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 12-6 Variations in Capital Structures among Firms 220 14-1b The Relationships among Working Capital
12-6a Capital Structures around the World 221 Accounts 245
Key Capital Structure Concepts 222 14-2 The Cash Conversion Cycle 248
14-3 Working Capital Investment and Financing
Policies 252
13 Distribution of Retained 14-3a Alternative Current Asset Investment
Earnings: Dividends and Stock Policies 252

Repurchases 225 14-3b Alternative Current Asset Financing

Policies 253
13-1 Dividend Policy and Stock Value 226 14-4 Advantages and Disadvantages of Short-Term
Financing 255
13-1a Information Content, or Signaling 226
14-4a Speed 255
13-1b Clientele Effect 227
14-4b Flexibility 255
13-1c Free Cash Flow Hypothesis 227
14-4c Cost of Long-Term versus Short-Term
13-2 Dividend Payments in Practice 228 Debt 256
13-2a Residual Dividend Policy 228 14-4d Risk of Long-Term versus Short-Term
13-2b Stable, Predictable Dividends 229 Debt 256
13-2c Constant Payout Ratio 230 14-5 Multinational Working Capital
13-2d Low Regular Dividend Plus Extras 231 Management 256
13-2e Application of the Different Types of Key Working Capital Policy Concepts 257
Dividend Payments: An Illustration 231
13-2f Payment Procedures 231
13-2g Dividend Reinvestment Plans (DRIPs) 233
13-3 Factors Influencing Dividend Policy 233 15 Managing
13-4 Stock Dividends and Stock Splits 234 Short-Term Assets 260
13-4a Stock Splits 234
13-4b Stock Dividends 235 15-1 Cash Management 261
13-4c Price Effects of Stock Splits 15-1a The Cash Budget 261
and Stock Dividends 235 15-1b Cash Management Techniques 265
13-4d Balance Sheet Effects of Stock Splits and 15-1c Acceleration of Receipts 265
Stock Dividends 235 15-1d Disbursement Control 266
13-5 Stock Repurchases 236 15-2 Marketable Securities 267
13-5a Advantages and Disadvantages of Stock 15-3 Credit Management 267
Repurchases 237
15-3a Credit Policy 267
13-6 Dividend Policies Around the World 238 15-3b Receivables Monitoring 268
Key Distribution of Retained Earnings 15-3c Analyzing Proposed Changes in Credit
Concepts 239 Policy 269
15-4 Inventory Management 270
PART 6 Working Capital 15-4a Types of Inventory 272
15-4b Optimal Inventory Level 272
Management 242 15-4c Inventory Control Systems 275
15-5 Multinational Working Capital
14 Working Capital Management 276
Policy 242 15-5a Cash Management 276
15-5b Credit Management 276
14-1 Working Capital 243 15-5c Inventory Management 277
14-1a The Requirement for External Working Key Concepts for Managing Short-Term
Capital Financing 243 Assets 277

Contents vii
16 Managing Short-Term
Liabilities (Financing) 280
16-1 Sources of Short-Term Financing 281
16-1a Accruals 281
16-1b Accounts Payable (Trade Credit) 281
16-1c Short-Term Bank Loans 282
16-1d Commercial Paper 284
16-2 Computing the Cost of Short-Term Credit 285
16-2a Computing the Cost of Trade Credit
(Accounts Payable) 286
16-2b Computing the Cost of Bank Loans 286
16–2c Computing the Cost of Commercial
Paper 287
16–2d Borrowed (Principal) Amount versus
Required (Needed) Amount 288
16–3 Use of Secured Short-Term Financing 289
16–3a Accounts Receivable Financing 290
16–3b Inventory Financing 291
Key Concepts for Managing Short-Term
Liabilities 293
PART 7 Strategic Planning
and Financing Decisions 295
17 Financial Planning
and Control 295
17-1 Projected (Pro Forma) Financial
Statements 296
17-1a Step 1: Forecast the Income
Statement 296
17-1b Step 2: Forecast the Balance Sheet 297
17-1c Step 3: Raising the Additional Funds
Needed 299
viii Contents
17-1d Step 4. Accounting for Financing
Feedbacks 299
17-1e Analysis of the Forecast 300
17-2 Other Considerations in Forecasting 301
17-2a Excess Capacity 301
17-2b Economies of Scale 302
17-2c Lumpy Assets 302
17-3 Financial Control—Budgeting and
Leverage 302
17-3a Operating Breakeven Analysis 302
17-3b Operating Leverage 305
17-3c Financial Breakeven Analysis 307
17-3d Financial Leverage 309
17-3e Combining Operating and Financial
Leverage—Degree of Total Leverage (DTL) 311
17-4 Using Leverage and Forecasting for
Control 312
Key Financial Planning and Control Concepts 313
Appendix A Using
Spreadsheets to Solve Financial
Problems 315
A-1 Setting up Mathematical Relationships 315
A–2 Solving Time Value of Money (TVM) Problems
Using Preprogrammed Spreadsheet Functions 316
A-2a Solving for Future Value (FV): Lump-Sum
Amount and Annuity 317
A-2b Solving for Present Value (PV): Lump-Sum
Amount and Annuity 319
A-2c Solving for r: Lump-Sum Amount
and Annuity 320
A-2d Solving for n: Lump-Sum Amount
and Annuity 320
A-2e Solving for Present Value and Future Value:
Uneven Cash Flows 321
A-2f Setting Up an Amortization Schedule 322
 PART 1
Introduction to
Managerial Finance

chapter 1

An Overview of Managerial
Finance
Learning Outcomes
LO.1 Explain what finance entails and why everyone should have an understanding of basic financial concepts.

LO.2 Identify different forms of business organization as well as the advantages and disadvantages of each.

LO.3 Identify major goal(s) that firms pursue and what a firm’s primary goal should be.

LO.4 Explain the roles that ethics and good governance play in successful businesses.

LO.5 Describe how foreign firms differ from U.S. firms and identify factors that affect financial
decisions in multinational firms.

I
Study Tools

n this chapter, we introduce finance by providing you with (1) a description of the Problems are
discipline and (2) an indication of the goals companies should attain, as well as the found at the end
of this chapter
conduct that is acceptable when pursuing these goals. As you will discover, a corpora-
tion acts in the best interests of its owners (stockholders) when decisions are made that +
increase the firm’s value, which in turn increase the value of its stock. Login to CourseMate
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Chapter 1: An Overview of Managerial Finance 1


