Chapter 1
An Overview of
Managerial
Finance
© 2005 Thomson/South-Western
Career Opportunities in
Finance
 Financial Markets and Institutions
 Investments
 Managerial Finance
2
Managerial Finance
in the Twentieth Century
 Business globalization
 Information technology
 Regulatory attitude of the government
 Prosperous economy = business friendly
 Poor economy = consumer/investor friendly
3
Alternative Forms of
Business Organization
 Proprietorship
 71% of all businesses
 90% have assets under $100,000
 Partnership
 9% of all businesses
 Corporation
 20% of all businesses
 85% of all dollar value of sales
4
Proprietorship
 Advantages:
 Ease of formation
 Subject to few government regulations
 No corporate income taxes
 Limitations:




Unlimited personal liability
Difficult to raise capital
Transferring ownership is difficult
Limited life
5
Partnership
 Like a proprietorship, except two or
more owners
 A partnership has roughly the same
advantages and limitations as a
proprietorship
6
Corporation
 Advantages:




Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
 Disadvantages:
 Double taxation
 Earnings taxed at corporate level
 Dividends taxed as income to stockholders
 Cost of set-up and report filing
7
Finance in the Organizational
Structure of the Firm
Board of Directors
President
Vice-President:
Sales
Vice-President:
Operations
Treasurer
Credit
Manager
Inventory
Manager
Director of
Capital
Budgeting
Vice-President:
Finance
Vice-President:
Information Systems
Controller
Cost
Financial
Tax
Accounting Accounting Department8
The Financial Manager’s
Responsibilities
 Forecasting and planning
 Major investment and financing decisions
 Coordination and control
 Dealing with financial markets
9
Goals of the Corporation
 Primary goal:
maximize stockholder wealth
= maximize stock price
 Managerial incentives
 controlled by competitive forces
 Social responsibility
 must be mandated initially to reduce
disadvantages
 Stock price maximization and social welfare
 Maximizing stock = benefiting society
10
Managerial Actions to
Maximize Stockholder Wealth
 Capital Structure Decisions
 How much and what types of debt and equity should be
used to finance the firm?
 Capital Budgeting Decisions
 What types of assets should be purchased to help generate
cash flows?
 Dividend Policy Decisions
 What should be done with net cash flows generated by the
firm—reinvest or pay dividends?
11
How Manager’s Actions Affect
Stock Price
 Projected earnings per share
 Net Income/# of shares
 Timing of earnings streams
 The sooner the better
 Riskiness of projected earnings
 The safer the better
 Use of debt (capital structure)
 Dividend policy
12
Value of the Firm
Market Factors/Considerations
Economic Conditions
Government Regulations and Rules
Competitive Environment
Firm Factors/Considerations
Normal Operations
Financing Policy=Capital Structure
Investing Policy=Capital Budgeting
Dividend Policy
Investor Factors/Considerations
Income/Savings
Age/Lifestyle
Interest Rates
Risk Attitude
Net Cash Flows, CF
Rates of Return, k
Value of the Firm
=
^ +
CF
1
(1+k)1
N
^
^
^
CF2 + . . . + CFN = CF
t
(1=k)2
(1+k)N
t=1
(1+k)t
13
Agency Relationships
 An agency relationship = when a principal
hires an agent to act on their behalf
 Within corporations, agency relationships
exist between:
 Stockholders and managers
 Stockholders and creditors
14
Stockholders versus Managers
 Managers are naturally inclined to act in their
own best interests.
 But the following factors affect managerial behavior:
 The threat of firing
 The threat of takeover
 Structuring managerial incentives
 Performance Shares
 Executive Stock Options
 Restricted Stock Grants
15
Stockholders versus Creditors
 Stockholders (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.
16
The External Environment
Summary of Major Factors Affecting Stock Prices
External
Constraints:
1. Antitrust Laws
2. Environmental
Regulations
3. Product and
Workplace Safety
Regulations
4. Employment
Practices Rules
5. Federal Reserve
Policy
6. International
Developments
Strategic Policy
Decisions Controlled
by Management
1. Types of Products
and Services
Produced
2. Production Methods
Used
3. Relative Use of Debt
Financing
Level of Economic
Activity and
Corporate Taxes
Stock Market
Conditions
Expected
Profitability
Timing of Cash
Flows
Stock Price
Degrees of Risk
4. Dividend policy
17
Business Ethics
 Webster: “A standard of conduct and moral
behavior.”
 Business Ethics: A company’s attitude and conduct
toward its employees, customers, community, and
stockholders
 Sarbanes-Oxley Act of 2002
 accounting standards
 How is ethical behavior profitable?
18
Forms of Business in
Other Countries
 U.S. firms have a more dispersed ownership = “open”
 Non-US firms have higher concentrations of ownership
 Many firms are not publicly traded
 Less ownership by individuals
 Nature of relationship with financial institutions differs from U.S.
 Banks are less regulated
 Banks can finance large companies, keeping them private
 Shareholders assign banks their proxy votes for the directors of
companies
19
Multinational Corporations
Firms that operate in two or more countries
Five reasons firms go “international”
1.
2.
3.
4.
5.
To seek new markets—e.g., Coke
To seek raw material—e.g., Exxon Mobil
To seek new technology—e.g., Xerox
To seek production efficiency—e.g., GM
To avoid political and regulatory hurdles—
20
e.g., Honda, Nissan, Toyota
Factors Distinguishing Domestic
Firms from Multinational Firms
1.
2.
3.
4.
5.
6.
Different currency denominations
Economic and legal ramifications
Language differences
Cultural differences
Role of governments
Political risk
21
Next Class
Homework: Chapter 1 questions
22