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CHAPTER 1
An Overview of Financial Management
Career opportunities
Forms of business organization
Goals of the corporation
Issues of the new millenium
Agency relationships

Copyright 2002 by Harcourt, Inc. All rights reserved.

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Career Opportunities in Finance

Institutions and capital markets

Investments
Financial management

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Alternative Forms of
Business Organization

Sole proprietorship
Partnership
Corporation

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Sole Proprietorship

Advantages:
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages:
Limited life
Unlimited liability
Difficult to raise capital
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Partnership

A partnership has roughly the same

advantages and disadvantages as a
sole proprietorship.

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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
Copyright 2002 by Harcourt, Inc. All rights reserved.
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Goals of the Corporation

The primary goal is shareholder wealth

maximization, which translates to
maximizing stock price.
Should firms behave ethically? YES!
Do firms have any responsibilities to
society at large? YES! Shareholders
are also members of society.

Copyright 2002 by Harcourt, Inc. All rights reserved.

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Is maximizing stock price good for
society, employees, and customers?

Employment growth is higher in firms

that try to maximize stock price. On
average, employment goes up in:
firms that make managers into
owners (such as LBO firms)
firms that were owned by the
government but that have been sold
to private investors
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Consumer welfare is higher in

capitalist free market economies
than in communist or socialist
economies.
Fortune lists the most admired firms.
In addition to high stock returns,
these firms have:
high quality from customers view
employees who like working there

Copyright 2002 by Harcourt, Inc. All rights reserved.

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Factors that Affect Stock Price

Amount of cash flows expected by

shareholders
Timing of the cash flow stream
Risk of the cash flows

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Three Determinants of Cash Flows

Sales
Current level
Short-term growth rate in sales
Long-term sustainable growth rate in
sales
Operating expenses
Capital expenses

Copyright 2002 by Harcourt, Inc. All rights reserved.

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Factors that Affect the Level and
Risk of Cash Flows
Decisions made by financial
managers:
Investment decisions (product
lines, production processes,
geographic market, use of
technology, marketing strategy)
Financing decisions (choice of debt
policy and dividend policy)
The external environment
Copyright 2002 by Harcourt, Inc. All rights reserved.
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Financial Management
Issues of the New Millenium

Use of computers and electronic

transfers of information
The globalization of business

Copyright 2002 by Harcourt, Inc. All rights reserved.

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Agency Relationships

An agency relationship exists

whenever a principal hires an agent
to act on his or her behalf.
Within a corporation, agency
relationships exist between:
Shareholders and managers
Shareholders and creditors

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Shareholders versus Managers

Managers are naturally inclined to act

in their own best interests.
But the following factors affect
managerial behavior:
Managerial compensation plans
Direct intervention by shareholders
The threat of firing
The threat of takeover
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Shareholders versus Creditors

Shareholders (through managers)

could take actions to maximize
stock price that are detrimental to
creditors.
In the long run, such actions will
raise the cost of debt and
ultimately lower stock price.

Copyright 2002 by Harcourt, Inc. All rights reserved.