1-1 What is Finance?
In simple terms, finance is concerned with decisions
about money. Financial decisions deal with how money
is raised and used by businesses, governments, and in-
dividuals. To make sound financial decisions, you must
understand three general, yet reasonable, concepts. Ev-
erything else equal, (1) more value is preferred to less;
(2) the sooner cash is received, the more valuable it is;
and (3) less risky assets are more valuable than (pre-
ferred to) riskier assets. These concepts are discussed in
detail later in the book. At this point, we can state that
firms that make decisions with these concepts in mind
are able to provide better products to customers at low-
er prices, pay higher salaries to employees, and still pro-
vide greater returns to investors. In general, then, sound
financial management contributes to the well-being of
both individuals and the general population.
Although the emphasis in this book is business
finance, you will discover that the same concepts that
firms apply when making sound business decisions can
be used to make informed decisions relating to personal
finances. For example, consider the decision you might
have to make if you won a state lottery worth $105
million. Which would you choose: a lump-sum pay-
ment of $54 million today or a payment of $3.5 mil-
lion each year for the next 30 years? Which should you
choose? In Chapter 4, we will show the time value of
money techniques that firms use to make business deci-
sions. These same techniques can be used to answer this
and other questions that relate to personal finances.
1-1a General Areas of Finance
The study of finance consists of four interrelated areas:
1. Financial markets and institutions—Financial institutions,
which include banks, insurance companies, savings
and loans, and credit unions, are an integral part of
the general financial services marketplace. The success
of these organizations requires an understanding of
factors that cause interest rates and other returns in
the financial markets to rise and fall, regulations that
affect such institutions, and various types of financial
instruments, such as mortgages, automobile loans, and
certificates of deposit, that financial institutions offer.
2. Investments—This area of finance focuses on the de-
cisions made by businesses and individuals as they
choose securities for their investment portfolios.
The major functions in the investments area are
2 Part 1: Introduction to Managerial Finance
(a) determining the values, risks, and returns associ-
ated with such financial assets as stocks and bonds
and (b) determining the optimal mix of securities
that should be held in a portfolio of investments.
3. Financial services—Financial services refer to func-
tions provided by organizations that deal with the
management of money. Persons who work in these
organizations, which include banks, insurance com-
panies, brokerage firms, and similar companies,
provide services that help individuals and compa-
nies determine how to invest money to achieve such
goals as home purchase, retirement, financial stabil-
ity and sustainability, budgeting, and so forth.
4. Managerial (business) finance—Managerial finance
deals with decisions that all firms make concerning
their cash flows, including both inflows and outflows.
As a consequence, managerial finance is important in
all types of businesses, whether they are public or
private, and whether they deal with financial services
or the manufacture of products. The duties encoun-
tered in managerial finance range from making deci-
sions about plant expansions to choosing what types
of securities should be issued to finance such expan-
sions. Financial managers also have the responsibility
for deciding the credit terms under which customers
can buy, how much inventory the firm should carry,
how much cash to keep on hand, whether to acquire
other firms (merger analysis), and how much of each
year’s earnings should be paid out as dividends ver-
sus how much should be reinvested in the firm.
Although our concern in this book is primarily with
managerial finance, because all areas of finance are inter-
related, an individual who works in any one area should
have a good understanding of the other areas as well. For
example, a banker lending to a business must have a basic
understanding of managerial finance to judge how well
the borrowing company is operated. The same holds true
for a securities analyst, who must understand how a firm’s
current financial position can affect its future prospects
and thus its stock price. At the same time, corporate fi-
nancial managers need to know what their bankers are
thinking and how investors are likely to judge their corpo-
rations’ performances when establishing their stock prices.
1-1b The Importance of Finance
in Non-Finance Areas
Everyone is exposed to finance concepts almost every day.
For example, when you borrow to buy a car or house,
finance concepts are used to determine the monthly
payments you are required to make. When you retire,
finance concepts are used to determine the amount of
the monthly payments you receive from your retirement
funds. Further, if you want to start your own business, an
understanding of finance concepts is essential for surviv-
al. Thus, even if you do not intend to pursue a career in a
finance-related profession, it is important that you have
some basic understanding of finance concepts. Similarly,
if you pursue a career in finance, it is important that you
have an understanding of other areas in the business, in-
cluding marketing, accounting, production, and so forth,
to make better informed financial decisions.
Let’s consider how finance relates to some of a
business’s non-finance areas that students often study
in college.
1. Management—When we think of management, we of-
ten think of personnel decisions and employee rela-
tions, strategic planning, and the general operations
of the firm. Strategic planning, which is one of the
most important activities of management, cannot be
accomplished without considering how such plans im-
pact the overall financial well-being of the firm. Such
personnel decisions as setting salaries, hiring new staff,
and paying bonuses must be coordinated with finan-
cial decisions to ensure that needed funds are avail-
able. For these reasons, managers must have at least a
general understanding of financial management con-
cepts to make informed decisions in their areas.
2. Marketing—If you have taken a basic marketing
course, you learned that the four Ps of marketing—
product, price, place, and promotion—determine
the success of products that are manufactured and
sold by companies. Clearly, the price that should be
charged for a product and the amount of advertising
a firm can afford for the product must be determined
in conjunction with financial managers, because the
firm will lose money if the price of the product is
too low or too much is spent on advertising. Co-
ordination of the finance function and the market-
ing function is critical to the success of a company,
especially a small, newly formed firm, because it is
necessary to ensure that sufficient cash is generated
to survive. For these reasons, people in marketing
must understand how marketing decisions affect
and are affected by such issues as funds availability,
inventory levels, and excess plant capacity.
3. Accounting—In many firms (especially small ones), it
is difficult to distinguish between the finance func-
tion and the accounting function. Because the two
disciplines are closely related, often accountants are
involved in finance decisions and financial manag-
ers are involved in accounting decisions. As our dis-
cussions will show, financial managers rely heavily
on accounting information, because making deci-
sions about the future requires information that ac-
countants provide about the past. As a consequence,
accountants must understand how financial man-
agers use accounting information in planning and
decision making so that it can be provided in an
accurate and timely fashion. Similarly, accountants
must understand how accounting data are viewed
(used) by investors, creditors, and others who are
interested in the firm’s operations.
4. Information Systems—To make sound decisions, fi-
nancial managers rely on accurate information that
is available when needed. The process by which the
delivery of such information is planned, developed,
and implemented is costly, but so are the problems
caused by a lack of good information. Without ap-
propriate information, decisions relating to finance,
management, marketing, and accounting could
prove disastrous. Different types of information re-
quire different information systems, so information
system specialists work with financial managers to
determine what information is needed, how it should
be stored, how it should be delivered, and how man-
aging information affects the profitability of the firm.
5. Economics—Finance and economics are so simi-
lar that some universities offer courses related
to these two subjects in the same functional area
(department). Many tools used to make financial
decisions evolved from theories or models devel-
oped by economists. Perhaps the most noticeable
difference between finance and economics is that
financial managers evaluate information and make
decisions about cash flows associated with a par-
ticular firm or a group of firms, whereas economists
analyze information and forecast changes in activi-
ties associated with entire industries and the econ-
omy as a whole. It is important that financial man-
agers understand economics and that economists
understand finance, because economic activity and
policy impact financial decisions, and vice versa.
Finance will be a part of your life no matter what
career you choose. There will be a number of times
during your life, both in business and in your personal
finances, that you will make finance-related decisions.
Therefore, it is vitally important that you have some
understanding of general finance concepts. There are
financial implications in virtually all business decisions,
Chapter 1: An Overview of Managerial Finance 3
and non-financial executives must know enough fi-
nance to incorporate these implications into their own
specialized analyses. For this reason, every student of
business, regardless of his or her major, should be con-
cerned with finance.
Finance in the Organizational Structure of
the Firm. Although organizational structures vary
from company to company, the chief financial officer
(CFO), who often has the title of vice president of fi-
nance, generally reports to the president. The financial
vice president’s key subordinates are the treasurer and
the controller. In most firms, the treasurer has direct re-
sponsibility for managing the firm’s cash and marketable
securities, planning how the firm is financed and when
funds are raised, managing risk, and overseeing the cor-
porate pension fund. The treasurer also supervises the
credit manager, the inventory manager, and the director
of capital budgeting, who analyzes decisions related to
investments in fixed assets. The controller is responsible
for the activities of the accounting and tax departments.
1-2Alternative Forms of Business
Organization
There are three major forms of business organization
in the United States: (1) proprietorships, (2) partner-
ships, and (3) corporations. In terms of numbers, 70–
75 percent of businesses are operated as proprietor-
ships, 8–10 percent are partnerships, and the remaining
15–20 percent are corporations. Based on the dollar value
of sales, however, approximately 83 percent of all busi-
ness is conducted by corporations, while the remaining
17 percent is generated by proprietorships (3–4 per-
cent) and partnerships (13–14 percent).1 Because most
business is conducted by corporations, we will focus on
that form in this book. However, it is important to un-
derstand the differences among the three major forms
of business, as well as the popular “hybrid” forms of
business that have evolved from these major forms.
1-2a Proprietorship
A proprietorship is an unincorporated business
owned by one individual. Starting a proprietor-
ship is fairly
proprietorship An easy—just be-
unincorporated business owned by
one individual.
gin business
operations.
4 Part 1: Introduction to Managerial Finance
The proprietorship has three important advantages:
1. It is easily and inexpensively formed. Not much
“red tape” is involved when starting such a busi-
ness; generally, only licenses required by the state
and the municipality in which the business operates
are needed.
2. It is subject to few government regulations. Large
firms that potentially threaten competition are
much more heavily regulated than small so-called
mom-and-pop businesses.
3. It is taxed like an individual, not like a corporation;
thus, earnings are taxed only once. The double taxa-
tion of dividends is discussed later in the chapter.
The proprietorship also has four important
limitations:
1. The proprietor has unlimited personal liability for
business debts, because any debts of the business are
considered obligations of the sole owner. With un-
limited personal liability, the proprietor (owner) can
potentially lose all of his or her personal assets, even
those assets not invested in the business; thus, losses
can far exceed the money that he or she has invested
in the company. An explanation of this concept is
given later in this chapter.
2. A proprietorship’s life is limited to the time the in-
dividual who created it owns the business. When a
new owner takes over the business, legally the firm
becomes a new proprietorship (even if the name of
the business does not change).
3. Transferring ownership is somewhat difficult. Dis-
posing of the business is similar to selling a house
in that the proprietor must seek out and negotiate
with a potential buyer, which generally takes weeks
or months to complete.
4. It is difficult for a proprietorship to obtain large
sums of capital because the firm’s financial strength
generally is based only on the financial strength of
the sole owner. A proprietorship’s funds are derived
from the owner’s sources of credit, which include
his or her credit cards, access to bank loans, loans
from relatives and friends, and so forth. Unlike cor-
porations, proprietorships cannot raise funds by
issuing stocks and bonds to investors.
1
The statistics provided in this section are based on business tax filings reported by the Internal
Revenue Service (IRS), which can be found on the IRS website at http://www.irs.ustreas.gov
/taxstats/.
 For these reasons, individual proprietorships are 1-2c Corporation
confined primarily to small business operations. In fact,
A corporation is a legal entity created by a state,
only about 1 percent of all proprietorships have assets
which means that a corporation has the legal author-
that are valued at $1 million or more; nearly 90 percent
ity to act like a person when conducting business.
have assets valued at $100,000 or less. However, most
It is separate and distinct from its owners and man-
businesses start out as proprietorships and then convert
agers. This separateness gives the corporation four
to corporations when their growth causes the disad-
major advantages:
vantages of being a proprietorship—namely, unlimited
personal liability and the inability to raise large sums of 1. A corporation offers its owners limited liability. To
money—to outweigh the advantages. illustrate the concept of limited liability, suppose
you invested $10,000 to become a partner in a
business formed as a partnership that subsequently
1-2b Partnership went bankrupt, owing creditors $1 million. Because
A partnership is the same as a proprietorship, except the owners are liable for the debts of a partnership,
that it has two or more owners. Partnerships can oper- as a partner you would be assessed for a share of
ate under different degrees of formality, ranging from the company’s debt; you could even be held liable
informal, oral understandings to formal agreements for the entire $1 million if your partners could not
filed with the secretary of the state in which the partner- pay their shares. This is the danger of unlimited li-
ship does business. Most legal experts recommend that ability. On the other hand, if you invested $10,000
partnership agreements be put in writing. in the stock of a corporation that then went bank-
The advantages of a partnership are the same as rupt, your potential loss on the investment would
those of a proprietorship, except that most partner- be limited to your $10,000 investment.2
ships have more sources available for raising funds
because there are more owners, with more relatives, 2. Ownership interests can be divided into shares
more friends, and more opportunities to raise funds of stock, which can be transferred far more easily
through credit. Even though they generally have than can proprietorship or partnership interests.
greater capabilities than proprietorships to raise Shares of stock can be bought and sold in minutes,
funds to support growth, partnerships still have diffi- whereas interests in proprietorships and partner-
culty in attracting substantial amounts of funds. This ships generally cannot.
is not a major problem for a slow growing business. 3. A corporation can continue after its original owners
However, if a business’ products really catch on and and managers no longer have a relationship with
it needs to raise large amounts of funds to capitalize the business; thus it is said to have unlimited life.
on its opportunities, the difficulty of attracting funds The life of a corporation is based on the longevity
becomes a real drawback. For this reason, growth of its stock, not the longevity of those who own the
companies, such as Microsoft and Dell Computer, stock (the owners).
generally begin life as proprietorships or partner-
ships, but at some point find it necessary to convert 4. The first three factors—limited liability, easy trans-
to corporations. ferability of ownership interest, and unlimited
Under partnership law, each partner is liable for the life—make it much easier for corporations than for
debts of the business. Therefore, if any partner is unable proprietorships or partnerships to raise money in
to meet his or her pro rata claim in the event the part- the financial markets. In addition, corporations can
nership goes bankrupt, the remaining partners must issue stocks and bonds to raise funds, whereas pro-
make good on the unsatisfied claims, drawing on their prietorships and partnerships cannot.
personal assets if necessary. Thus, the business-related Even though the corporate form of business of-
activities of any of the firm’s partners can bring ruin to fers significant advan-
the other partners, even though those partners are not tages over propri- partnership An unincorporated
direct parties to such activities. etorships and part- business owned by two or more persons.
nerships, it does corporation A legal entity created by a state,
have two major separate and distinct from its owners and managers,
2
In the case of small corporations, the limited liability feature is often a fiction because bankers disadvantages: having unlimited life, easy transferability of ownership,
and credit managers frequently require personal guarantees from the stockholders of small, and limited liability.
weak corporations.

Chapter 1: An Overview of Managerial Finance 5

1. Setting up a corporation, as well as periodic filings generally will be set up as one of two forms. In some
of required state and federal reports, is more com- states an LLP can be established that permits persons
plex and time-consuming than for a proprietorship to invest in partnerships without exposure to the per-
or a partnership. When a corporation is created, sonal liability that general partners face. With this
(a) a corporate charter, which provides general in- type of LLP, at least one partner is designated a gen-
formation, including the name of the corporation, eral partner and the others are limited partners. The
types of activities it will pursue, amount of stock general partners remain fully personally liable for all
that initially will be issued, and so forth, must be business debts, whereas the limited partners are li-
filed with the secretary of the state in which the firm able only for the amounts they have invested in the
incorporates; and (b) a set of rules, called bylaws, business. Only the general partners can participate
that specify how the corporation will be governed in the management of the business. In other states,
must be drawn up by the founder. all partners in an LLP are fully liable for the general
debts of the business, but an individual partner is not
2. Because the earnings of the corporation are taxed at
liable for the negligence, irresponsibility, or similar
the corporate level and then any earnings paid out as
acts committed by any other partner (thus the limited
dividends are again taxed as income to stockholders,
liability). Some states require LLPs to file partnership
corporate earnings are subject to double taxation.3
agreements with the secretary of state, whereas other
states do not.
1-2d Hybrid Forms of Business:
LLP, LLC, and S Corporation Limited Liability Company (LLC). A limited li-
Alternative business forms that include some of the ability company (LLC) is a relatively new business form
advantages, and avoid some of the disadvantages, of that has become popular during the past couple of
the three major forms of business have evolved over decades; it combines features of a corporation and a
time. These alternative forms of business combine partnership. An LLC offers the limited personal liabil-
some characteristics of proprietorships and partner- ity associated with a corporation, but the company
ships with some characteristics of corporations. In can choose to be taxed as either a corporation or as
this section, we provide a brief description of three a partnership. If an LLC is taxed like a partnership,
popular hybrid business forms that exist today. income is said to pass through to the owners, so that
it is taxed only once. The structure of the LLC is fairly
Limited Liability Partnership (LLP). In the
flexible; owners generally can divide liability, manage-
earlier discussion of a part-
ment responsibilities, ownership shares, and control
nership, we described the
corporate charter A document of the business any way they please. In addition, LLC
form of business that is
filed with the secretary of the state in owners, which are called “members,” can be individu-
referred to as a general
which a business is incorporated that als or other businesses. Unlike a partnership, an LLC
provides information about the company, partnership, wherein
can have a single owner. As with a corporation, legal
including its name, address, directors, and each partner is per-
paperwork, which is termed articles of organization,
amount of capital stock. sonally liable for
must be filed with the state in which the business is set
bylaws A set of rules drawn up by the any of the debts of
up, and there are certain financial reporting require-
founders of the corporation that indicates how the the business. It is
company is to be governed; includes procedures for
ments after the formation of an LLC. Because LLCs
possible to limit
electing directors, rights of stockholders, and how to are created by state laws, which vary considerably,
the liability
change the bylaws when necessary. there can be substantial differences between how an
faced by some
limited liability partnership (LLP) LLC can be formed in one state versus another state.
of the partners
A partnership wherein at least one partner is As this type of business organization becomes more
by establishing
designated as a general partner with unlimited widespread, state regulation most likely will become
personal financial liability, and the other partners a limited liabil-
more uniform.
are limited partners whose liability is limited to ity partnership
amounts they invest in the firm. (LLP). The legal
limited liability company (LLC) Offers aspects of LLPs 3
There was a push in Congress in 2003 to eliminate the double taxation of dividends by either
the limited personal liability associated with a vary from state treating dividends paid by corporations the same as interest—that is, making them a tax-
corporation; however, the company’s income is taxed to state. Even deductible expense—or allowing dividends to be tax exempt to stockholders. Congress passed
like that of a partnership. so, an LLP neither; instead, the tax on dividends received by investors was reduced from the ordinary tax
rate to the capital gains rate.

