial Reports of Public Companies.
GAAP: authorized by the Financial Accounting Standards Board (FASB).
The Sarbanes-Oxley Act of 2002: established the Public Company Accounting
Oversight Board (PCAOB).
Form 10-K: Annual report filed with the SEC that contains the company’s audited
financial statements.
Annual report: Report that companies provide prior to the annual stockholders’
meeting.
It also contains four key financial statements: the income statement, the balance
sheet, the statement of stockholders’ equity, and the statement of cash flows.
TYPES OF RATIO COMPARISONS
Cross-sectional: analysis Comparison of different firms’ financial ratios at the
same time.
Benchmarking: A type of cross-sectional analysis in which the firm’s ratio values
are compared with those of competitors or with other firms that it wishes to
emulate.
Time-series analysis: Evaluation of the firm’s financial performance over time
using financial ratio analysis.
Combined Analysis: combines cross-sectional and time-series analyses.

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Principles of Managerial Finance
LG 2 Understand who uses financial ratios and how they use
them.
Financial ratios uses stockholders, lenders, and the firm’s managers to evaluate the
firm’s financial performance. It can be performed on a cross-sectional or a time-
series basis. Benchmarking is a popular type of cross-sectional analysis.
Liquidity: A firm’s ability to satisfy its short-term obligations as they come due.
Current ratio: A measure of liquidity calculated by dividing the firm’s current
assets by its current liabilities.
Quick (acid-test) ratio: A measure of liquidity calculated by dividing the firm’s
current assets less inventory by its current liabilities.
Activity ratios: Measure the speed with which various accounts convert into sales
or cash.

LG 4 Discuss the relationship between debt and financial

leverage.
The more debt a firm uses, the greater its financial leverage, which magnifies both
risk and return. Financial debt ratios measure both the degree of indebtedness and
the ability to service debts.
Financial leverage: Refers to the degree to which a firm uses debt financing and to
the effects of debt financing.
Degree of indebtedness: Ratios that measure the amount of debt relative to other
significant balance sheet amounts.
Ability to repay debt coverage ratios: Ratios that measure a firm’s ability to make
required debt payments and to pay other fixed charges such as lease payments.

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Principles of Managerial Finance
CHAPTER 5
LG 1 Discuss the role of time value in finance, the use of
computational tools, and the basic patterns of cash flow.
The time value of money: the observation that it is better to receive money sooner
than later.
Financial managers use time value-of-money techniques when assessing the value
of expected cash flow streams.
Financial calculators and electronic spreadsheets.
Cash flow basic are of three types: a single amount, an annuity, or a mixed
stream.
LG 2 Describe the difference between future value and present
value, their calculation for single amounts, and the relationship
between them.
Future value (FV): The value on some future date of money that you invest today.
The present value (PV): The value in today’s dollars of some future cash flow.
The relationship between future value and present value
The present value of a future amount is the amount of money today that is
equivalent to the given future amount, considering the return that can be earned.
Present value is the inverse of future value.
Compound interest: Interest that is earned on a given deposit and has become part
of the principal at the end of a specified period.
Principal: The amount of money on which interest is paid.
Simple interest: Interest that is earned only on an investment’s original principal
and not on interest that accumulates over time.
Discounting cash flows: The process of finding present values; the inverse of
compounding interest.
Annuity: A stream of equal periodic cash flows over a specified time period.
These cash flows can be inflows or outflows of funds.

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Principles of Managerial Finance

TYPES OF ANNUITIES
Ordinary annuity: An annuity for which the cash flow occurs at the end of each
period.
Annuity due: An annuity for which the cash flow occurs at the beginning of each
period.
LG 6 Describe the procedures involved in (1) determining
deposits needed to accumulate a future sum, (2) loan
amortization, (3) finding interest or growth rates, and (4)
finding an unknown number of periods.
(1) The periodic deposit to accumulate a given future sum can be found
by solving the equation for the future value of an annuity for the annual
payment.
(2) A loan can be amortized into equal periodic payments by solving the
equation for the present value of an annuity for the periodic payment.
(3) Interest or growth rates can be estimated by finding the unknown
interest rate in the equation for the present value of a single amount or
an annuity.
(4) The number of periods can be estimated by finding the unknown
number of periods in the equation for the present value of a single
amount or an annuity.

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