Chapter 1 The Role of Managerial FinanceLearning Goals Define Finance and the managerial finance function Describe the Tegal forms of business organizatfon Describe the goal of the firm, and explain why maximizing the value of @ firm is an appropriate goal for a business Describe how the managerial finance function is related to eonomics and and accounting Identify the primary activities of the financial manager Describe the nature of the principte-agent relationship between ovners and managers of a corporation, and explain how various corporate governance echanisns attempt to menage agency preblensNotes Definition of Finance and the Managerial Finance Function Foes the sttace and at of managing money. Al individuals at organzations earn ose ‘money. Finances conceme with the proces, station, mates, and iastrmensivelved it te tansfer of money among and between inivdaals businesses, and government (Career opportunites in finance en be beoen down int two boa are 1 Financial sevice deal withthe design and delivery of avice and aan products to ‘ndivdaas, business, ani goverament Career cpportnies comer en banking, nail planing investment, elect, and insurance 2 Managerial finance is concerned with the duties ofthe financial manager working ina bosines. Tho financial manage is responsible for sch asks as budgeting, Sania forecasting cash management, credit administration, investient analysis, and fads procurement Allmanages,regarless ofthc job descpions, usually have to provce financial jstifeation {rte resources they ned odo thei job: therefore studying managed faance is impor 0 all manager a4(Carers in Finance tome > Cars-nanee Careers in Finance 1 —> Ste nto Welcome to Careers In Finance! 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The pois fromm the sole ‘ropritrship are xed asthe owners pesonal income, andthe sole proprietor bas limited Tabi. 2. Partnerships are fred whe two or more individual entero a asines lationship fo the purpose of pros Like the sole proprietorship, partnerships aetaxed a the personal ‘income of each parr, according o tat partoc's percentage of oxnership,Parterships also Ive unlimited ability ote creditors ofthe busines. 5 Acorporstin i. form of business oranzation hits treated a a eparate legal entity fom tbe owners ofthe business. corporation cane and bese, be pry to contri, an engage in ny business function that would normaly be performed by ndvidoale. A ‘omporation hs limited aii. a that the owners’ wealth protec rom the corporation's ‘The owners of acoporton are ts socbolers, whose ownership is evidenced by either common cor prefered stock. Stockholders benefit from ether an appreciation ine val of ther shares or ‘om receipt of dvidends. The boards of decs ae elect by the ck and ae responsible for approving sustgic goals and pans, sting general poy, guiding export air and approving major expenditures.r+ _ potent sets Fs exerted song ol sown 9 sro) pum yunaGoals of the Firm ‘The goal of the financial mansger snot © maximise the profits ofthe finn, but to maximize the shareholders" wealth, Profit maximization fal to recognie the ining Of etn, cashflows, tnd Fisk The financial manager increases sareolder wealth by taking these sues into account 2. Taming af rerum: Because fim can ear eens on fund it receives, a dollar that is ‘eoeived sooner i much more valuble haa dolar tat is eceved tc. (Cash flows available stoctholders: Faaneil managers ould make decisions tht Ineretse the cash flows avalable tothe shareholders, Financia mangges can increase cash flows to the stoetholders by adopting plies that ead to increased dividends o increased stock peices. 3. Ritk ‘The financial manage should examine the trade-off tha exists between risk and rerun ‘he higher the risk ofa parla project, th higher he retumshoul bet the frm, Which leads increased cash ows forthe stoke Firs must lo includ the imterests of stakeholders aswell as shacholders. Stakeholders ae _roups such as employes, customers, supplier, reir, owners an ote who havea rec ‘sonomie Hak othe fs A~fk‘onyea oun uo uo 1oayjo ssasse_ |pue Apsouoy pue qoroyyo | uoneuosuT are SOUP Tranay sisar01u i es epjoupuog, -9q 89 s1s03) yom01g cn er Bunooyy jenuuy - wppeoa pxvog - sepjouyoo1s suaBouou ozrulxey On 29 OL ae uonoun,y aAnoalqy [eotssefD oy,Choose a Different Objective Function Firms can always focus on a different objective function Examples would include 1 maximizing earnings 15 maximizing revenues 1 maximizing frm size 1 maximizing market share 2 maximizing EVA 1c The key thing to remember is that these are intermediate objective functions. 