6 Part 1: Introduction to Managerial Finance

S Corporation. A domestic corporation that has
no more than 100 stockholders and only one type
of stock outstanding can elect to file taxes as an
S corporation. If a corporation elects the S corporation
status, then its income is taxed the same as income
earned by proprietorships and partnerships; that
is, income passes through the company to the owners
so that it is taxed only once. The major differences
between an S corporation and an LLC are that an
LLC can have more than 100 stockholders (members)
and more than one type of stock (membership
interest).
For the following reasons, the value of any business,
other than a very small concern, probably will be maxi-
mized if it is organized as a corporation:
1. Limited liability reduces the risks borne by inves-
tors. All else equal, the lower the firm’s risk, the
higher its market value.
2. A firm’s current value is related to its future growth
opportunities, and corporations can more easily
attract funds to take advantage of growth oppor-
tunities than can unincorporated businesses (only
corporations can issue stocks and bonds to raise
funds).
3. Corporate ownership can be transferred more easily
than ownership of either a proprietorship or a part-
nership. Therefore, all else equal, investors would
be willing to pay more for a corporation than for
a proprietorship or partnership, which means that
the corporate form of organization can enhance the
value of a business.
Most firms are managed with value maximization
in mind, and this, in turn, has caused most large busi-
nesses to be organized as corporations.
1-3What Goal(s) Should
Businesses Pursue?
Depending on the form of business, one firm’s major
goals might differ somewhat from another firm’s major
goals. But, in general, every business owner wants the
value of his or her investment in the firm to increase.
The owner of a proprietorship has direct control over
his or her investment in the company, because it is the
proprietor who owns and runs the business. As a result,
a proprietor might choose to work three days per week
and play golf or fish the rest of the week as long as the
business remains successful and he or she is satisfied
living this type of life. On the other hand, the owners
(stockholders) of a large corporation have very little
control over their investments because they generally
do not run the business. Because they are not involved
in the day-to-day decisions, these stockholders expect
that the managers who run the business do so with the
best interests of the owners in mind.
Investors purchase the stock of a corporation
because they expect to earn an acceptable return on the
money they invest. Because we know investors want to
increase their wealth positions as much as possible, all
else equal, it follows that managers should behave in
a manner that is consistent with enhancing the firm’s
value. For this reason, throughout this book we oper-
ate on the assumption that management’s primary goal
is stockholder wealth maximization, which, as we will
see, translates into maximizing the value of the firm as
measured by the price of its common stock. Firms do,
of course, have other objectives. In particular, manag-
ers who make the actual decisions are also interested
in their own personal satisfaction, in their employees’
welfare, and in the good of the community and of soci-
ety at large. Still, stock price maximization is the most
important goal of most corporations.
If a firm attempts to maximize its stock price,
is this good or is this bad for society? In general, it
is good. Aside from such illegal actions as attempting
to form monopolies, violating safety codes, and fail-
ing to meet pollution control requirements, the same
actions that maximize stock prices also benefit society.
First, note that stock price maximization requires
efficient, low-cost plants that produce high-quality
goods and services that are sold at the lowest possible
prices. Second, stock price maximization requires the
development of products that consumers want and
need, so the profit motive leads to new technology,
to new products, and to new jobs. Finally, stock price
maximization necessitates efficient and courteous ser-
vice, adequate stocks
of merchandise, and
S corporation A corporation with no
well located busi- more than 100 stockholders that elects to
ness establish- be taxed in the same way as proprietorships
ments. These and partnerships, so that business income is only
factors are taxed once.
necessary to stockholder wealth maximization The
maintain a appropriate goal for management decisions; considers
customer base the risk and timing associated with expected cash flows
to maximize the price of the firm’s common stock.
that generates
Chapter 1: An Overview of Managerial Finance 7
sustainable profits. Therefore, most actions that help a
firm increase the price of its stock also are beneficial to
society at large. This is why profit-motivated, free-en-
terprise economies have been so much more successful
than socialistic and communistic economic systems.
Because managerial finance plays a crucial role in the
operation of successful firms and because successful
firms are necessary for a healthy, productive economy,
it is easy to see why finance is important from a social
standpoint.4
1-3aManagerial Actions to Maximize
Shareholder Wealth
How do we measure value, and what types of actions
can management take to maximize value? Although
we will discuss valuation in much greater detail later
in the book, we introduce the concept of value here
to give you an indication of how management can af-
fect the price of a company’s stock. First, the value of
any investment, such as a stock, is based on the cash
flows the asset is expected to generate during its life.
Second, investors prefer to receive
a particular cash flow sooner
rather than later. And, third,
investors generally are risk
averse, which means they
are willing to pay more
for investments with
more certain future cash
flows than for invest-
Com
stock
ments with less certain, /Gett
y Im
ages
or riskier, cash flows, everything
else equal. For these reasons, we know that
managers can increase the value of a firm by making
decisions that increase the firm’s expected future cash
flows, generate the expected cash flows sooner, in-
crease the certainty of the expected cash flows, or pro-
duce any combination of these actions.
The financial manager makes decisions about the
expected cash flows of the firm, which include decisions
about how much and what types of debt and equity
should be used to finance the firm (capital structure de-
cisions); what types of assets should be purchased to
help generate expected cash flows (capital budgeting de-
cisions); and what to do with net cash flows generated
by the firm—reinvest them in the firm or pay dividends
(dividend policy deci-
value The present, or current, value sions). Each of
of the cash flows that an asset is expected these topics will
to generate in the future.
be addressed in
8 Part 1: Introduction to Managerial Finance
detail later in the book. But, at this point, it should be
clear that the decisions financial managers make can
significantly affect a firm’s value, because they affect the
amount, timing, and riskiness of the cash flows the firm
produces.
Although managerial actions affect the value of
a firm’s stock, external factors also influence stock
prices. Included among these factors are legal con-
straints, the general level of economic activity, tax
laws, and conditions in the financial markets. Based
on both internal and external constraints, manage-
ment makes a set of long-run strategic policy deci-
sions that chart a future course for the firm. These
policy decisions, along with the general level of eco-
nomic activity and government regulations and rules
(for instance, tax payments), influence the firm’s ex-
pected cash flows, the timing of these cash flows, as
well as their eventual transfer to stockholders in the
form of dividends, and the degree of risk inherent in
the expected cash flows.
Figure 1.1 diagrams the general relationships in-
volved in the valuation process. As you can see, and as
we will discuss in much greater detail throughout the
book, a firm’s value is ultimately a function of the cash
flows it is expected to generate in the future and the
rate of return at which investors are willing
to provide funds to the firm for the
purposes of financing operations
and growth. Many factors, includ-
ing conditions in the economy and
financial markets, the competitive
environment, and the general oper-
/Jup
iterim
ages
ations of the firm, affect the determi-
nation of the expected cash flows and
the rates people demand when investing
their funds. As we progress through the
book, we will discuss these and other factors that af-
fect a firm’s value. For now, however, it is important to
know that when we refer to value, we mean the worth
of the expected future cash flows restated in current
dollars—that is, the present (current) value of the fu-
ture cash flows.
4
People sometimes argue that firms, in their efforts to raise profits and stock prices,
increase product prices and gouge the public. In a reasonably competitive economy, which
exists in the United States, prices are constrained by competition and consumer resistance.
If a firm raises its prices beyond reasonable levels, it will simply lose its market share.
Of course, firms want to earn more, and they constantly try to cut costs or develop new
products in an attempt to earn above-normal profits. Note, though, that if they are indeed
successful and do earn above-normal profits, those very profits will attract competition
that will eventually drive prices down so that normal profits are generated; again, the main
long-term beneficiary is the consumer.
 FIGURE 1.1 Value of the Firm

Market Factors/Considerations:
Economic conditions
Government regulations and rules
Competitive environment—domestic and foreign

Firm Factors/Considerations: Investor Factors/Considerations:

Normal operations—revenues and expenses Income/savings
Financing (capital structure) policy Age/lifestyle
Investment (capital budgeting) policy Interest rates
Dividend policy Risk attitude/preference

^ Rate of return, r
Net cash flows, CF

Value of the Firm

^
Value = Current (present) value of expected (future) cash flows (CF)
based on the return demanded by investors (r), which
is dependent on the risk associated with the firm

1-3bShould Earnings per Share
(EPS) Be Maximized?
Will profit maximization also result in stock price
maximization? In answering this question, we introduce
the concept of earnings per share (EPS), which equals net
income (NI) divided by the number of outstanding shares
of common stock (Shares)—that is, EPS 5 NI/Shares.
Many investors use EPS to gauge the value of a stock.
A primary reason EPS receives so much attention is the
belief that net income, and thus EPS, can be used as a
barometer for measuring the firm’s potential for gen-
erating future cash flows. Although current earnings
and cash flows are generally highly correlated, as men-
tioned earlier, a firm’s value is determined by the cash
flows it is expected to generate in the future, as well
as the risk associated with those expected cash flows.
Thus, financial managers who attempt to maximize
earnings might not maximize value, because earnings
maximization is a shortsighted goal. Most managers
who focus solely on earnings do not consider the im-
pact that maximizing earnings in the current period
has on either future earnings (timing) or the firm’s fu-
ture risk position.
First, consider the timing of the earnings. Suppose
Xerox has a project that will cause earnings per share
to rise by $0.20 per year for five years, or $1 in total,
whereas another project would have no effect on earn-
ings for four years but would increase EPS by $1.25 in
the fifth year. Which project is better? In other words,
is $0.20 per year for five years better or worse than
$1.25 in Year 5? The answer depends on which project
contributes the most to the value of the firm, which in
turn depends on the time value of money to investors.
Thus, timing is an important reason to concentrate on
wealth as measured by the price of the stock rather than
on earnings alone.
Second, consider risk. Suppose one project is ex-
pected to increase EPS by $1, while another is expected
to increase earnings by $1.20 per share. The first proj-
ect is not very risky. If it is undertaken, earnings will
almost certainly rise by approximately $1 per share.
However, the other project is quite risky. Although our
best guess is that earnings will rise by $1.20 per share,
we must recognize the possibility that there might be no
increase whatsoever or that the firm might even suffer a
loss. Depending on how averse stockholders are to risk,
the first project might be preferable to the second.

