THE CORPORATION
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Legal entity created to sell goods and/or
services.
Owned by shareholders who purchase
its stock.
Possible returns to shareholders:
– 1) dividends
– 2) stock price appreciation
FINANCE DECISIONS
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Investment
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Financing
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Dividend
Investment
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What assets does the company need to
accomplish its mission?
Buildings, machinery, equipment? (Ch 7
and Ch 8)
Cash, accounts receivable, inventory?
(Ch 9)
Financing
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How should firm’s assets be financed?
Liabilities (debt) or Equity (selling new
stock or reinvesting profits)?
What is best mix of debt and equity?
Valuation (Ch 5); Cost of Capital (Ch 6)
Dividend
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What to do with Earnings After Taxes
(profit, net income)?
Pay dividends to stockholders?
Reinvest into company (retained
earnings)?
Some combination of both?
Goal of Financial Management
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Most people would say goal is to
maximize profits
Profits when? - this quarter, this year,
next 5 years…
Which measure of profit to use? - net
income, income before extraordinary
items, EPS…
Better Goal
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Who owns firm?
Stockholders.
Why do they buy stock?
To gain financially when stock price
goes up (buy low, sell high)
Goal: MAXIMIZE STOCK PRICE
Advantages of Stock Price
Maximization as a Goal
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Easy to measure
Readily available
Provides immediate feedback on how
market values decisions of firm’s
managers
Disadvantage of Stock Price
Maximization as a Goal
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Majority of stocks owned by institutional
investors
Managers of institutional funds push for
short-term returns
When corporate managers focus on
short-term stock price maximization,
they may make decisions harmful to the
corporation in the long-run.
Examples of Institutional
Investors
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Mutual Funds
Hedge Funds
Private Equity Funds
Sovereign Wealth Funds
Pension Plans
Insurance Companies
Endowment Funds
Stakeholders in a corporation
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Shareholders (individuals + institutions)
Employees, including managers
Customers
Suppliers
Community
Creditors
Government
Stakeholder Theory
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Says that managers should make
decisions that maximize interests of all
stakeholders
Example: UAW got BIG 3 Auto Makers
to give big concessions in 1970s
Look how that turned out in long-run for
everyone!
Agency Theory
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Managers are agents of stockholders
(principal)
Managers sometimes act in own
interest instead of stockholders’
Adelphia, Enron, Global Crossing,
Qwest, Tyco, WorldCom, to name a few
Agency costs – making sure that
managers are acting appropriately; e.g.
auditing
Long-term Decision Making
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All stakeholders, including employees,
managers, and stockholders, have an
interest in the continued operation of a
corporation
Managers should make decisions that
maximize stock price in the long-run
Taking the long view benefits all
stakeholders
3 Steps to Follow in Making
Financial Decisions
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Estimate impact of decision on future
cash flows
Adjust future cash flows for time value
of money (Ch 3)
Adjust future cash flows for risk (chance
that actual cash flow will not be what is
expected) (Ch 4)
Where We Are Headed
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Ch 2: Overview of Financial Markets
Ch 3: Time Value of Money
Ch 4: Risk
Ch 5 and Ch 6 – Financing Decision
Ch 7, 8, 9 – Investment Decision
Ch 10 – Financial Statement Analysis
Ch 11 – Financial Planning