1 To the degree that they are correlated with the ong term health ‘and value of the company, they work well 1 To the degree that they do not, the firm can end up with a isaster~~ Nick Dukakis, che financial manager of Nepeune Manufacturing, a produce: of imaroe engine components choosing between two invesments, Rotor tnd alee The following cable shows the EPS thar ech investment i expected C0 Inve overs yee ig he) lores Yor War Yous Teel ryan roads to tems ofthe profit maximization goa Valve would be prefered ever Rotor beet esas in higher otal earings per share over the 3-year evo ($5.00 EPS compared with $2.80 EP), ‘But does prof maximization lad tthe highest posible she price? Fer at leat thee seaons the answer offen mo. Fis, dining is importante. An ives ‘ment that provide lower pon the shoe an maybe preferable 0 one at ‘his higher profi he long ren. Second, profs an cash flows are nt ien- fas The prot thc firm epotiesimply an estimate of bow is doing. an ‘mae thr inflsence by many dlleeat accounting choices that frms make ‘when astmbling thei financial reports Cath low i more staghtforward Incase of the money flowing ita end ost of he company. Companies has to py tec ile with cath ot ering, 9 csh How is what aces most to fan- Ei managere Thi ek meters gent eal. A Gem tha eats a low but She pete might be more alae than anthem eh pro shat Mace 3 ‘ret del an therefor an be vey high or ery low a feet times). ‘Timing Because the fran earns rrm on fans secives the recep offi sooner rather than later i prefered. ln oat example inspite ofthe fact that the tal ‘ming from Rotor ae smullee than those from Vale, Rotor provides mach [enter earnings per shat inthe fee ear The larger ecm in Year 1 cold be Finest to povide pester rere earnings. com Flows Profits do not necessary resin cash Bows svallable to the stockholders. Thre iso guzante the the board of deters wil increase dividends when profits increase In ado, the accounting assumptions and teenigues that fim ‘opt can sometimes allow 2 fam to show a postive profi even when ts cash ‘utows exceed cash flows Turtermore, higher eanings do ne neces translate ino a higher eck price, Only when earnings increases are accompanied by increased fare cash ows i's igher tock pice expected. For example, frm with a high-quality rod so in very competi macker ould cease its earings by sg tly eeding its equipment maimenance expenditures. The firms expenses ‘rould be reduced hereby increasing profs Bcf the reduced maintenance 4‘esl in lower produce quay, the fem may impai its competitive postion, and ‘ss sok pie could drop as many welinfoomed invest sl the sock atc- ‘pation of lower future cash ows Ta his case, the earings increas wat am ‘nied by lower future cash Hows and therefore a lower ck pit, Rise roi maximization alo fils zo account for ssk—zhe hance that sual oat Gomes ay difer fom those expeced A basic promise ie managerial finance thaca cadeoff exis beeween tum (eas ow) ands Return ct, the key determinants of share price, ebch represent the ioalh ofthe ‘uners inthe frm, “Cash flow and isk afc share rice feeny: Holling risk ied bigher ‘ash low is genealy assisted wih high share price Incontrst holding ash flow fied higher tk ends to zs ina lower share pice because the stock holies do ao like rik, For example, Apple's CEO, Steve Job, tok aleve of sence ro bate serious health sss, andthe fis tock sled a ul ‘This ocated aoe beatae of ny nets cash low edn bu i pons 0 the firms increased rere hance ht the es lak of meen eae ship could rel in zedsced fore eth flows Siply gut the increased ak ‘ede the ir’ sharpie In general, rockholdes a sik vee hat ey ius be compensated for Bering sk. In other word investor expect o ear higher ers on ike investments, and they wil secep lowe etre on tl ‘rey sf inert : 4-40Relationship of Managerial Finance Function to Economics end Accounting People inal aces of responsiblity within the firm mus interact with nance personel and rcedures to get thi jobs done. Managerial finance has siniliies'o both economies ad cooing, Finance is closely related tothe el of economics, in that th financial manager must understand ‘sconomic theory and be avare ofthe consequences of varying levels ef economic activity and. ‘hangs in economic plicy, ‘The financial manager eis heavily on te economic pinipe Of ‘marginal cost-enefi anassis to make Gnanlal decisions Final managers use accounting DOL oncentaeon eat flows and decisionmaking. The ies of finance and uocouning ar closely elated in that bth ae concerned wi the éalelation and reporting of information tha els in measring the pecformance of «business and ‘ssesing its faacial postion. The main difference between the tw0felds is thatthe anc "manage must go one step fer and make decisions based om the scout’ financial data ‘bo, aecounans compute income wing generally accepted procedure, while financial managers foncetrate on cash ws, A-14Key Activities of the Financial Manager "The ols ofthe financial manager canbe broken down nto thee primary atts: 1. Perform financial analysis and planing 2. Make investment decisions 3. Make financing decisions Principle-Agent Relationships and Corporate Governance “The agency problem can be defied asthe likelihood that managers may place personal goals stead of corporate goals. There are two factors that Work to contain the agency problem. 