Fundamentals of Financial Management

Chapter 1: The Role of FM Study Objectives What is FM The goal of the firm Organization of the FM A brief history about the role of a financial manager Until around the first half of the 1900s, financial managers primarily raised funds and managed their firms cash positions As the scale of the firm is on the rising, money is always in great need. In the 1950s, the increasing acceptance of present value concept encouraged financial managers to expand their responsibilities and to become concerned with the selection of capital investment projects Why? The severe competition has rendered some project to low level of profit, even spell loss to firms Today, external factors have an increasing impact on the financial manager. As a result, finance is required to play an even more vital strategic role within the corporation Case: Kelon Financial Failure: Expand too rapidly, exhaust all its resources with slow return The Responsibility of Contemporary Financial Manager Forecasting and Planning: The financial manager must interact with other executives as they look ahead and lay the plans which will shape the firms future Major Investment and Financing Decisions A successful firm usually has rapid growth in sales, which requires investments in plant, equipment, and inventory. The financial manager must help decide the optimal sales growth rate, and he or she must help decide what specific assets to acquire and the best way to finance those assets Coordination and control The financial manager must interact with other executives to ensure that the firm is operated as efficiently as possible. All business decisions have financial implications, and all managers--financial and otherwise---need to take this into account Dealing with the financial markets The firms securities are traded in the financial markets Financial markets offers opportunities for the firm Useful information Risk management All businesses face risks, however, many of these risks can be reduced by purchasing insurance or by hedging in the derivatives markets. The financial manager is usually responsible for the firms overall risk management program, including identifying the risks that should be hedged and hedging them in the most efficient manner What is FM? Why we need FM? How to use funds to maximize the value of the firm with limited resource. It is not a problem of manufacturing efficiency and minimizing cost. (2)FM is concerned with the acquisition, financing and management of assets with some overall goals in mind Acquisition of assets---investment decision

Two problems to be solved: how much dollar of amount is needed and what is the composition of these assets The investment decision is the most important of the firms three major decisions when it comes to value creation The value creation of the firm is determined to a great extent by the investment decisions, compared to the financing and assets management Case of Jiuyao Corporation Financing decision: concerned with the problem of raising money to meet the need of investment decision Financing decision is also very important: it concerns with capital cost, investment opportunities, and the existence of a firm Asset management decision The main task of asset management is how to use the acquired assets as efficiently as possible--to speed up the turnover of the asset Here financial managers are concerned more with current assets than fixed assets, why? Financial policies affect the turnover of current asset, and fixed assets are largely determined by operation needs It is also very important, for speeding up asset turnover can increasing the profit level in a certain period What do others say about FM? CPA Examination Textbook FM is a management job concerning the raising, using and distributing of funds The object of FM is the recycle and turnover of cash The main contents of FM is financing, investment, and dividend distribution The main function of FM is deciding, planning and controlling The Goal of the Firm Why do we need a goal? Because judgement as to whether or not a financial decision is efficient must be made in light of some standards Profit maximizing is chosen by classic economist as the best goal However, it is not the case in the real life because it is shaded by a little flaw: it may induce a manager to increase profit by issuing more stock and using the proceeds to invest in Treasury Bills, so the earning per share will fall and this will harm the shareholders interest Maximizing EPS is not a fully appropriate goal either, because : It does not specify the timing or duration of expected returns It does not consider the risk of the firm Maximizing the market value of the firm---the stock price is by far the best MV(market value)=present value of net cash flow/(1+risk) Why that? Because investors will consider a firms current and future earnings, risks, and other factors which will influence a firm before he decides to make a investment decision, and the market price of the stock will reflect all the information about these factors Why maximizing the MV is the best goal? It takes into account present and future EPS, the timing, the duration, and the risk of these earnings It also considers the dividend policy of the firm, and the other factors that bear on the market price

of the stock Why should managers work hard to maximize stock price? If they do not work hard to maximize stock price, they will be removed by the firms board of directors or by outside forces Others said that managers are forced by product and labor markets to work hard for the firm, why? Agency Problems What is agency problem? The agent do not act in the interest of the principal, but in his own interest (2)Why does this happen? We assume that people are always self-interested The object of the agent may differ from that of the principal, so when the behavior of the agent cannot be closely watched, agent may choose to act in his own interest In the case of a firm, this can also be the case: Chu Shijian Phenomenon (a good example of agent problem) Shareholders---Principal, managers---agent Wolfgun said that the failure of socialist is due to too much agency problems How can shareholders solve the agent problem? Monitor Motivate---surplus share Bear loss All these can bring about contract cost, this cost is also called agency cost The shareholders objective is to minimize agency cost Social Responsibility What is social responsibility? Some responsibility carried on the firm according to social ethics (2)Why shall the firm carry out social responsibility? Carrying out social responsibility can create a good environment for the firm In our modern market economy, social responsibility will be more appreciated by the society. Paper industry, Coal-mining industry, food and drug industry are all the issues we watch on. For example, poisonous milk powder event. The goal of the firm---a linear program Maximize shareholders interest Subject to: Minimize agency cost Meet social responsibility Organization of the FM Function Fig. 1-1, Page 7