Chapter 1: An Overview of Managerial Finance 9

 In many instances, firms have taken actions that
increased earnings per share, yet the stock price de-
creased because investors believed that either the higher
earnings would not be sustained in the future or the risk
level of the firm would be increased substantially. Of
course, the opposite effect has been observed as well. We
see, then, that the firm’s stock price, and thus its value,
is dependent on (1) the cash flows the firm is expected
to provide in the future, (2) when those cash flows are
expected to occur, and (3) the risk associated with those
cash flows. As we proceed through the book, you will
discover that every significant corporate decision should
be analyzed in terms of these factors and their effects on
the firm’s value, and hence the price of its stock.
1-3c Managers’ Roles as Agents
of Stockholders
Because they generally are not involved in day-to-day
operations, stockholders of large corporations “permit”
(empower) the executives to make decisions about how
the firms are run. Of course, the stockholders want the
managers to make decisions that are consistent with the
goal of wealth maximization. However, managers’ inter-
ests can potentially conflict with stockholders’ interests.
An agency relationship exists when one or more
individuals, who are called the principals, hire anoth-
er person, the agent, to perform a service and delegate
decision-making authority to that agent. If a firm is a
proprietorship, there is no agency relationship because
the owner–manager operates the business in a fashion
that will improve his or her own welfare, with welfare
measured in the form of increased personal wealth, more
leisure, or perquisites.5 However, if the owner–manager
incorporates and sells some of the firm’s stock to outsid-
ers, potential conflicts of interest immediately arise. For
example, the owner–manager (agent) might now decide
not to work as hard to maximize shareholder (principals’)
wealth because less of the firm’s wealth will go to him or
her, or he or she might decide to take a higher salary or
enjoy more perquisites because part of those costs will
fall on the outside stockholders. This potential conflict be-
tween two parties—the principals (outside shareholders)
and the agents (managers)—is an agency problem.
The potential for agency problems is greatest in large
corporations with widely dispersed ownership—for
example, IBM and Gen-
agency problem A potential eral Motors—be-
conflict of interest between outside
cause individual
shareholders (owners) and managers who
make decisions about how to operate the firm. stockholders
own extremely
10 Part 1: Introduction to Managerial Finance
small proportions of the companies and managers
have little, if any, of their own wealth tied up in these
companies. For this reason, managers might be more
concerned about pursuing their own agendas, such as
increased job security, higher salaries, or more power,
than about maximizing shareholder wealth.
Mechanisms used by large corporations to motivate
managers to act in the shareholders’ best interests include:
1. Managerial compensation (incentives)—A common
method used to motivate managers to operate in a
manner consistent with stock price maximization
is to tie managers’ compensation to the company’s
performance. Such compensation packages should
be developed so that managers are rewarded on the
basis of the firm’s performance over a long period of
time, not on its performance in any particular year.
For example, a company might implement a com-
pensation plan where managers earn 100 percent
of a specified reward when the company achieves
a targeted growth rate. If the performance is above
the target, higher rewards can be earned, whereas
managers receive lower rewards when performance
is below the target. Often the reward that manag-
ers receive is the stock of the company. If managers
own stock in the company, they are motivated to
make decisions that will increase the firm’s value
and thus the value of the stock they own.
All incentive compensation plans should be
designed to accomplish two things: (1) Provide in-
ducements to executives to act on those factors un-
der their control in a manner that will contribute to
stock price maximization. (2) Attract and retain top-
level executives. Well-designed plans can accomplish
both goals.
2. Shareholder intervention—More than 25 percent of
the individuals in the United States invest directly
in stocks. Along with such institutional stockhold-
ers as pension funds and mutual funds, individual
stockholders often “flex their muscles” to ensure
that firms pursue goals that are in the best interests
of shareholders rather than of the managers (where
conflicts might arise). In addition, many institu-
tional investors routinely monitor top corporations
to ensure that managers pursue the goal of wealth
maximization. When it is determined that action
is needed to realign management decisions with
the interests of investors, these institutional inves-
tors exercise their influence by suggesting possible
5
Perquisites (or “perks”) are executive fringe benefits, such as luxurious offices, use of corporate
planes and yachts, personal assistants, and general use of business assets for personal purposes.
 remedies to management or by sponsoring propos-
als that must be voted on by stockholders at the an-
nual meeting. Stockholder sponsored proposals are
not binding, but the results of the votes are noticed
by corporate management.
In situations where large blocks of the stock
are owned by a relatively few large institutions that
have enough clout to influence a firm’s operations,
these institutional owners often have enough voting
power to overthrow management teams that do not
act in the best interests of stockholders. Examples of
major corporations whose managements have been
ousted in past years include Coca-Cola, General
Motors, and United Airlines.
3. Threat of takeover—Hostile takeovers, instances in
which management does not want the firm to be
taken over, are most likely to occur when a firm’s
stock is undervalued relative to its potential, which
often is caused by inefficient operations that result
from poor management. In a hostile takeover, the
managers of the acquired firm generally are fired,
and those who stay on typically lose the power they
had prior to the acquisition. Thus, to avoid takeover
threats, managers have a strong incentive to take ac-
tions that maximize stock prices.
Because wealth maximization is a long-term goal
rather than a short-term goal, management must be able
to convey to stockholders that their best interests are be-
ing pursued. As you proceed through this book, you will
discover that many factors affect the value of a stock,
which make it difficult to determine precisely when man-
agement is acting in the stockholders’ best interests. How-
ever, a firm’s management team will find it difficult to fool
investors, both in general and for a long period, because
stockholders can generally determine which major deci-
sions increase value and which ones decrease value.
1-4What Roles do Ethics and
Governance Play in Business
Success?
In the previous section, we explained how the man-
agers of a firm, who act as the agents of the owners,
should make decisions that are in the best interests of
the firm’s investors. Would you consider it unethical
for managers to act in their own best interests rather
than the best interests of the owners? Would you invest
in a firm that espoused unethical practices or had no di-
rection about how the company’s day-to-day operations
should be handled? Probably not. In this section, we dis-
cuss business ethics and corporate governance, and the
roles each of these concepts play in successful businesses.
1-4a Business Ethics
The word ethics can be defined as “moral behavior” or
“standards of conduct.” Business ethics can be thought of
as a company’s attitude and conduct toward its employees,
customers, community, and stockholders. High standards
of ethical behavior demand that a firm treat each party it
deals with in a fair and honest manner. A firm’s commit-
ment to business ethics can be measured by the tendency
of the firm and its employees to adhere to laws and regu-
lations relating to such factors as product safety and qual-
ity, fair employment practices, fair marketing and selling
practices, the use of confidential information for personal
gain, community involvement, bribery, and illegal pay-
ments to foreign governments to obtain business.
Although most firms have policies that espouse
ethical business conduct, there are many instances
of large corporations that have engaged in unethical
behavior. Companies such as Arthur Andersen, Enron,
and WorldCom MCI have fallen or been changed signifi-
cantly as the result of unethical, and sometimes illegal,
practices. In some cases, employees (generally top man-
agement) have been sentenced to prison for illegal actions
that resulted from unethical behavior. Not long ago, the
number of high-profile instances in which unethical be-
havior provided substantial gains for executives at the
expense of stockholders’ positions increased to the point
where public outcry resulted in legislation aimed at ar-
resting the apparent tide of unethical behavior in the cor-
porate world. A major reason for the legislation was that
accounting scandals caused the public to be skeptical of
accounting and financial information reported by large
U.S. corporations. Simply put, the public no longer trust-
ed what managers said. Investors felt that executives were
pursuing interests that too often resulted in large gains for
themselves and large losses for stockholders. As a result,
Congress passed the
hostile takeover The acquisition
Sarbanes-Oxley Act
of 2002. of a company over the opposition of its
management.
The 11 sec-
tions (titles) in the business ethics A company’s attitude and
conduct toward its stakeholders (employees, customers,
Sarbanes-Oxley
stockholders, and community). Ethical behavior
Act of 2002 es- requires fair and honest treatment of all parties.
tablish standards
Chapter 1: An Overview of Managerial Finance 11
for accountability and responsibility in reporting financial
information for publicly traded corporations. The act pro-
vides that a corporation must (1) have a committee that
consists of outside directors to oversee the firm’s audits,
(2) hire an external auditing firm that will render an unbi-
ased (independent) opinion concerning the firm’s financial
statements, and (3) provide additional information about
the procedures used to construct and report financial state-
ments. In addition, the firm’s chief executive officer (CEO)
and CFO must certify financial reports that are submitted
to the Securities and Exchange Commission. The act also
stiffens the criminal penalties that can be imposed for pro-
ducing fraudulent financial information and gives regula-
tory bodies greater authority to prosecute such actions.
Despite the recent decline in investor trust of fi-
nancial reporting by corporations, the executives of
most major firms in the United States believe their firms
should, and do, try to maintain high ethical standards
in all of their business dealings. Further, most executives
believe that there is a positive correlation between eth-
ics and long-run profitability because ethical behavior
(1) prevents fines and legal expenses, (2) builds public
trust, (3) attracts business from customers who appreciate
and support ethical policies, (4) attracts and keeps employ-
ees of the highest caliber, and (5) supports the economic
viability of the communities where these firms operate.
Today most large firms have in place strong codes
of ethical behavior, and they conduct training programs
designed to ensure that all employees understand what
the correct behavior is in different business situations. It
is imperative that executives and top management—the
company’s chairman, president, and vice presidents—be
openly committed to ethical behavior and that they com-
municate this commitment through their own personal ac-
tions as well as through company policies, directives, and
punishment/reward systems. Investors expect nothing less.
1-4b Corporate Governance
The term corporate governance has become a regu-
lar part of business vocabulary. As a result of the
scandals uncovered at
Arthur Andersen, En-
corporate governance
Deals with the set of rules that a firm ron, WorldCom, and
follows when conducting business; these many other compa-
rules identify who is accountable for major nies, stockholders,
financial decisions.
managers, and
stakeholders Those who are associated with a
Congress have
business, including managers, employees, customers,
become quite
suppliers, creditors, stockholders, and other parties
with an interest in the firm’s well-being. concerned with
how firms are
12 Part 1: Introduction to Managerial Finance
operated. Corporate governance deals with the set of rules
that a firm follows when conducting business. These rules
provide the “road map” that managers follow to pursue
the various goals of the firm, including maximizing its
stock price. It is important for a firm to clearly specify its
corporate governance structure so that individuals and en-
tities that have an interest in the well-being of the business
understand how their interests will be pursued. A good
corporate governance structure should provide those who
have a relationship with a firm with an understanding of
how executives run the business and who is accountable
for important decisions. As a result of the Sarbanes-Oxley
Act of 2002 and increased stockholder pressure, most firms
carefully write their corporate governance policies so that
all stakeholders—managers, stockholders, creditors, cus-
tomers, suppliers, and employees—better understand their
rights and responsibilities.6 In addition, from our previous
discussions, it should be clear that maximizing shareholder
wealth requires the fair treatment of all stakeholders.
Studies show firms that practice good corporate
governance generate higher returns to stockholders than
those that don’t have good governance policies. Good
corporate governance includes a board of directors
with members who are independent of the company’s
management. An independent board generally serves as
a checks-and-balances system that monitors important
management decisions, including executive compensa-
tion. It has also been shown that firms that develop gov-
ernance structures that make it easier to identify and
correct accounting problems and potentially unethical
or fraudulent practices perform better than firms that
have poor governance policies (internal controls).7
1-5 Forms of Businesses
in Other Countries
Large U.S. corporations can best be described as “open”
companies because they are publicly traded organiza-
tions that, for the most part, are independent of each
other and of the government. While most developed
6
Broadly speaking, the term stakeholders should include the environment in which we live and do
business. It should be apparent that a firm cannot survive—that is, remain sustainable—unless
it treats both human stakeholders and environmental stakeholders fairly. A firm that destroys
either the trust of its employees, customers, and shareholders, or the environment in which it
operates, destroys itself.
7
See, for example, Reshma Kapadia, “Stocks Reward Firms” Good Behavior,” The Wall Street
Journal Online, March 18, 2006, and David Reilly, “Checks on Internal Controls Pay Off,” The Wall
Street Journal, May 8, 2006, C3.
countries with free economies have business orga-
nizations that are similar to U.S. corporations, some
differences exist relating to ownership structure and
management of operations. Although a comprehensive
discussion is beyond the scope of this book, this sec-
tion provides some examples of differences between
U.S. companies and non-U.S. companies.
Firms in most developed economies, such as cor-
porations in the United States, offer equities with lim-
ited liability to stockholders that can be traded in do-
mestic financial markets. However, such firms are not
always called corporations. For instance, a comparable
firm in England is called a public limited company, or
PLC, while in Germany it is known as an Aktiengesell-
schaft, or AG. In Mexico, Spain, and Latin America,
such a company is called a Sociedad Anónima, or SA.
Some of these firms are publicly traded, whereas others
are privately held.
Like corporations in the United States, most large
companies in England and Canada are open, which
means their stocks are widely dispersed among a
large number of different investors, both individu-
als and institutions. On the other hand, in much of
continental Europe, stock ownership is more concen-
trated; major investor groups include families, banks,
and other corporations. In Germany and France, for
instance, other domestic companies represent the
primary group of shareholders, followed by families.
Although banks in these countries do not hold large
numbers of shares of stock, they can greatly influence
companies because many shareholders assign banks
their proxy votes for the directors of the companies.
In addition, often the family unit has concentrated
ownership and thus represents a major influence in
many large companies in developed countries such
as these. The ownership structures of these firms and
many other large non-U.S. companies often are con-
centrated in the hands of a relatively few investors or
investment groups. Such firms are considered closed
because shares of stock often are not publicly traded,
relatively few individuals or groups own the stock,
and major stockholders generally are involved in the
firms’ daily operations.
The primary reason non-U.S. firms are likely to be
more closed, and thus have more concentrated owner-
ship, than U.S. firms results from the universal banking
relationships that exist outside the United States. Fi-
nancial institutions in other countries generally are less
regulated than in the United States, which means for-
eign banks can provide businesses with a greater variety
of services than U.S. banks can, including short-term
loans, long-term financing, and even stock ownership.
As a result, non-U.S. firms tend to have close relation-
ships with individual banking organizations that also
might take ownership positions in the companies. What
this means is that banks in countries like Germany can
meet the financing needs of family-owned businesses,
even if they are very large. Therefore, such companies do
not need to go public, and thus relinquish control in or-
der to finance additional growth. The opposite is true in
the United States, where large firms do not have compa-
rable “one-stop” financing outlets. Hence, their growth
generally must be financed by bringing in outside own-
ers, which results in more widely dispersed ownership.
In some parts of the world, firms belong to
industrial groups, which are organizations composed
of companies in different industries that have com-
mon ownership interests and, in some instances, shared
management. Firms in an industrial group are linked by
a major lender, typically a bank, which often also has
a significant ownership interest, along with other firms
in the group. The objective of an industrial group is to
create an organization that ties together all the func-
tions of production and sales from start to finish by
including firms that provide the materials and services
required to manufacture and sell the group’s products.
Thus, an industrial group encompasses firms involved in
manufacturing, financing, marketing, and distribution
of products: suppliers of raw materials, production or-
ganizations, retail stores, and creditors. A portion of the
stocks of firms that are members of an industrial group
might be traded publicly, but the lead company, which
is typically a major creditor, controls the management
of the entire group. Industrial groups are most promi-
nent in Asian countries. In Japan, an industrial group is
called a keiretsu, while it is called a chaebol in Korea.
Well-known keiretsus include Mitsubishi, Toshiba, and
Toyota, while Hyundai probably is the most recogniz-
able chaebol. The success of industrial groups in Japan
and Korea has inspired the formation of similar orga-
nizations in developing countries in Latin America and
Africa as well as in other parts of Asia.
The differences in
ownership concen-
proxy votes Voting power that is
tration of non-U.S. assigned to another party, such as another
firms might cause stockholder or institution.
the behavior of industrial groups Organizations of
managers, and companies in different industries with common
thus the goals ownership interests, which include firms necessary
they pursue, to to manufacture and sell products; networks of
differ. For in- manufacturers, suppliers, marketing organizations,
distributors, retailers, and creditors.
stance, often it
Chapter 1: An Overview of Managerial Finance 13
is argued that the greater concentration of ownership example, Xerox has introduced more than 80 dif-
of non-U.S. firms permits managers to focus more on ferent office copiers in the United States that were
long-term objectives, especially wealth maximization, engineered and built by its Japanese joint venture,
than on short-term earnings, because these firms have Fuji Xerox.
easier access to credit in times of financial difficulty. In
4. To seek production efficiency—Companies in countries
other words, creditors who also are owners generally
where production costs are high tend to shift pro-
have greater interest in supporting both short-term and
duction to low-cost countries. The ability to shift
long-term survival. On the other hand, it also has been
production from country to country has important
argued that the ownership structures of non-U.S. firms
implications for labor costs in all countries. For ex-
create an environment where it is difficult to change
ample, when Xerox threatened to move its copier
managers, especially if they are significant stockhold-
rebuilding work to Mexico, its union in Rochester,
ers. Such entrenchment could be detrimental to firms if
New York, agreed to work rule and productivity
management is inefficient. Whether the ownership struc-
improvements that kept the operation in the United
ture of non-U.S. firms is an advantage or a disadvantage
States.
is debatable. What we do know is that the greater con-
centration of ownership in non-U.S. firms permits greater 5. To avoid political and regulatory hurdles—Many years
monitoring and control by individuals or groups than do ago, Japanese auto companies moved production to
the more dispersed ownership structures of U.S. firms. the United States to get around U.S. import quo-
tas. Now, Honda, Nissan, and Toyota all assemble
automobiles or trucks in the United States. Simi-
1-5a Multinational Corporations larly, one of the factors that prompted U.S. phar-
Large firms, both in the United States and in other coun- maceutical maker SmithKline and U.K. drug com-
tries, generally do not operate in a single country; rather, pany Beecham to merge in 1989 was the desire to
they conduct business throughout the world. Because
large multinational companies are involved in all phases
of the production process, from extraction of raw ma-
terials, through the manufacturing process, to distribu-
tion to consumers throughout the world, managers of
such firms face a wide range of issues that are not pres-
ent when a company operates in a single country.
U.S. and foreign companies “go international” for
the following major reasons:
1. To seek new markets—After a company has saturated
its home market, growth opportunities often are bet-
ter in foreign markets. As a result, such homegrown
firms as Coca-Cola and McDonald’s have aggres-
sively expanded into overseas markets, and foreign
firms such as Sony and Toshiba are major competi-
tors in the U.S. consumer electronics market.
2. To seek raw materials—Many U.S. oil companies,
such as ExxonMobil, have major subsidiaries
around the world to ensure that they have contin-
ued access to the basic resources needed to sustain
their primary lines of business.
3. To seek new technology—No single nation holds
PhotoLink/Getty Images

