Contemporary
Financial Management
8th Edition
by
Moyer, McGuigan, and Kretlow
Prepared by
Tom Peacock
University of Houston
© 2001 South-Western College Publishing
Chapter 1
The Role and Objective
of
Financial Management
Questions Faced in Finance
How is finance related to other fields of
study?
What are the goals and objectives of
financial managers?
How has the finance field evolved?
How is the finance field changing today?
3
Principal Forms of Business
Organizations
Sole proprietorship
Partnership
Corporation
4
Sole Proprietorship
Owned by one person
Easy formation
advantage
Unlimited liability
disadvantage
Difficulty raising funds disadvantage
Represent 75% of all businesses
Account for < 6% of the $ volume
5
Partnership
Owned by two or more persons
Classified as general or limited
Partnership dissolves when a general
partner dies
6
Liability of Partners
General Partner
Has unlimited liability for all obligations of the
business
Limited Partner
Liability limited to the partnership agreement
7
Corporation
 Limited liability
 Legal entity
 Permanency
 Have a board of
 Flexibility
directors
 Owners are
stockholders
 Easy marketability of
shares of ownership
 Ability to raise of
capital
8
Stockholders
elect a board
of directors
Board of
directors
then hire
management
( officers )
9
Who Manages ?
 Board of directors
deals with broad
policy
 Management makes
most of the decisions
10
Stockholder Rights
Dividend
Asset
Voting
Preemptive
Corporate Securities
in Order or Priority
Bonds
Preferred stock
Common stock ( C/S )
( highest)
( lowest )
11
Optimal Form of Organization
Influenced by
 Cost
 Raising capital
 Complexity
 Decision making
 Liability
 Tax considerations
 Continuity
12
Objective
of
Financial Management
( FM )
Objective of the
financial manager
Shareholder
Wealth
Maximization
(SWM)
NOT
profit maximization
Does not consider
time value of money
13
SWM
Considers the timing and risk of the benefits
from stock ownership
Determines that a good decision increases
the price of the firm's common stock (c/s)
Is an impersonal objective
Is concerned for social responsibility
14
Social Responsibility
Ethical issues will constantly confront
financial managers as they achieve the goal
of the firm ( SWM ).
Managers Must
Avoid personal conflicts
Maintain confidentiality
Be objective
Act fairly
15
Agency Relationships / Problems
Owners (shareholders)
 Problem created
by separation of
Management and
Employees
 Management may maximize
its own welfare instead
of the owners wealth
Job security
16
Job Security
Management decisions based on retaining
management rather than SWM
Example–A decision to retain suppliers
rather than selecting new suppliers
providing higher quality or lower cost
Why–If the transition is mishandled
management will be scrutinized but if no
change is made the issue will be ignored
17
Agency Costs
Management incentives
Monitor performance
Owners protection
Complex organization structures
Recent Trends
To flatten organization structures to cut costs
18
Problem created by
separation of
Owners
Management
Owners
A similar problem
Creditors
Protective covenants
in loan agreements
19
Examples of Protective Covenants
Limitations of Common stock dividends
Limitations on additional debts
Not entering into sale and lease back
arrangements
20
Shareholder Wealth Maximizing Is a
Market Concept and Results in
Maximizing PV of E(R)
Measured by Market Value of C/S
21
3 Basic Factors Determine
C/S Market Value
1) Amount of
2) Timing of
Expected cash
flows
3) Risk of
22
Conditions Affecting Market Value
Economic environment factors
Decisions under management control
Conditions in financial markets
Expected cash flows
23
Competitive Forces Influencing
C/S Market Value
New entrants
Substitute products
Bargaining power of buyers
Bargaining power of suppliers
Rivalry among current competitors
24
Cash Flow Concept Used for
Financial analysis
Planning
Resource allocation
CF does not equal accounting profit
Cash
Internal sources
External sources
25
NPV of an Investment
NPV = PV of future cash flows
minus cash outlays
The NPV of an investment
represents the contributions of
that investment to the value of
the firm and passes on to SWM
26
Different Size Businesses
Small Business
Vs.
Large Corporations
Fundamental concepts are the same
27
Small Business
 Not the dominant firm in the industry
 Tend to grow more rapidly
 Limited access to financial market
 Lack management resources
 Have a high failure rate
 Stock is not publicly traded
 Poorly diversified
 Owner/manager frequently the same
28
Controller’s Activities
Financial accounting
Cost accounting
Taxes
Data processing
29
Treasurer’s Activities
Management of cash and marketable
securities
Capital budgeting
Financial planning
Credit analysis
Investors relations
Pension fund management
30
Disciplines used in Finance
Finance
Economics
Accounting
Marketing
Production
Human Resources
Quantitative Analysis
31
Professional Organizations
Financial Executive Institute
Institute of Charted Financial Analysis
Financial Management Association
Institute of Management Accounting
32
Exciting Career Opportunities in
Finance
VP of Finance
Financial Analyst
Director
Account Executive
Investor Relations
Assistant Treasurer
Tax Manager
Security Broker
Mortgage Analyst
Banking
33