tag:blogger.com,1999:blog-29521340032575773042023-11-15T08:59:32.244-08:0010 Axioms of Financial ManagementLina Magnolia Albayhttp://www.blogger.com/profile/16019456999643638164noreply@blogger.comBlogger1125tag:blogger.com,1999:blog-2952134003257577304.post-86083625181917495692011-05-16T07:59:00.000-07:002011-05-16T07:59:23.251-07:0010 Axioms of Financial ManagementThe Ten Axioms<br />
The Foundations of Financial Decision Making<br />
1. The Risk-Return Trade-off<br />
The more risk an investment has, the higher its expected return should be<br />
If you bet on a horse, you want greater odds on the long shot<br />
If you invest in a risky business (Semiconductor, oil wells, junk bonds), you should demand a greater return<br />
Every decision you make should be evaluated for risk<br />
2. The Time Value of Money<br />
A dollar received today is worth more than a dollar received in the future<br />
If you receive a dollar today, you can invest it and earn more<br />
Because of inflation, a dollar you receive today will buy more than a dollar you receive in the future<br />
So the sooner you get the money, the better<br />
The sooner you invest your money, the better (i.e. retirement)<br />
3. Cash is King<br />
You can not spend “profit” or “net income”. These are paper figures only<br />
Cash is what is received by the firm and can be reinvested or used to pay bills<br />
Cash flow does not equal net income; there are timing differences in accrual accounting between when you record a transaction and when you receive or pay the cash<br />
4. Incremental Cash Flows<br />
It’s only the increase or decrease in cash that really counts<br />
It’s the difference between cash flows if the project is done versus if the project is not done<br />
Consider all related cash flows, i.e., equip., inventory, etc.<br />
Brief case example<br />
5. Curse of Competitive Markets<br />
It’s hard to find and maintain exceptionally profitable projects<br />
High profits attract competition<br />
How to keep very profitable projects<br />
Product differentiation (Kleenex, Xerox)<br />
Low cost (Costco, Honda)<br />
Service and quality (Mercedes, Lexus)<br />
Give examples for each of the above<br />
6. Efficient Capital Markets<br />
The markets are quick and the prices are right<br />
Information is incorporated into security prices at the speed of light!<br />
Assuming the information is correct, then the prices will reflect all publicly available information regarding the value of the firm<br />
Example: announcing a stock split<br />
7. The Agency Problem<br />
Managers are typically not the owners of a company<br />
Managers may make decisions that are in their best interests and not in line with the long term best interests of the owners<br />
Example, cutting Research and Development costs on new products to maximize current income<br />
Pay for performance; stock options<br />
8. Taxes Bias Business Decisions<br />
Because cash is king, we must consider the after-tax cash flow on an investment<br />
The tax consequences of a business decision will impact (reduce) cash flow<br />
Companies are given tax incentives by the government to influence their decisions<br />
Examples : investment tax credit and environmental credits reduce taxes; purchase of Prius<br />
9. All Risk is Not Equal<br />
Some risk can be diversified away and some cannot<br />
Don’t put all your eggs in one basket<br />
Diversification creates offsets between good results and bad results<br />
Example: drilling for oil wells<br />
10. Ethical Behavior Means Doing the Right Thing<br />
Ethical Dilemmas are everywhere in finance; just read the news (back date stock options, Madoff)<br />
Unethical behavior eliminates trust, results in loss of public confidence<br />
Shareholder value suffers and it takes a long time to recover<br />
Social responsibility means firms have to be responsible to more than just owners<br />
- all stakeholders!Lina Magnolia Albayhttp://www.blogger.com/profile/16019456999643638164noreply@blogger.com11