1. Markt forces constantly monitor te weaknesses ofa fim, and any weakaeses that rise due to te agency problem il be comeced bythe ona forces. 2 Agen costs, bore bythe stockholders ofa company, attempt to prevent minimize the ‘agency problem. There are four main ies of ageney cos, 2 Monitoring expenditures Bonding expenditures & Opporuity costs 4. Structuring expenitres Corporate goverance refers othe rules, presses, and laws by which companies are operated. Corporate goveriance esto ruceor eliminate the piaciplo-agont problem by ying to ensue ‘manager imterest are alied with shareholder’ by approaches such as sracuring management ‘compensation to corespond with rm performance Incentive plans such a sack options rede agency costs by aligning managers interests mow closely to those of stockholes. Government regulation generally shapes the corporate govemance of al firms. The Sacbanes (Oxley Act of 2002 focuses on eliminating many dislosite and confit of inte problems that ‘were uncovered by the corporate mised of Int 1990s. Thi ct i the following: 1. estaishe an oversight board monitor the accounting indy 2. tightened anit regulations and contos 53. toughened peas agsins executives who commit corporate fad 4. strengibened sccounting disclosure requirements 5. estalsed bord structure and membesship zune 6. required instant closure of sock sales by corporat executives 11. increased security eguaton sutbority and badges for abies and investigators A~42yeULLOgUL yovar sexo ua [Sumpeaysrut ‘pur soyeisruy optaoad ayou sayy | 30 smou peq Aejaq ‘way 07 pen {yo poddu 108 ‘9q touted sisoo owI0S, Dev eee |Risi908 «+ sto ee] «+ | StHeFTOHANO] fOUOPY PUT SISO} [R1D0g 1UwOLITUsIS Staprowpfe0rs aAoge | syoSeueUL 190 sisoxonuy sTotp and sroSeunyy | (RN? THT OPEL {3U0IM 08 uD YA,chapter 2 ‘The Financial Narket Environment.Learning Goals Understand the role that financial institutions play in managerial finance Contrast the functions of financial institutions and Financial markets Describe the differences between the capital markets and the soney markets Understand the major regulations and regulatory bodies that a’fect Financial institutfons and markets Discuss bustness taxes and their importance in financial decistonsNotes ‘The Role of Financial Institutions in Managerial Finance ims can obtain funds from extemal sources in tee ways: |. Financial institutions serve as intermediaries, accepting savings and wansfering them to those ‘who ned funds 2. Financial markets, which are orgunized forums in which the supplies and demandes of varios types of funds can make transactions 3. Private plicemei isthe sl f a new security directly oan investor or group of investors “The net suppliers of funds are generally individuals ox households wh save mare money than they boro. Businesses and governments are generaly net demangers of funds meaning tha they borow more money th they sve ‘The major financial insintions inthe U.S economy ae commercial banks, savings an loans, edi unions, sevings banks, insurance companies, mul fans, and pension fend Investmeat ‘banks are institutions that asst ompaoies in using capital, advise fms on or transactions and engage in trading and market making advtes. The shadow banking system, which ere fn ‘he 19%, is when a group ofistitions engage in leading svi, hike wadional banks, bat do not aecepe deposits and therefore, rent subject f the same regulation a dona banks Contrast Functions of Financial Institutions and Financial Markets ‘Both nana institutions and financial masks help businesses raise the money they ned to fund ‘ew iavestnents for growth. However, financial iastutions collect the savings of inivdaal and ‘anne those funds to borrowers suc as businesses and governments, wheres financial markets provides forum in which savers and borrowers can ustssct busines dinely. Bisinestes tnd Bovernmets issue det andeauty secre drety to the poli ia the paar market ‘Sabsequen ting ofthese secures between investors cur inte secondary markeThe Financial System ‘The