a commanding advantage in all technologies, so

companies scour the
multinational companies globe for lead-
Firms that operate in two or more
ing scientific and
countries.
design ideas. For

14 Part 1: Introduction to Managerial Finance

 avoid licensing and regulatory delays in their largest
markets. Now, GlaxoSmithKline, as the company is
known, can identify itself as an inside player in both
Europe and the United States.
The substantial growth that has occurred in
multinational business during the past few decades
has created an increasing degree of mutual influence
and interdependence among business enterprises and
nations, to which the United States is not immune. Po-
litical and social developments that influence the world
economy also influence U.S. businesses and financial
markets.
Multinational Versus Domestic
1-5b
Managerial Finance
In theory, the concepts and procedures discussed in the
remaining chapters of this book are valid for both do-
mestic and multinational operations. However, several
problems associated with the international environment
increase the complexity of the manager’s task in a mul-
tinational corporation, and they often force the man-
ager to change the way alternative courses of action are
evaluated and compared. Six major factors distinguish
managerial finance as practiced by firms operating
entirely within a single country from management by
firms that operate in several different countries:
1. Different currency denominations—Cash flows in vari-
ous parts of a multinational corporate system often
are denominated in different currencies. Hence, an
analysis of exchange rates and the effects of fluctuat-
ing currency values must be included in all multina-
tional financial analyses.
2. Economic and legal ramifications—Each country in
which the firm operates has its own political and
economic institutions, and institutional differences
among countries can cause significant problems
when a firm tries to coordinate and control the
worldwide operations of its subsidiaries. For ex-
ample, differences in tax laws among countries can
cause after-tax consequences that differ substan-
tially depending on where a transaction occurs. In
addition, differences in legal systems of host nations
complicate many matters, from the simple record-
ing of a business transaction to the role played by
the judiciary in resolving conflicts. Such differences
can restrict multinational corporations’ flexibility
to deploy resources as they wish, and can even make
procedures illegal in one part of the company that
are required in another part. These differences also
make it difficult for executives trained in one coun-
try to operate effectively in another.
3. Language differences—The ability to communicate
is critical in all business transactions. Persons
born and educated in the United States often are
at a disadvantage because they generally are fluent
only in English, whereas European and Asian busi-
nesspeople usually are fluent in several languages,
including English. As a result, it is often easier for
international companies to invade U.S. markets
than it is for American firms to penetrate interna-
tional markets.
4. Cultural differences—Even within geographic re-
gions long considered fairly homogeneous, differ-
ent countries have distinctive cultural heritages that
shape values and influence the role of business in
the society. Multinational corporations find that
such matters as defining the appropriate goals of
the firm, attitudes toward risk taking, dealing with
employees, and the ability to curtail unprofitable
operations can vary dramatically from one country
to the next.
5. Role of governments—Most traditional models in fi-
nance assume the existence of a competitive mar-
ketplace in which the terms of trade are determined
by the participants. The government, through its
power to establish basic ground rules, is involved in
this process, but its participation is minimal. Thus,
the market provides both the primary barometer of
success and the indicator of the actions that must
be taken to remain competitive. This view of the
process is reasonably correct for the United States
and a few other major industrialized nations, but it
does not accurately describe the situation in most
of the world. Frequently, the terms under which
companies compete, the actions that must be taken
or avoided, and the terms of trade on various trans-
actions are determined by direct negotiation be-
tween the host government and the multinational
corporation rather than in the marketplace. This is
essentially a political process, and it must be treated
as such.
6. Political risk—The main characteristic that differen-
tiates a nation from a multinational corporation
is that the nati-
on exercises exchange rates The prices at which the
sovereign- currency of one country can be converted into the
ty over the currencies of other countries.
Chapter 1: An Overview of Managerial Finance 15
 people and property in its territory. Hence, a na-
tion is free to place constraints on the transfer of
corporate resources and even to expropriate—that
is, take for public use—the assets of a firm without
compensation. This is political risk, and it tends
to be a given rather than a variable that can be
changed by negotiation. Political risk varies from
country to country, and it must be addressed ex-
plicitly in any multinational financial analysis. An-
other aspect of political risk is terrorism against
KEy MANAGERIAL FINANCE CONCEPTS
To conclude this chapter, we summarize some key concepts.
Financial decisions deal with cash flows, both in-
▼
▼
flows and outflows.
All else equal, investors prefer (1) more value rather
▼
▼
than less value, (2) to receive cash sooner rather
than later, and (3) less risk rather than more risk.
The three principal forms of business organization
▼
▼
in the United States are (1) proprietorship, (2) part-
nership, and (3) corporation.
The primary goal of the financial manager should
▼
▼
be to maximize the value of the firm.
The managers of a firm are the decision-making
▼
▼
agents of its owners (that is, the stockholders in a
PROBLEMS For more problems, login to CourseMate for CFIN at CengageBrain.com
1–1 What is finance? What types of decisions do
people in finance make?
1–2 Why should persons who pursue careers in busi-
ness have a basic understanding of finance even
if their jobs are in areas other than finance, such
as marketing or personnel?
1–3 What does it mean to maximize the value of a
corporation?
1–4 In general terms, how is value measured? What
three factors determine value? How does each
factor affect value?
1–5 What is the difference between stock price max-
imization and profit maximization? Under what
conditions might profit maximization not lead
to stock price maximization?
16 Part 1: Introduction to Managerial Finance
U.S. firms or executives abroad. For example, in the
past, U.S. executives have been abducted and held
for ransom in several South American and Middle
Eastern countries.
These six factors complicate managerial fi-
nance within multinational firms, and they in-
crease the risks these firms face. However, pros-
pects for high profits often make it worthwhile
for firms to accept these risks and to learn how to
minimize or at least live with them.
corporation). When managers do not make deci-
sions that are in the best interests of the owners,
agency problems exist. Agency problems can be
mitigated by rewarding managers for making deci-
sions that help maximize the firm’s value.
Firms that are ethical and have good governance
▼
▼
policies generally perform better than firms that
are less ethical or have poor governance policies.
Firms “go international” for a variety of reasons,
▼
▼
including to operate in new markets, to search for
raw materials, to attain production efficiency, and
to avoid domestic regulations.
Foreign firms generally are less open—that is, have
▼
▼
fewer owners (stockholders)—than U.S. firms.
1–6 What are some actions stockholders can take to
ensure that management’s interests and those
of stockholders coincide? What are some other
factors that might influence management’s ac-
tions?
1–7 If you were the owner of a proprietorship, would
you make decisions to maximize the value of
your business or your personal satisfaction?
1–8 Suppose you are the president of a large corpora-
tion located in Seattle, Washington. How do you
think the stockholders will react if you decide to
increase the proportion of the company’s assets
that is financed with debt from 35 percent to
50 percent? In other words, what if the firm used
much more debt to finance its assets.
Another random document with
no related content on Scribd:
swell-headed plutes out on Royal Ridge,” reflected the Reverend Mr.
Gantry.
Through his old acquaintance, Gil O’Hearn of the O’Hearn
House, Elmer met a responsible contractor and inquired into the
fruitfulness of the Wellspring vineyard.
“Yes, they’re dead certain to build a bunch of apartment-houses,
and pretty good ones, in that neighborhood these next few years. Be
a big residential boom in Old Town. It’s near enough in to be handy
to the business section, and far enough from the Union Station so’s
they haven’t got any warehouses or wholesalers. Good buy,
Reverend.”
“Oh, I’m not buying—I’m just selling—selling the gospel!” said the
Reverend, and he went to inform Bishop Toomis that after prayer
and meditation he had been led to accept the pastorate of the
Wellspring Church.
So, at thirty-nine, Cæsar came to Rome, and Rome heard about
it immediately.
 CHAPTER XXIII

