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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
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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 don’t run out of
cash while executing their plans?
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Career Opportunities in Finance
Institutions and capital markets
Investments
Financial management
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Alternative Forms of
Business Organization
Sole proprietorship
Partnership
Corporation
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Sole Proprietorship
Advantages:
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages:
Limited life
Unlimited liability
Difficult to raise capital
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Partnership
A partnership has roughly the same
advantages and disadvantages as a
sole proprietorship.
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Corporation
Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Double taxation
Cost of set-up and report filing
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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.
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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
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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
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Factors that Affect Stock Price
Amount of cash flows expected by
shareholders
Timing of the cash flow stream
Risk of the cash flows
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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
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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
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Financial Management
Issues of the New Millenium
Use of computers and electronic
transfers of information
The globalization of business
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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
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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
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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.
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