Chapter 1

Introduction to Financial Management

Forms of Business Organization Stock Prices and Shareholder Value Intrinsic Values, Stock Prices, and

Executive Compensation Important Business Trends Conflicts Between Managers, Stockholders, and Bondholders

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Finance Within the Organization

Board of Directors

Chief Executive Officer (CEO)

Chief Operating Officer (COO) Marketing, Production, Human Resources, and Other Operating Departments

Chief Financial Officer (CFO) Accounting, Treasury, Credit, Legal, Capital Budgeting, and Investor Relations
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Forms of Business Organization

Proprietorship Partnership Corporation

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Proprietorships and Partnerships

Advantages

Ease of formation Subject to few regulations No corporate income taxes

Disadvantages

Difficult to raise capital Unlimited liability Limited life

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Corporation

Advantages

Unlimited life Easy transfer of ownership Limited liability Ease of raising capital
Disadvantages

Double taxation Cost of set-up and report filing

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Stock Prices and Shareholder Value

The primary financial goal of management is shareholder wealth maximization, which translates to maximizing stock price.

Value of any asset is present value of cash flow

stream to owners.

Most significant decisions are evaluated in terms

Stock prices change over time as conditions

of their financial consequences.

change and as investors obtain new information about a companys prospects.

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Stock Prices and Intrinsic Value

In equilibrium, a stocks price should equal its true or intrinsic value. Intrinsic value is a long-run concept. To the extent that investor perceptions are incorrect, a stocks price in the short run may deviate from its intrinsic value. Ideally, managers should avoid actions that reduce intrinsic value, even if those decisions increase the stock price in the short run.
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Determinants of Intrinsic Values and Stock Prices

Managerial Actions, the Economic Environment, Taxes, and the Political Climate

True Investor Returns

True Risk

Perceived Investor Returns

Perceived Risk

Stocks Intrinsic Value

Stocks Market Price

Market Equilibrium: Intrinsic Value = Stock Price

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Some Important Business Trends

Recent corporate scandals have reinforced the importance of business ethics, and have spurred additional regulations and corporate oversight. Increased globalization of business. The effects of ever-improving information technology have had a profound effect on all aspects of business finance.

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Conflicts Between Managers and Stockholders

Managers are naturally inclined to act in their own best interests (which are not always the same as the interest of stockholders). But the following factors affect managerial behavior:

Managerial compensation packages Direct intervention by shareholders The threat of firing The threat of takeover

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Conflicts Between Stockholders and Bondholders

Stockholders are more likely to prefer riskier projects, because they receive more of the upside if the project succeeds. By contrast, bondholders receiving fixed payments are more interested in limiting risk. Bondholders are particularly concerned about the use of additional debt. Bondholders attempt to protect themselves by including covenants in bond agreements that limit the use of additional debt and constrain managers actions.
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