1-0

CHAPTER 1
An Overview of Financial Management

Role 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.

1-1

What three questions does financial management seek to answer? What causes a company to have a particular stock value?
How can managers make choices that add value to their companies? How can managers ensure that their companies dont run out of cash while executing their plans?
Copyright 2002 by Harcourt, Inc. All rights reserved.

1-2

Career Opportunities in Finance

Institutions and capital markets Investments

Financial management

Copyright 2002 by Harcourt, Inc.

All rights reserved.

1-3

Alternative Forms of Business Organization Sole proprietorship Partnership

Corporation

Copyright 2002 by Harcourt, Inc.

All rights reserved.

1-4

Sole Proprietorship
Advantages: Ease of formation Subject to few regulations No corporate income taxes Disadvantages: Limited life Unlimited liability Difficult to raise capital
Copyright 2002 by Harcourt, Inc. All rights reserved.

1-5

Partnership

A partnership has roughly the same advantages and disadvantages as a sole proprietorship.

Copyright 2002 by Harcourt, Inc.

All rights reserved.

1-6

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.

1-7

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.

1-8

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
Copyright 2002 by Harcourt, Inc. All rights reserved.

1-9

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.

1 - 10

Factors that Affect Stock Price

Amount of cash flows expected by shareholders Timing of the cash flow stream Risk of the cash flows

Copyright 2002 by Harcourt, Inc.

All rights reserved.

1 - 11

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.

1 - 12

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.

1 - 13

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.

1 - 14

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
Copyright 2002 by Harcourt, Inc. All rights reserved.

1 - 15

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
Copyright 2002 by Harcourt, Inc. All rights reserved.

1 - 16

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.