I
he did not stand by the altar now, uplifted in a vow that he would
be good and reverent. He was like the new general manager of a
factory as he bustled for the first time through the Wellspring
Methodist Church, Zenith, and his first comment was “The plant’s run
down—have to buck it up.”
He was accompanied on his inspection by his staff: Miss Bundle,
church secretary and personal secretary to himself, a decayed and
plaintive lady distressingly free of seductiveness; Miss Weezeger,
the deaconess, given to fat and good works; and A. F. Cherry,
organist and musical director, engaged only on part time.
He was disappointed that the church could not give him a
pastoral assistant or a director of religious education. He’d have
them, soon enough—and boss them! Great!
He found an auditorium which would hold sixteen hundred people
but which was offensively gloomy in its streaky windows, its brown
plaster walls, its cast-iron pillars. The rear wall of the chancel was
painted a lugubrious blue scattered with stars which had ceased to
twinkle; and the pulpit was of dark oak, crowned with a foolish,
tasseled, faded green velvet cushion. The whole auditorium was
heavy and forbidding; the stretch of empty brown-grained pews
stared at him dolorously.
“Certainly must have been a swell bunch of cheerful Christians
that made this layout! I’ll have a new church here in five years—one
with some pep to it, and Gothic fixin’s and an up-to-date educational
and entertainment plant,” reflected the new priest.
The Sunday School rooms were spacious enough, but dingy,
scattered with torn hymn books; the kitchen in the basement, for
church suppers, had a rusty ancient stove and piles of chipped
dishes. Elmer’s own study and office was airless, and looked out on
the flivver-crowded yard of a garage. And Mr. Cherry said the organ
was rather more than wheezy.
“Oh, well,” Elmer conferred with himself afterward, “what do I
care! Anyway, there’s plenty of room for the crowds, and, believe me,
I’m the boy can drag ’em in! . . . God, what a frump that Bundle
woman is! One of these days I’ll have a smart girl secretary—a
good-looker. Well, hurray, ready for the big work! I’ll show this town
what high-class preaching is!”
Not for three days did he chance to think that Cleo might also like
to see the church.

II
Though there were nearly four hundred thousand people in
Zenith and only nine hundred in Banjo Crossing, Elmer’s reception in
the Zenith church basement was remarkably like his reception in the
Banjo basement. There were the same rugged, hard-handed
brothers, the same ample sisters renowned for making doughnuts,
the same brisk little men given to giggling and pious jests. There
were the same homemade ice cream and homemade oratory. But
there were five times as many people as at the Banjo reception, and
Elmer was ever a lover of quantity. And among the transplanted
rustics were several prosperous professional men, several well-
gowned women, and some pretty girls who looked as though they
went to dancing school, Discipline or not.
He felt cheerful and loving toward them—his, as he pointed out to
them, “fellow crusaders marching on resolutely to achievement of the
Kingdom of God on earth.”
It was easy to discover which of the members present from the
Official Board of the church were most worth his attentions. Mr.
Ernest Apfelmus, one of the stewards, was the owner of the Gem of
the Ocean Pie and Cake Corporation. He looked like a puffy and
bewildered urchin suddenly blown up to vast size; he was very rich,
Miss Bundle whispered; and he did not know how to spend his
money except on his wife’s diamonds and the cause of the Lord.
Elmer paid court to Mr. Apfelmus and his wife, who spoke quite a
little English.
Not so rich but even more important, Elmer guessed, was T. J.
Rigg, the famous criminal lawyer, a trustee of Wellspring Church.
Mr. Rigg was small, deep-wrinkled, with amused and knowing
eyes. He would be, Elmer felt instantly, a good man with whom to
drink. His wife’s face was that of a girl, round and smooth and blue-
eyed, though she was fifty and more, and her laughter was lively.
“Those are folks I can shoot straight with,” decided Elmer, and he
kept near them.
Rigg hinted, “Say, Reverend, why don’t you and your good lady
come up to my house after this, and we can loosen up and have a
good laugh and get over this sewing-circle business.”
“I’d certainly like to.” As he spoke Elmer was considering that if
he was really to loosen up, he could not have Cleo about. “Only, I’m
afraid my wife has a headache, poor girl. We’ll just send her along
home and I’ll come with you.”
“After you shake hands a few thousand more times!”
“Exactly!”
Elmer was edified to find that Mr. Rigg had a limousine with a
chauffeur—one of the few in which Elmer had yet ridden. He did like
to have his Christian brethren well heeled. But the sight of the
limousine made him less chummy with the Riggses, more respectful
and unctuous, and when they had dropped Cleo at the hotel, Elmer
leaned gracefully back on the velvet seat, waved his large hand
poetically, and breathed, “Such a welcome the dear people gave me!
I am so grateful! What a real outpouring of the spirit!”
“Look here,” sniffed Rigg, “you don’t have to be pious with us! Ma
and I are a couple of old dragoons. We like religion; like the good old
hymns—takes us back to the hick town we came from; and we
believe religion is a fine thing to keep people in order—they think of
higher things instead of all these strikes and big wages and the kind
of hell-raising that’s throwing the industrial system all out of kilter.
And I like a fine upstanding preacher that can give a good show. So
I’m willing to be a trustee. But we ain’t pious. And any time you want
to let down—and I reckon there must be times when a big cuss like
you must get pretty sick of listening to the sniveling sisterhood!—you
just come to us, and if you want to smoke or even throw in a little jolt
of liquor, as I’ve been known to do, why we’ll understand. How about
it, Ma?”
“You bet!” said Mrs. Rigg. “And I’ll go down to the kitchen, if cook
isn’t there, and fry you up a couple of eggs, and if you don’t tell the
rest of the brethren, there’s always a couple of bottles of beer on the
ice. Like one?”
“Would I!” cheered Elmer. “You bet I would! Only—I cut out
drinking and smoking quite a few years ago. Oh, I had my share
before that! But I stopped, absolute, and I’d hate to break my record.
But you go right ahead. And I want to say that it’ll be a mighty big
relief to have some folks in the church that I can talk to without
shocking ’em half to death. Some of these holier-than-thou birds
—— Lord, they won’t let a preacher be a human being!”
The Rigg house was large, rather faded, full of books which had
been read—history, biography, travels. The smaller sitting-room, with
its log fire and large padded chairs, looked comfortable, but Mrs.
Rigg shouted, “Oh, let’s go out to the kitchen and shake up a welsh
rabbit! I love to cook, and I don’t dast till after the servants go to
bed.”
So his first conference with T. J. Rigg, who became the only
authentic friend Elmer had known since Jim Lefferts, was held at the
shiny white-enamel-topped table in the huge kitchen, with Mrs. Rigg
stalking about, bringing them welsh rabbit, with celery, cold chicken,
whatever she found in the ice box.
“I want your advice, Brother Rigg,” said Elmer. “I want to make
my first sermon here something sen—well, something that’ll make
’em sit up and listen. I don’t have to get the subject in for the church
ads till tomorrow. Now what do you think of some pacifism?”
“Eh?”
“I know what you think. Of course during the war I was just as
patriotic as anybody—Four-Minute Man, and in another month I’d of
been in uniform. But honest, some of the churches are getting a lot
of kick out of hollering pacifism now the war’s all safely over—some
of the biggest preachers in the country. But far’s I’ve heard, nobody’s
started it here in Zenith yet, and it might make a big sensation.”
“Yes, that’s so, and course it’s perfectly all right to adopt pacifism
as long as there’s no chance for another war.”
“Or do you think—you know the congregation here—do you think
a more dignified and kind of you might say poetic expository sermon
would impress ’em more? Or what about a good, vigorous, right-out-
from-the-shoulder attack on vice? You know, booze and immorality—
like short skirts—by golly, girls’ skirts getting shorter every year!”
“Now that’s what I’d vote for,” said Rigg. “That’s what gets ’em.
Nothing like a good juicy vice sermon to bring in the crowds. Yes, sir!
Fearless attack on all this drinking and this awful sex immorality
that’s getting so prevalent.” Mr. Rigg meditatively mixed a highball,
keeping it light because next morning in court he had to defend a
lady accused of running a badger game. “You bet. Some folks say
sermons like that are just sensational, but I always tell ’em: once the
preacher gets the folks into the church that way—and mighty few
appreciate how hard it is to do a good vice sermon; jolt ’em enough
and yet not make it too dirty—once you get in the folks, then you can
give ’em some good, solid, old-time religion and show ’em salvation
and teach ’em to observe the laws and do an honest day’s work for
an honest day’s pay, ’stead of clock-watching like my doggone clerks
do! Yep, if you ask me, try the vice. . . . Oh, say, Ma, do you think the
Reverend would be shocked by that story about the chambermaid
and the traveling man that Mark was telling us?”
Elmer was not shocked. In fact he had another droll tale himself.
He went home at one.
“I’ll have a good time with those folks,” he reflected, in the luxury
of a taxicab. “Only, better be careful with old Rigg. He’s a shrewd
bird, and he’s onto me. . . . Now what do you mean?” indignantly.
“What do you mean by ‘onto me’? There’s nothing to be onto! I
refused a drink and a cigar, didn’t I? I never cuss except when I lose
my temper, do I? I’m leading an absolutely Christian life. And I’m
bringing a whale of a lot more souls into churches than any of these
pussy-footing tin saints that’re afraid to laugh and jolly people. ‘Onto
me’ nothing!”

