CHAPTER 1

AN OVERVIEW OF FINANCIAL
MANAGEMENT AND THE
FINANCIAL ENVIRONMENT

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 1-1. The Five-Minute Business
Degree
• Two main goals of all successful companies:
– Having products or services highly valued by
customers
– Selling products/services at prices high enough to
cover costs and reward investors
• The key attributes of successful companies:
– Having skilled people
– Having strong external relationships
– Having sufficient capital

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 1-2. The Corporate Life Cycle
• Structures of business organizations:
– Sole proprietorship
– Partnership
– Corporation

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1-2. Starting up as a Proprietorship
• Advantages:
– Ease of formation
– Subject to few regulations
– No corporate income taxes
• Disadvantages:
– Difficult to raise capital to support growth
– Unlimited liability
– Limited life span
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1-2. Starting as, or Growing into, a
Partnership
• A partnership involves two or more entities
with various privileges and responsibilities.
– General vs. limited partner
– Limited liability partnership (LLP)

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 1-2. Becoming a Corporation
• A corporation is a legal entity separate from its
owners and managers.
• File papers and prepare reports with
Corporations Canada.
– Articles of incorporation
– Bylaws
– http://www.bizfilings.com/comparison.aspx
– C-Corporation, S- corporation
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1-2. Advantages and Disadvantages of
a Corporation
• Advantages:
– Unlimited life
– Easy transfer of ownership
– Limited liability
– Ease of raising capital
• Disadvantages:
– Double taxation
– Higher setup cost
– Endless report filing
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 1-2. Special Types of Corporations
• Professional corporations (PCs)
– For professionals such as doctors, lawyers, and
accountants
• Income trusts
– Created to distribute all of a business’s free
cash flow to investors in a tax-efficient manner
– Appropriate for businesses with stable cash
flows and not requiring significant capital
expenditures
– Allowable only for real estate (REIT) now
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1-2. Growing and Managing a Corporation
• have products/services that attract customers, a
corporation must attract investors.
– Raise equity capital issuing new stock (IPO)

– Borrowing from banks, and issuing bonds and

additional shares
• Separation of ownership and management
– Agency problem
– Corporate governance

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1-3. What Should Be Management’s
Primary Objective?
• The primary objective should be shareholder
wealth maximization, which translates to
maximizing the fundamental share price, not just
the current market price.
– Should firms behave ethically? YES!
• Business ethics are a company’s attitude and
conduct toward its employees, customers,
community, and shareholders.

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 1-3. Stock Price Maximization and
Social Welfare
• Do firms have any responsibilities to society at
large? Yes!
• Unethical behaviour destroys public trust and
confidence.
• Maximizing share price is good for society.
Why?
• Shareholders are also members of society.

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1-3. Is Maximizing Stock Price Good
for Consumers?
• To maximize stock price, corporations have to
produce and deliver high-quality goods and
services at the lowest possible cost to
consumers.
• Consumers can improve quality of life by their
direct or indirect investments in the stock
market.

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 1-3. Is Maximizing Stock Price
Good for Employees?
• Employment growth is higher in firms that try
to maximize stock price. On average,
employment goes up in:
– Firms that were previously owned by the
government but that have been sold to
private investors.

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1-3. Managerial Actions to Maximize
Shareholder Wealth
• Improve a firm’s ability to generate cash flows
now and in the future by focusing on:
– The amount of expected cash flows (bigger is
better).
– The timing of the cash flow stream (sooner is
better).
– The risk of the cash flows (less risk is better).

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 1-3. Free Cash Flows (FCF)
• FCF are cash flows available (or free) for
distribution to all investors (stockholders and
creditors).
• FCF = sales revenues – operating costs –
operating taxes – required investments in
operating capital.
• There are many ways firms can increase free
cash flows.

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 1-3. Weighted Average Cost of Capital (WACC)
• In addition to FCF, another factor of determining a
firm’s value and its long-term stock price is WACC.
• WACC is the average rate of return required by all
of the company’s investors.
• WACC is affected by:
– Capital structure
(the firm’s relative amounts of debt and equity)
– Interest rates9
– Investors’ overall attitude toward risk

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 The Big Picture
• A manager’s primary job is to increase the firm’s
intrinsic value.
• Intrinsic value: The present value of the firm’s
expected free cash flows (FCF), discounted at
WACC
• Two approaches to increasing intrinsic value:
– Improve FCF and/or
– Reduce WACC
• You are to learn tools used to make decisions to
increase intrinsic value.
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