CHAPTER 1 MGMT 109 Essay

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Pages: 3

CHAPTER 1- introduction

1.1 The Goal of Finance: Relative Valuation
There is one principal theme that carries through all of finance: VALUE
The better you can assess value, the smarter your decisions will be
The main reason why you need to estimate value is that you will want to buy objects whose values are above their costs and avoid those where it is the reverse
The law of one price:
It states that two identical items at the same venue should cost the same
It is easier to determine whether an object is worth more or less than equivalent alternatives, than it is to put an absolute value on it
If you put too low a value on your car, you would sell it cheaply. If you put too high a value on you car, you would not be able to sell it.
“Opportunity cost”
Approximations: Similar goods that are not perfectly the same
In the absence of similar objects, valuation is more difficult

1.2 Investments, Projects, and Firms
The most basic object in finance is the project
As far as finance is concerned, every project is a set of flows of money (cash flows)
Most projects require an up-front cash outflow (an investment or expense or cost) and are followed by a series of later cash inflows (payoffs or revenues or returns)
To value projects, make sure to use all costs and benefits, including opportunity costs and pleasure benefits
Projects need not be physical. E.g. “Customer relations”
A firm is viewed as a collection of projects
The value of a firm is the value of all its projects’ net cash flows, and nothing else
There are two important specific kinds of projects that you may consider investing in- bonds and stocks, also called debt and equity
The firm is the sum of all its inflows and all its outflows. Stocks and bonds are just projects with inflows and outflows
Entire Firm= All Outstanding Stocks+ All Outstanding Liabilities
Entire Firm= All (Current and Future) Net Earnings
Entire Firm= All (Current and Future Cash) Inflows- Outflows

1.3 Firms versus Individuals
We use the same principles in corporate finance as in “home economics”
Relative valuation often works well in the corporate world
Value in the corporate context can depend on the quality of the market
Separation of ownership and