Contemporary Financial
Management, 9th Edition
by
Moyer, McGuigan, Kretlow
Instructor: Wen-I Chuang
Copyright ©2003 South-Western/Thomson Lea
Chapter
1
The Role and Objective of
Financial Management
Copyright ©2003 South-Western/Thomson Learning
Introduction
• This chapter introduces the financial
management process of the typical
firm. It looks at the financial manager,
the field of finance, financial
decisions and their implications, and
the daily questions faced by the firm’s
financial management.
Questions Faced in Finance
• How is finance related to other fields of
study?
• What are financial managers’ goals
and objectives?
• How has the finance field evolved?
• How is the finance field changing
today?
• More questions are listed in the text.
Principal Forms of Business
Organizations
• Sole proprietorship
• Partnership
• Corporation
Sole Proprietorship
•
•
•
•
Owned by one person
Easy formation → advantage
Unlimited liability → disadvantage
Difficulty raising funds
→ disadvantage
• Represent 75 percent of all
businesses
• Account for less than 6% of the dollar
volume
Partnership
• Owned by two or more persons
• Classified as general or limited
– General Partner: Has unlimited liability for
all obligations of the business →
disadvantage
– Limited Partner: Liability limited to the
partnership agreement → advantage
• Partnership dissolves when a general
partner dies. → disadvantage
Corporation
• Limited liability
• Flexibility
• Permanency
• Legal entity
• Ability to raise capital • Easy marketability
of shares of
ownership
• Has a board of
directors
• Owners are
stockholders
All advantages
Board of Directors
• Stockholders elect a board of directors
• Board of directors then elect the officers
–
–
–
–
–
–
–
–
Chairman of the board
Chief executive officer (CEO)
Chief operating officer (COO)
President
Chief financial officer (CFO)
Vice presidents
Treasurer
Secretary
Management
Who Manages?
• Board of
directors deals
with broad policy
• Management
makes most of the
decisions
• 3 to 5 year
strategic plan
• Day-to-day
decisions following
the strategic plan
Stockholder Rights
• Dividend
• Voting
• Asset
• Preemptive
Priority of Corporate Securities
Bonds
(highest)
Preferred stock
Common stock (C/S)
Major corporate Web sites
http://www.ford.com/
http://www.gm.com/
http://www.porsche.com/
(lowest)
Optimal Form of Organization
Influenced by
• Cost
• Complexity
• Liability
• Continuity
• Raising capital
• Decision making
• Tax considerations
Shareholder Wealth Maximization
Objective of
financial
management
Shareholder
Wealth
Maximization
(SWM)
Objective of the
financial manager
NOT
Profit maximization,
which does not consider the
time value of money
Shareholder Wealth Maximization
• 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
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
Agency Relationships/Problems
• Problem
created by
separation of
Owners (shareholders)
Management and
Employees
• Management may maximize
its own welfare instead
of the owners’ wealth.
Job security
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 and/or lower cost
– Why? If a change is made management
will be scrutinized, but if no change is
made, the issue will be ignored.
Agency Costs
•
•
•
•
Management incentives
Monitor performance
Owners protection
Complex organization structures
Recent Trends
Flatten organization structures to cut costs
Problems
Problem created by
separation of
Owners
Management
Owners
A similar problem
Creditors
Protective covenants
in loan agreements
Problems
• Creditors have a fixed financial claim on
the company’s resources in the form of
long-term debt, bank loans, commercial
papers, lease, accounts payable, taxes
payable, and so on.
Examples of Protective Covenants
• Limitations on
– common stock dividends
– the type of investments
– divestitures
– additional debts
– poison puts: A “poison puts” is an option
contained in a bond indenture that permits
the bondholder to sell the bond back to the
issuing company at face value under certain
circumstances, such as a leveraged buyout
that raises the risk for existing debt holders.
Shareholder Wealth Maximizing Is
a Market Concept and Results in
• Maximizing PV of E(R)
• Measured by Market Value of Common
Stock (C/S)
Three Basic Factors Determine
C/S Market Value
• 1) Amount of
• 2) Timing of
• 3) Risk of
Expected cash flows
Conditions Affecting Market Value
• Economic environment factors
• Decisions under management control
• Conditions in financial markets
• Expected cash flows
Cash Flow Concept Used for
• Financial analysis
• Planning
• Resource allocation
CF does not equal accounting profit
Internal sources
Cash
• Please see Figure 1.2
External sources
Competitive Forces Influencing
C/S Market Value
• New entrants
• Substitute products
• Bargaining power of buyers
• Bargaining power of suppliers
• Rivalry among current competitors
NPV of an Investment
• NPV = present value of future cash
flows minus initial cash outlays
• The NPV of an investment made by a
firm represents the contribution of that
investment to the value of the firm and,
accordingly, passes on to SWM.
Different Size Businesses
Small Business
vs.
Large Corporations
Fundamental concepts are the same
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
Controller’s Activities
• Financial accounting
• Cost accounting
• Taxes
• Data processing
Treasurer’s Activities
• Management of cash and marketable
securities
• Capital budgeting
• Financial planning
• Credit analysis
• Investors relations
• Pension fund management
Disciplines Impacting Finance
Economics
Accounting
Marketing
Production
Human Resources
Quantitative Analysis
MIS
Please see Figure 1.4
Finance
Professional Organizations
• Financial Executive Institute
• Institute of Charted Financial Analysis
• Financial Management Association
• Institute of Management Accounting
Exciting Career Opportunities
• VP of Finance
• Financial Analyst
• Director Investor
Relations
• Account Executive
Security Broker
• Assistant Treasurer • Mortgage Analyst
• Tax Manager
• Banking
Check out http://www.careerpath.com/