financial system can be viewed from two different angles: ‘© Institutional perspective: the financial system encompasses the mar- kkets, intermediaries, instruments, clients ete.; and '* Functional perspective: the financial system facilitates the allocation and deployment of economic resources, across time and space and in uncertain environment. While its institutional composition changes over time anc space (dif ferent places on the globe), the basie functions ofa financial system are essentially the same in all economies. The institutional dimension results from the functional needs, 22(rte ID IA Peapod fomurp — ~ eel eee eee Vissejont- = ea = mye deny Liner Bee yee pepe pho seteou 2 Sey py theo Ipuy ly = Tish yey women aorrernren — bymba apned 1 ise = spy eee Hoary Prey Se Sere een Hey oe OE RYreap packaty sony Tre wemrpaoty Savery sagrrg bommeg a POT FIM prea tons De 7 herpes Pye, een “9 ahapag pas An eaqnery 2°45, Hearn t 2-4fest neem, Se oe ropa tye — yoy ye 7payywerwentg pet mater] nary Hernwon| yr meray ope, = \ paley perm = eon danny Papsty 22) aa ISN ey ews | yr? pee ee fen bay Ve Pepe OF 1 Fou Deen,Differences between the Capital Markets and the Money Markets ~ Twoley financial masks are the money mask nd the capital markt In he money markt, the investors ae savers who want se tempoay place to deposit funds ver they car eam incest and inact with bomowers who hve otter need for fends senealy a year less, Maseable secures including Tress bil commerial paper, and ter nsument ac the primary secotes traded inthe money market. The Euocttaney market isthe intemational eguivalest ofthe domesie money market In contrast. the capital makati the frum in which savers and berowers interact ona fong-term bss, more tha a year Fim issue ether debt bonds) or eauty (common and prefered stock) Scents in he eptal market The Eurobond market typically ess 2onde denominated in bolas and sels them to ivestors locate outside the United Stats, The international sy ‘market allows corportions to sll blocks of shares 10 inventors ina mime of etferet counties Simulizneouty (Once issued, these scares wade om secondary mazkes that are ithe broker markets or daler ‘ares. In broker markt. forte tad to ake pce, tb buyer and eller are brought together ‘tnd the securities change hands on the Nor of m exchane. In he dealer market, the bayer and feller are never brought together direc instead market maker execute the orders though ‘lecwonic wading plato. An imporan function ofthe capital mares to determine the underlying vale ofthe ecues ‘ssued by busineses. Inan efficient marke, the price of security is an unbiced estimate of fe toe value. An efficient markt allocates funds ther moet producive ees ae a result of ‘compton among wealy-aximizing investors and this as investors iar new information itis reflected quckly instock piesBusiness Taxes and Their Importance in Financial Decisions Corporate income is subject to corporate axe, Coote tax ats apply to tet einary income {GRE dedocton of ellwable expenses) aud captal gains. Ordinary income iocome earned ‘hrough the sale of goods or services, The mores ered, the greter the peresage of tax oWed- ‘Tae average tik ete pid by comporatios ranges from 15 to 35 percent. Comore taxpayer Teeth tates though cera provisions inthe a cod: dividend incom exclusions and ax edb expenses. ‘he average ns he amount of tx pid divided by total income, The margin x ate the percentage of tx owed on the next dollar etned. Marginal ates usually excted average mes, Capital guns are income earned due othe sl fan asset fr more thn i inl purchase pce. ‘Cuenca puns se added to odnary oem snd aed atthe regular corporat ate, With tbe manne rt of S96-To simpy ax caeslaton, fixed rae of 40% wil be used throughout the remating chapters inthis tex egudess of whet itis dna or capital gin income, 24The Choices in Financing There are only two ways in which a business can raise money. 1 The first is debt. The essence of debt is that you promise to make fixed payments in the future (interest payments and repaying principal). If you fail to make those payments, you lose control of your business, 1D The other is equity. With equity, you do get whatever cash flows are left over after you have made debt payments. ae ere Ey ESS Pty Poach Treble {wet rt Rec oo RecreSere Sona SST a 2-FaDest Equity Financing alcernatives available to major corporations 7 Sebsiaes fangs 9 [Fed Dollar Bank debt 3 € Private = placement 5 Long term | 3 “Non-dollart | Public L-Fosing} offering Cacield)) 2 7 US. commercial E eee 5 o Adjustable-rate Short term 4 PoRered stock, Euro commercial paper debt sh lable =— fetoot (UI Tet) Ecuiyontns