Chapter One
An overview of Managerial Finance
What is Finance
 Finance is the application of economic
principles
 Finance is the art and science of managing
money
 Finance is concerned with the process of
money transfer between the various
economic units ( individuals, households,
businesses and governments).
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Corporation:
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A legal entity created by a state
Separate and distinct from it’s owners and
managers.
Management is separated from owners
Incorporation : is the process by which a
company receives a state charter allowing
it to operate as a corporation.
Articles of incorporation: document filed
with a state or government by the founders
of a corporation.
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Advantages of Corporations
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Limited liability
Large capital could be obtained
Ownership easily transferred
Unlimited life.
Can easily raise money in the financial
market.
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Disadvantages of Corporations
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Double taxation
Subject to greater government regulation
Expensive and complex to form.
Setting up a corporation could be time
consuming.
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Finance in the organizational structure of the firm
Board of Directors
President
CEO
Vice President
Vice President
Finance
CFO
Treasurer
Vice President
Vice president
Controller
Credit Manager
Tax Dept
Inventory Manager
Cost Acc.
Director of capital budgeting
Finan. Acc.
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Responsibilities of Financial Management
Main responsibility is to make decisions
concerning the acquisition and use of
funds for the greatest benefit of the firm
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Financial Managers Activities
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Forecasting and planning
Making investment decisions
Making financial decisions
Coordination and control
Dealing with the financial markets
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Goals of Corporation
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The Main goal of corporations is maximizing
shareholders wealth ( maximizing the value of the
firm) by maximizing the price of the firm’s stock.
Managerial Incentives to Maximize Shareholder
Wealth:
Besides wealth and dividend maximization objectives,
managers may pursue other objectives such as higher
executive salaries and employee benefits. However,
competitive forces generally require managers to
make attempts to maximize shareholders wealth. If
they don't, then managers risk loosing their jobs.
Social responsibility; May include welfare of the
employees, customer satisfaction and the community
at large.
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Goals of Corporation…………cont.
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Ethical Responsibility ;providing safe working
environment, avoid polluting the air and to produce safe
products.
Socially responsible actions have costs and firms which act
in a a socially responsible manner ,while others do not ,will
be at a disadvantage in attracting funds.
Cost –increasing actions associated with social
responsibility will have to be put on a mandatory rather
than a voluntary basis to ensure that the burden falls
uniformly on all businesses and to maintain fair
competition.
Stock price maximization and social welfare: Most actions
that help a firm increase the price of its stock also are
beneficial to society at large.
Most executives believe that there is a positive correlation
between ethics and long run profitability of the firm !!!! 9
Managerial Actions to Maximize Shareholder Wealth
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Management’s decisions can significantly affect
the firm’s value.
Managers can increase the value of a firm by
making decision that :
- Increase the level of expected future cash flows
(CFs)
- Generate the expected (CFs) sooner (The timing
of CFs)
- Increase the certainty of the expected CFs.
(riskiness of CFs)
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Managerial Actions to………cont
Decisions about expected CFs include :
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Capital structure decisions : how much and what
type of debt and equity should be used to finance
the firm?
 Capital budgeting decisions : what type of assets
should be purchased to help generate future CFs?
 Dividend Policy decisions: How much of current
earnings to pay out as dividends rather than to
retain for reinvestment in the firm
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Managerial actions……………..cont
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Given external factors and constraints such as ;
the legal constraints, level of economic activity,
tax laws and stock market conditions,
management makes a set of long-run strategic
policy decisions that chart a future course for the
firm.
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Should Earnings Per Share (EPS) be maximized?
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Financial managers who attempt to maximize
earnings might not maximize value.!!
Earnings maximization is a short-sighted goal
as it does not consider the timing of earnings
nor the firm’s future risk position.
N.B (EPS= NI divided by the numbers of shares
outstanding)
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The firm’s stock price and thus its value is
dependent on: its future expected cash flows,
the timing of the CFs and the risk associated
with such CFs.
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Agency Relationships
Agency relationship exist when one or more
persons (The principals) hire another person (The
agent) to act on their behalf.
In corporations ,important agency relationship exist :
 Between stockholders and managers, and
 Between stockholders and creditors
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Agency Problems
Shareholders versus managers :
 Management is separate from ownership
 Agency problem arises when a manager own less
than 100%of the co.’s ownership
 Managers may make decisions that are not in line
with the goal of maximizing stockholders wealth (
may work less eagerly and tend to benefit
themselves in terms of salary and perks)
 Agency costs: Are costs associated with agency
problem such as reduced stock price and “perks”
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Mechanisms Used To Ensure That Managers Act In The
Shareholders Best Interest
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Managerial compensation (Incentives) plans: include
giving management performance shares, stock options or
restricted stock grants.
The proper structuring of managerial incentives( All
incentive compensation plans are designed to provide
inducements to management to act in a manner that will
contribute to stock price maximization as well as to
attract and retain top-level executives )
The threat of firing.
Shareholders intervention ( institutional shareholders
with large stakes in the firm)
The threat of takeover ( in a hostile takeover, the
managers of the acquired firm generally are fired)
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Tactics That Managers Can Use To Ward Off a Hostile
Takeovers :
Hostile takeover : takeover of a company against the wishes of
current management and the board of directors.
 Tactics used by management include:
- Scorched earth policy: technique used by a takeover- target
company to make itself unattractive to the acquirer.e.g it may agree
to sell off the most attractive parts of its business (Crown Jewels) or
it may schedule all debt to become due immediately after a merger.
- Poison Pill ; A move by a take over target company to make its
stocks less attractive to an acquirer.e.g issue a new series of
preferred stock that gives shareholders the right to redeem it at a
premium price after a takeover.
- Greenmail (Bon Voyage Bonus); payment of a premium to a raider
trying to take over a company through a proxy contest or other
means.
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Agency Problems……………..cont
Stockholders Versus Creditors
Creditors lend the firm at a certain interest rate based
on expectations regarding the factors that determine
the riskiness of the firm’s expected cash flows, such
as:
 The riskiness of the firm’s existing assets
 The riskiness of future asset additions
 Present capital structure.
 Expected capital structure
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Stockholders Versus Creditors…..cont.
Conflict develops if;
- Managers , acting in the interest of
shareholders, take on projects with a
greater risk than creditors anticipated.
-Raise the debt level higher than was
expected.
* The above actions tend to reduce the value of debt
outstanding.
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Agency Problem……………..cont.
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The goal of maximizing shareholders wealth
require fair play with the creditors and other
stakeholders !!
Managers as agents of both the creditors and
stockholders ,must act in a manner that is
fairly balanced between the interest of these
two classes of security holders
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Stakeholders
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Individual or entities that have interest in the
well-being of a firm such as:
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Stockholders
Creditors
Employees
Customers and
Suppliers
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Forms of businesses in other countries
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In the US : corporations are “open" companies, are publicly
traded and independent of each other and of the government.
In England & Canada: most large companies are “open" and their
stocks widely dispersed among different investors . However two
thirds of the traded stocks in England are owned by institutional
investors.
In much of Continental Europe stock ownership is more
concentrated. investor groups include families, Banks and other
corporations.
In Japan & S.Korea firms belong to industrial groups These are
organizations comprise of companies in different industries with
common ownership interest which include firms necessary to
manufacture and sell industrial products (a network of
manufacturers,suppliers,retailers etc) examples are
Toyota,Toshiba……
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