III
On Saturday morning, on the page of religious advertisements in
the Zenith newspapers, Elmer’s first sermon was announced in a
two-column spread as dealing with the promising problem: “Can
Strangers Find Haunts of Vice in Zenith?”
They could, and with gratifying ease, said Elmer in his sermon.
He said it before at least four hundred people, as against the
hundred who had normally been attending.
He himself was a stranger in Zenith, and he had gone forth and
he had been “appalled—aghast—bowed in shocked horror” at the
amount of vice, and such interesting and attractive vice. He had
investigated Braun’s Island, a rackety beach and dance-floor and
restaurant at South Zenith, and he had found mixed bathing. He
described the ladies’ legs; he described the two amiable young
women who had picked him up. He told of the waiter who, though he
denied that Braun’s Restaurant itself sold liquor, had been willing to
let him know where to get it, and where to find an all-night game of
poker—“and, mind you, playing poker for keeps, you understand,”
Elmer explained.
On Washington Avenue, North, he had found two movies in
which “the dreadful painted purveyors of putrescent vice”—he meant
the movie actors—had on the screen danced “suggestive steps
which would bring the blush of shame to the cheeks of any decent
woman,” and in which the same purveyors had taken drinks which
he assumed to be the deadly cocktails. On his way to his hotel after
these movies three ladies of the night had accosted him, right under
the White Way of lights. Street-corner loafers—he had apparently
been very chummy with them—had told him of blind pigs, of dope-
peddlers, of strange lecheries.
“That,” he shouted, “is what one stranger was able to find in your
city—now my city, and well beloved! But could he find virtue so
easily, could he, could he? Or just a lot of easy-going churches,
lollygagging along, while the just God threatens this city with the fire
and devouring brimstone that destroyed proud Sodom and
Gomorrah in their abominations! Listen! With the help of God
Almighty, let us raise here in this church a standard of virtue that no
stranger can help seeing! We’re lazy. We’re not burning with a fever
of righteousness. On your knees, you slothful, and pray God to
forgive you and to aid you and me to form a brotherhood of helpful,
joyous, fiercely righteous followers of every commandment of the
Lord Our God!”
The newspapers carried almost all of it. . . . It had just happened
that there were reporters present—it had just happened that Elmer
had been calling up the Advocate-Times on Saturday—it had just
happened that he remembered he had met Bill Kingdom, the
Advocate reporter, in Sparta—it had just happened that to help out
good old Bill he had let him know there would be something stirring
in the church, come Sunday.
The next Saturday Elmer advertised “Is There a Real Devil
Sneaking Around with Horns and Hoofs?” On Sunday there were
seven hundred present. Within two months Elmer was preaching,
ever more confidently and dramatically, to larger crowds than were
drawn by any other church in Zenith except four or five.
But, “Oh, he’s just a new sensation—he can’t last out—hasn’t got
the learning and staying-power. Besides, Old Town is shot to pieces,”
said Elmer’s fellow vinters—particularly his annoyed fellow
Methodists.

IV
Cleo and he had found a gracious old house in Old Town, to be
had cheap because of the ragged neighborhood. He had hinted to
her that since he was making such a spiritual sacrifice as to take a
lower salary in coming to Zenith, her father, as a zealous Christian,
ought to help them out; and if she should be unable to make her
father perceive this, Elmer would regretfully have to be angry with
her.
 She came back from a visit to Banjo Crossing with two thousand
dollars.
Cleo had an instinct for agreeable furniture. For the old house,
with its white mahogany paneling, she got reproductions of early
New England chairs and commodes and tables. There was a white-
framed fireplace and a fine old crystal chandelier in the living-room.
“Some class! We can entertain the bon ton here, and, believe
me, I’ll soon be having a lot of ’em coming to church! . . . Sometimes
I do wish, though, I’d gone out for the Episcopal Church. Lots more
class there, and they don’t beef if a minister takes a little drink,” he
said to Cleo.
“Oh, Elmer, how can you! When Methodism stands for—”
“Oh, God, I do wish that just once you wouldn’t deliberately
misunderstand me! Here I was just carrying on a philosophical
discussion, and not speaking personal, and you go and—”
His house in order, he gave attention to clothes. He dressed as
calculatingly as an actor. For the pulpit, he continued to wear
morning clothes. For his church study, he chose offensively
inoffensive lounge suits, gray and brown and striped blue, with linen
collars and quiet blue ties. For addresses before slightly boisterous
lunch-clubs, he went in for manly tweeds and manly soft collars,
along with his manly voice and manly jesting.
He combed his thick hair back from his strong, square face, and
permitted it to hang, mane-like, just a bit over his collar. But it was
still too black to be altogether prophetic.
The two thousand was gone before they had been in Zenith a
month.
“But it’s all a good investment,” he said. “When I meet the Big
Bugs, they’ll see I may have a dump of a church in a bum section but
I can put up as good a front as if I were preaching on Chickasaw
Road.”

V
 If in Banjo Crossing Elmer had been bored by inactivity, in Zenith
he was almost exhausted by the demands.
Wellspring Church had been carrying on a score of institutional
affairs, and Elmer doubled them, for nothing brought in more
sympathy, publicity, and contributions. Rich old hyenas who never
went to church would ooze out a hundred dollars or even five
hundred when you described the shawled mothers coming tearfully
to the milk station.
There were classes in manual training, in domestic science, in
gymnastics, in bird study, for the poor boys and girls of Old Town.
There were troops of Boy Scouts, of Camp Fire Girls. There were
Ladies’ Aid meetings, Women’s Missionary Society meetings, regular
church suppers before prayer-meeting, a Bible Training School for
Sunday School teachers, a sewing society, nursing and free food for
the sick and poor, half a dozen clubs of young men and women, half
a dozen circles of matrons, and a Men’s Club with monthly dinners,
for which the pastor had to snare prominent speakers without
payment. The Sunday School was like a small university. And every
day there were dozens of callers who asked the pastor for comfort,
for advice, for money—young men in temptation, widows wanting
jobs, old widows wanting assurance of immortality, hoboes wanting
hand-outs, and eloquent book-agents. Where in Banjo the villagers
had been shy to expose their cancerous sorrows, in the city there
were always lonely people who reveled in being a little twisted, a
little curious, a little shameful; who yearned to talk about themselves
and who expected the pastor to be forever interested.
Elmer scarce had time to prepare his sermons, though he really
did yearn now to make them original and eloquent. He was no longer
satisfied to depend on his barrel. He wanted to increase his
vocabulary; he was even willing to have new ideas, lifted out of
biology and biography and political editorials.
He was out of the house daily at eight in the morning—usually
after a breakfast in which he desired to know of Cleo why the deuce
she couldn’t keep Nat and Bunny quiet while he read the paper—and
he did not return till six, burning with weariness. He had to study in
the evening. . . . He was always testy. . . . His children were afraid of
him, even when he boisterously decided to enact the Kind Parent for
one evening and to ride them pickaback, whether or no they wanted
to be ridden pickaback. They feared God properly and kept his
commandments, did Nat and Bunny, because their father so
admirably prefigured God.
When Cleo was busy with meetings and clubs at the church,
Elmer blamed her for neglecting the house; when she slackened her
church work, he was able equally to blame her for not helping him
professionally. And obviously it was because she had so badly
arranged the home routine that he never had time for morning
Family Worship. . . . But he made up for it by the violence of his
Grace before Meat, during which he glared at the children if they
stirred in their chairs.
And always the telephone was ringing—not only in his office but
at home in the evening.
What should Miss Weezeger, the deaconess, do about this old
Miss Mally, who wanted a new nightgown? Could the Reverend
Gantry give a short talk on “Advertising and the Church” to the Ad
Club next Tuesday noon? Could he address the Letitia Music and
Literary Club on “Religion and Poetry” next Thursday at four—just
when he had a meeting with the Official Board. The church janitor
wanted to start the furnace, but the coal hadn’t been delivered. What
advice would the Reverend Mr. Gantry give to a young man who
wanted to go to college and had no money? From what book was
that quotation about “Cato learned Greek at eighty Sophocles” which
he had used in last Sunday’s sermon? Would Mr. Gantry be so kind
and address the Lincoln School next Friday morning at nine-fifteen—
the dear children would be so glad of any Message he had to give
them, and the regular speaker couldn’t show up. Would it be all right
for the Girls’ Basket Ball team to use the basement tonight? Could
the Reverend come out, right now, to the house of Ben T. Evers,
2616 Appleby Street—five miles away—because grandmother was
very ill and needed consolation. What the dickens did the Reverend
mean by saying, last Sunday, that hell-fire might be merely spiritual
and figurative—didn’t he know that that was agin Matthew V:29: “Thy
whole body should be cast into hell.” Could he get the proof of the
church bulletin back to the printers right away? Could the officers of
the Southwest Circle of Women meet in Mr. Gantry’s study
tomorrow? Would Reverend Gantry speak at the Old Town
Improvement Association Banquet? Did the Reverend want to buy a
secondhand motor-car in A-1 shape? Could the Reverend—
“God!” said the Reverend; and, “Huh? Why, no, of course you
couldn’t answer ’em for me, Cleo. But at least you might try to keep
from humming when I’m simply killing myself trying to take care of all
these blame’ fools and sacrificing myself and everything!”
And the letters.
In response to every sermon he had messages informing him
that he was the bright hope of evangelicism and that he was a
cloven-hoofed fiend; that he was a rousing orator and a human
saxophone. One sermon on the delights of Heaven, which he
pictured as a perpetual summer afternoon at a lake resort, brought in
the same mail four comments:

i have got an idea for you verry important since hearing yrs of
last sunday evening why do’nt you hold services every evning
to tell people & etc about heven and danger of hell we must
hurry hurry hurry, the church in a bad way and is up to us who
have many and infaliable proofs of heven and hell to hasten
yes we must rescew the parishing, make everywhere the call
of the lord, fill the churches and empty these damable theatre.
Yrs for his coming,
James C. Wickes,
2113 A, McGrew Street.

The writer is an honest and unwavering Christian and I want

to tell you, Gantry, that the only decent and helpful and
enjoyable thing about your sermon last Sunday a. m. was
your finally saying “Let us pray,” only you should have said
“Let me prey.” By your wibbly-wabbly emphasis on Heaven
and your fear to emphasize the horrors of Hell, you get people
into an easy-going, self-satisfied frame of mind where they
slip easily into sin, and while pretending to be an earnest and
literal believer in every word of the Scriptures, you are an
 atheist in sheep’s clothing. I am a minister of the gospel and
know whereof I speak.
Yours,
Almon Jewings Strafe.

I heard your rotten old-fashioned sermon last Sunday. You

pretend to be liberal, but you are just a hide-bound
conservative. Nobody believes in a material heaven or hell
any more, and you make yourself ridiculous by talking about
them. Wake up and study some modern dope.
A Student.

Dear Brother, your lovely sermon last Sunday about Heaven

was the finest I have ever heard. I am quite an old lady and
not awful well and in my ills and griefs, especially about my
grandson who drinks, your wonderful words give me such a
comfort I cannot describe to you.
Yours admiringly,
Mrs. R. R. Gommerie.

And he was expected, save with the virulent anonymous letters,

to answer all of them . . . in his stuffy office, facing a shelf of black-
bound books, dictating to the plaintive Miss Bundle, who never
caught an address, who always single-spaced the letters which
should have been double-spaced, and who had a speed which
seemed adequate until you discovered that she attained it by leaving
out most of the verbs and adjectives.