Wh werent Domestic International Project finance ‘Term loan Revolving facility (ASEERE ) Leasing. Asset backed Unsecured Domestic — Eurobond — Medium-term notes Floating-rate notes Variable-rate notes Straight wipart UnstrippedFinancing Chor mrs thee excle LT —— 4‘uawebeUeW U| 20104 & enieoes Kew SiEpIOY YBAIUOD PAEIS SI] SBIEIOIN J’NSS] UI VBA SLA Uly uononpap on, oyonpap yso1ayu quewjeen xe) euon paris Auumew 14a 01 ayeUIpIogng Aunbe 0} s0}Uag, }888e PUB eULOOU LO SUID, 82, on pluaweBEueU uJ 2010, Aunb3 eq onsue}eIeYD eyes yo odky. [piido> Ajinb pup yqag UseMjog SeoUusi9yIG Aey | Anda ic a8 198q Buyseuog ] jeudey Aunby } JO SunyeN su 24a,Preference rankings long-term finance: Results of a survey Ranking 1 2 Source Retained Barings Straight Debt Convertible Debt External Common Equity Straight Preferred Stock Convertible Preferred. Score 561 488 3.02 242 222 172Firms and Financial Markets 1 In theory: Financial markets are efficient. Managers convey information honestly and and in a timely manner to financial markets, and financial markets make reasoned judgments of the effects of this information on ‘true value’. As a consequence- @ Acompany that invests in good long term projects will be rewarded. 1 Short term accounting gimmicks will not lead to increases in market value. @ Stock price performance is a good measure of company performance. © In practice: There are some holes in the 'Efficient Markets’ assumption.Some critiques of market efficiency... a Investor irrationality: The base argument is that investors are irrational and prices often move for not reason at all. As a consequence, prices are much more volatile than justified by the underlying fundamentals. Earnings and dividends are much less volatile tran stock prices. © Manifestations of irrationality Reaction to news: Some believe that investors overreact to news, both good and bad. Others believe that investors sometimes under react to big news stories. © An insider conspiracy: Financial markets are manipulated by insiders; Prices do not have any relationship to value. 1 Short termism: Investors are short-sighted, and do not consider the long-term implications of actions taken by the firmChapter 3 Financial Statenents and Ratio AnalysisLearning Goals Review the contents of stockholder’s report and the procedures for consoli~ dating international Financial statenents Understand who uses finanefal ratfes, and how Use ratios to analyze a firms liquidity and activity Discuss the relationship between debt and financial leverage and the ratios used to analyze a firm's debt Use ratios to analyze a firn’s profitabitity and its market value Use a summary of financfal ratios and the DuPont systen of analysis to perform a complete ratio analysisNotes Stockholders’ Report and Procedures for Consolidating international Financial Statements (Corporations are equired vo produce annual stockholders repos thit are sn to al sharcholders. [wl usually begin with alter rom management soctoldrs that summarizes the sate of ‘he frm and managements views asf is future Thi leer i then fllowe by the four Basie 1. Income sterent: fea summary of the finm's operating results wing specified period. Balance sheet. summary ofthe fms fntoal poston at given ine Statement o eained earnings: Recencls the bet ncome eed durin a given yes, and any cas dividends pai, with the change in retained earnings between th atte the end oF ‘hat yer, 4 Staemen of cash flows: A summary ofthe ash flows over the period oeoncer ‘The sockhoiders’ report will conclude with noes othe financial statement. These provide detailed information onthe accountng polis, procedures, calculations, eof densacdons underlying ens in the nancial statements ‘The guidelines used to prepare and mains financial ecords and reports as known as generally cepted accounting principles (GAAP) These accounting paves snd procedutes re ‘utorized by the accounting professions rle-seting body. the Financial Accounting Standard Board (FASB). In aon, adios of pubic corporations ae overseen by Flic Company ‘Accounting Oversight Boa (PCAOB) exabiishe bythe Sarbanes Ostey At of 2002 [U.S based companies mast consolidate thee foreign and domestic nancial statements by ‘canslting thei freian-cuteney denominated assets an abilities info dlls using the cueat ‘ale (nslaion) method.Quel Comet Arrieta wal Fie tate Geww hea AR Invenfovies jolt Pred Avch Tanyille Ariel : Laws Quilting, ( Haden O10 Farmifne # By foros Velsielea Recent Araeta ( SLances Peslreretinns Dalen ‘ble Parle sla @ Gadebeldert Raut Correat (rebibrher AP Noles Payette Beemnals Loy - bene Debt Baul Teh oek Com Stovk Padus econ of POT Mel Earnings