VI
Whether or not he was irritable on week days, Sundays were to
his nervous family a hell of keeping out of his way, and for himself
they had the strain of a theatrical first night.
He was up at seven, looking over his sermon-notes, preparing his
talk to the Sunday School, and snarling at Cleo, “Good Lord, you
might have breakfast on time today, at least, and why in heaven’s
name you can’t get that furnace-man here so I won’t have to freeze
while I’m doing my studying—”
 He was at Sunday School at a quarter to ten, and often he had to
take the huge Men’s Bible Class and instruct it in the more occult
meanings of the Bible, out of his knowledge of the original Hebrew
and Greek as denied to the laity.
Morning church services began at eleven. Now that he often had
as many as a thousand in the audience, as he peeped out at them
from the study he had stage-fright. Could he hold them? What the
deuce had he intended to say about communion? He couldn’t
remember a word of it.
It was not easy to keep on urging the unsaved to come forward
as though he really thought they would and as though he cared a
hang whether they did or not. It was not easy, on communion
Sundays, when they knelt round the altar rail, to keep from laughing
at the sanctimonious eyes and prim mouths of brethren whom he
knew to be crooks in private business.
It was not easy to go on saying with proper conviction that
whosoever looked on a woman to lust after her would go booming
down to hell when there was a pretty and admiring girl in the front
row. And it was hardest of all, when he had done his public job, when
he was tired and wanted to let down, to stand about after the sermon
and be hand-shaken by aged spinster saints who expected him to
listen without grinning while they quavered that he was a silver-
plated angel and that they were just like him.
To have to think up a new, bright, pious quip for each of them! To
see large sporting males regarding him the while as though he were
an old woman in trousers!
By the time he came home for Sunday lunch he was looking for a
chance to feel injured and unappreciated and pestered and put
upon, and usually he found the chance.
There were still ahead of him, for the rest of the day, the Sunday
evening service, often the Epworth League, sometimes special
meetings at four. Whenever the children disturbed his Sunday
afternoon nap, Elmer gave an impersonation of the prophets. Why!
All he asked of Nat and Bunny was that, as a Methodist minister’s
children, they should not be seen on the streets or in the parks on
the blessed Sabbath afternoon, and that they should not be heard
about the house. He told them, often, that they were committing an
unexampled sin by causing him to fall into bad tempers unbecoming
a Man of God.
But through all these labors and this lack of domestic sympathy
he struggled successfully.

VII
Elmer was as friendly as ever with Bishop Toomis.
He had conferred early with the bishop and with the canny
lawyer-trustee, T. J. Rigg, as to what fellow-clergymen in Zenith it
would be worth his while to know.
Among the ministers outside the Methodist Church, they
recommended Dr. G. Prosper Edwards, the highly cultured pastor of
the Pilgrim Congregational Church, Dr. John Jennison Drew, the
active but sanctified leader of the Chatham Road Presbyterian
Church, that solid Baptist, the Reverend Hosea Jessup, and Willis
Fortune Tate, who, though he was an Episcopalian and very shaky
as regards liquor and hell, had one of the suavest and most
expensive flocks in town. And if one could endure the Christian
Scientists’ smirking conviction that they alone had the truth, there
was the celebrated leader of the First Christian Science Church, Mr.
Irving Tillish.
The Methodist ministers of Zenith Elmer met and studied at their
regular Monday morning meetings, in the funeral and wedding
chapel of Central Church. They looked like a group of prosperous
and active business men. Only two of them ever wore clerical
waistcoats, and of these only one compromised with the Papacy and
the errors of Canterbury by turning his collar around. A few
resembled farmers, a few stone-masons, but most of them looked
like retail shops. The Reverend Mr. Chatterton Weeks indulged in
claret-colored “fancy socks,” silk handkerchiefs, and an enormous
emerald ring, and gave a pleasant suggestion of vaudeville. Nor
were they too sanctimonious. They slapped one another’s backs,
they used first names, they shouted, “I hear you’re grabbing off all
the crowds in town, you old cuss!” and for the manlier and more
successful of them it was quite the thing to use now and then a
daring “damn.”
It would, to an innocent layman, have been startling to see them
sitting in rows like schoolboys; to hear them listening not to
addresses on credit and the routing of hardware but to short helpful
talks on Faith. The balance was kept, however, by an adequate
number of papers on trade subjects—the sort of pews most soothing
to the back; the value of sending postcards reading “Where were you
last Sunday, old scout? We sure did miss you at the Men’s Bible
Class”; the comparative values of a giant imitation thermometer, a
giant clock, and a giant automobile speedometer, as a register of the
money coming in during special drives; the question of gold and
silver stars as rewards for Sunday School attendance; the
effectiveness of giving the children savings-banks in the likeness of a
jolly little church to encourage them to save their pennies for
Christian work; and the morality of violin solos.
Nor were the assembled clergy too inhumanly unboastful in their
reports of increased attendance and collections.
Elmer saw that the Zenith district superintendent, one Fred Orr,
could be neglected as a creeping and silent fellow who was all right
at prayer and who seemed to lead an almost irritatingly pure life, but
who had no useful notions about increasing collections.
The Methodist preachers whom he had to take seriously as rivals
were four.
There was Chester Brown, the ritualist, of the new and ultra-
Gothic Asbury Church. He was almost as bad, they said, as an
Episcopalian. He wore a clerical waistcoat buttoned up to his collar;
he had a robed choir and the processional; he was rumored once to
have had candles on what was practically an altar. He was, to Elmer,
distressingly literary and dramatic. It was said that he had literary
gifts; his articles appeared not only in the Advocate but in the
Christian Century and the New Republic—rather whimsical essays,
safely Christian but frank about the church’s sloth and wealth and
blindness. He had been Professor of English Literature and Church
History in Luccock College, and he did such sermons on books as
Elmer, with his exhausting knowledge of Longfellow and George
Eliot, could never touch.
Dr. Otto Hickenlooper of Central Church was an even more
distressing rival. His was the most active institutional church of the
whole state. He had not only manual training and gymnastics but
sacred pageants, classes in painting (never from the nude), classes
in French and batik-making and sex hygiene and bookkeeping and
short-story writing. He had clubs for railroad men, for stenographers,
for bell-boys; and after the church suppers the young people were
encouraged to sit about in booths to which the newspapers referred
flippantly as “courting corners.”
Dr. Hickenlooper had come out hard for Social Service. He was in
sympathy with the American Federation of Labor, the I. W. W., the
Socialists, the Communists, and the Nonpartisan League, which was
more than they were with one another. He held Sunday evening
lectures on the Folly of War, the Minimum Wage, the need of clean
milk; and once a month he had an open forum, to which were invited
the most dangerous radical speakers, who were allowed to say
absolutely anything they liked, provided they did not curse, refer to
adultery, or criticize the leadership of Christ.
Dr. Mahlon Potts, of the First Methodist Church, seemed to Elmer
at first glance less difficult to oust. He was fat, pompous, full of heavy
rumbles of piety. He was a stage parson. “Ah, my dear Brother!” he
boomed; and “How are we this morning, my dear Doctor, and how is
the lovely little wife?” But Dr. Potts had the largest congregation of
any church of any denomination in Zenith. He was so respectable.
He was so safe. People knew where they were, with him. He was
adequately flowery of speech—he could do up a mountain, a sunset,
a burning of the martyrs, a reception of the same by the saints in
heaven, as well as any preacher in town. But he never doubted nor
let any one else doubt that by attending the Methodist Church
regularly, and observing the rules of repentance, salvation, baptism,
communion, and liberal giving, every one would have a minimum of
cancer and tuberculosis and sin, and unquestionably arrive in
heaven.
 These three Elmer envied but respected; one man he envied and
loathed.
That was Philip McGarry of the Arbor Methodist Church.
Philip McGarry, Ph. D. of the University of Chicago in economics
and philosophy—only everybody who liked him, layman or fellow-
parson, seemed to call him “Phil”—was at the age of thirty-five
known through the whole American Methodist Church as an enfant
terrible. The various sectional editions of the Advocate admired him
but clucked like doting and alarmed hens over his frequent
improprieties. He was accused of every heresy. He never denied
them, and the only dogma he was known to give out positively was
the leadership of Jesus—as to whose divinity he was indefinite.
He was a stocky, smiling man, fond of boxing, and even at a
funeral incapable of breathing, “Ah, sister!”
He criticized everything. He criticized even bishops—for being
too fat, for being too ambitious, for gassing about Charity during a
knock-down-and-drag-out strike. He criticized, but amiably, the social
and institutional and generally philanthropic Dr. Otto Hickenlooper,
with his clubs for the study of Karl Marx and his Sunday afternoon
reception for lonely traveling-men.
“You’re a good lad, Otto,” said Dr. McGarry—and openly, in the
preachers’ Monday meetings: “You mean well, but you’re one of
these darned philanthropists.”
“Nice word to use publicly—’darned’!” meditated the shocked
Reverend Elmer Gantry.
“All your stuff at Central, Otto,” said Dr. McGarry, “is paternalistic.
You hand out rations to the dear pee-pul and keep ’em obedient. You
talk about socialism and pacifism, and say a lot of nice things about
’em, but you always explain that reforms must come in due time,
which means never, and then only through the kind supervision of
Rockefeller and Henry Ford. And I always suspect that your activities
have behind ’em the sneaking purpose of luring the poor chumps
into religion—even into Methodism!”
The whole ministerial meeting broke into yelps.
“Well, of course, that’s the purpose—”
 “Well, if you’ll kindly tell me why you stay in the Methodist Church
when you think it’s so unimportant to—”
“Just what are you, a minister of the gospel, seeking except
religion—”
The meeting, on such a morning, was certain to stray from the
consideration of using egg-coal in church furnaces to the question as
to what, when they weren’t before their congregations and on record,
they really believed about the whole thing.
That was a very dangerous and silly thing, reflected Elmer
Gantry. No telling where you’d get to, if you went blatting around
about a lot of these fool problems. Preach the straight Bible gospel
and make folks good, he demanded, and leave all these ticklish
questions of theology and social service to the profs!
Philip McGarry wound up his cheerful attack on Dr. Hickenlooper,
the first morning when Elmer disgustedly encountered him, by
insisting, “You see, Otto, your reforms couldn’t mean anything, or
you wouldn’t be able to hold onto as many prosperous money-
grabbing parishioners as you do. No risk of the working-men in your
church turning dangerous as long as you’ve got that tight-fisted Joe
Hanley as one of your trustees! Thank Heaven, I haven’t got a
respectable person in my whole blooming flock!”
(“Yeh, and there’s where you gave yourself away, McGarry,”
Elmer chuckled inwardly. “That’s the first thing you’ve said that’s
true!”)
Philip McGarry’s church was in a part of the city incomparably
more run-down than Elmer’s Old Town. It was called “The Arbor”; it
had in pioneer days been the vineyard-sheltered village, along the
Chaloosa River, from which had grown the modern Zenith. Now it
was all dives, brothels, wretched tenements, cheap-jack shops. Yet
here McGarry lived, a bachelor, seemingly well content, counseling
pick-pockets and scrubwomen, and giving on Friday evenings a
series of lectures packed by eager Jewish girl students, radical
workmen, old cranks, and wistful rich girls coming in limousines
down from the spacious gardens of Royal Ridge.
 “I’ll have trouble with that McGarry if we both stay in this town.
Him and I will never get along together,” thought Elmer. “Well, I’ll
keep away from him; I’ll treat him with some of this Christian charity
that he talks so darn’ much about and can’t understand the real
meaning of! We’ll just dismiss him—and most of these other birds.
But the big three—how’ll I handle them?”
He could not, even if he should have a new church, outdo
Chester Brown in ecclesiastical elegance or literary messages. He
could never touch Otto Hickenlooper in institutions and social
service. He could never beat Mahlon Potts in appealing to the well-
to-do respectables.
Yet he could beat them all together!
Planning it delightedly, at the ministers’ meeting, on his way
home, by the fireplace at night, he saw that each of these stars was
so specialized that he neglected the good publicity-bringing features
of the others. Elmer would combine them; be almost as elevating as
Chester Brown, almost as institutional and meddling as Otto
Hickenlooper, almost as solidly safe and moral as Mahlon Potts. And
all three of them, in fact every preacher in town except one
Presbyterian, were neglecting the—well, some people called it
sensational, but that was just envy; the proper word, considered
Elmer, was powerful, or perhaps fearless, or stimulating—all of them
were neglecting a powerful, fearless, stimulating, and devil-
challenging concentration on vice. Booze. Legs. Society bridge. You
bet!
Not overdo it, of course, but the town would come to know that in
the sermons of the Reverend Elmer Gantry there would always be
something spicy and yet improving.
“Oh, I can put it over the whole bunch!” Elmer stretched his big
arms in joyous vigor. “I’ll build a new church. I’ll take the crowds
away from all of ’em. I’ll be the one big preacher in Zenith. And then
—— Chicago? New York? Bishopric? Whatever I want! Whee!”