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CHAPTER 1
An Overview of Financial Management

 Career opportunities
 Issues of the new millennium
 Forms of business organization
 Goals of the corporation
 Agency relationships
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The Key Attributes of Successful

Companies

 successful companies have skilled people

 successful companies have strong relationships
with groups outside the company
 successful companies have enough funding to
execute their plans and support their operations.

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Career Opportunities in Finance

 Money and capital markets

 Investments
 Financial management

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Responsibilities of the Financial Staff

 Forecasting and planning

 Investment and financing decisions
 Coordination and control
 Transactions in the financial markets
 Managing risk

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Financial Management
Issues of the New Millennium

 Use of computers and electronic

transfers of information
 The globalization of business

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Alternative Forms of Business

Organization

 Sole proprietorship
 Partnership
 Corporation

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Sole Proprietorship

 Advantages:
 Ease of formation
 Subject to few regulations
 No corporate income taxes (Personnel Income
Tax)
 Disadvantages:
 Limited life
 Unlimited liability
 Difficult to raise capital
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Partnership

 A partnership has roughly the same

advantages and disadvantages as a sole
proprietorship.
 Number of Partners
 Liability of Partners
 Types of Partners
 Limited (limited Control, liability)
 General (Full control and Unlimited liability)

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Corporation

 Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
 Disadvantages:
Double taxation
Cost of set-up and report filing
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Goals of the Corporation

 The primary goal is shareholder

wealth maximization, which translates
to maximizing stock price.
Do firms have any responsibilities
to society at large?
Is stock price maximization good or
bad for society?
Should firms behave ethically?
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Agency Relationships

 An agency relationship exists

whenever a principal hires an agent
to act on their behalf.
 Within a corporation, agency
relationships exist between:
Shareholders and managers
Shareholders and creditors
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Shareholders versus Managers

 Managers are naturally inclined to act

in their own best interests.
 But the following factors affect
managerial behavior:
Managerial compensation plans
Direct intervention by shareholders
The threat of firing
The threat of takeover
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Shareholders versus Creditors

 Shareholders (through managers)

could take risky actions to
maximize stock price but are
detrimental to creditors.
 In the long run, such actions will
raise the cost of debt and ultimately
lower stock price.

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Creation of Corporation
 Setting up a corporation involves preparing a
charter, writing a set of bylaws, filing the many
required state and federal reports
 Types of Other Corporation
Professional Corporation
Professional Association
 S corporation

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Stock Price and Firm Value

How Stock Price is set?

1. All Available information
2. Due to Intrinsic Value
Intrinsic Stock Value Maximization and Social
Welfare
1. To a large extent, the owners of stock are society
2. Consumers benefit.
3. Employees benefit.
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Stock Price and Firm Value

What are Managerial Actions to Maximize Shareholder

Wealth/ Firm Value (Page 12)
 Managing financial asset,
 Managing cash flows
 Manage Risk

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Stock Price and Firm Value

Firm Value and Free Cash Flow, FCF

FCF are available (or free) for distribution to all
the company’s investors, including creditors and
stockholders.

FCF = Sales revenues - Operating costs -

Operating taxes - Required new investments in
operating capital
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Stock Price and Firm Value

Firm Value and Free Cash Flow, FCF

WACC = Weighted Average Cost of Capital

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Does profit maximization equal stock

price maximization?

No, there is generally a high correlation

between EPS, cash flow, and stock price,
but today’s stock price relies not only on
current earnings, but future earnings and
cash flows.
Some actions may increase earnings yet
cause stock price to decrease (and vice
versa).
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Factors that Affect Stock Price

 Projected cash flows to shareholders

 Timing of the cash flow stream
 Riskiness of the cash flows

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Factors that Affect the Level and

Riskiness of Cash Flows

 Decisions made by financial managers:

Investment decisions
Financing decisions (the relative use
of debt financing)
Dividend policy decisions
 The external environment

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Types of Securities, Claims, Financial

Instrument

 Page 15, 16
Table 1-1

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The Cost of Money

 Factors That Affect the Cost of Money (Page 19)

(1) production opportunities,
(2) time preferences for consumption,
(3) risk, and
(4) inflation.

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The Cost of Money

 Economic Conditions and Policies That Affect the

Cost of Money
(1) Federal/Government Reserve policy;
(2) the federal budget deficit or surplus;
(3) the level of business activity;
(4) international factors, including the foreign trade balance,
the international business climate, and exchange rates.

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Financial Institutions

 Investment Banks and Brokerage Activities

Investment banking houses
 Deposit-Taking Financial Intermediaries
Savings and Loan Associations (S&Ls)
Credit Unions
Commercial Banks
 Investment Funds

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Financial Institutions

 Investment Funds
Mutual Funds.
Hedge Funds.
Private Equity Funds.
 Life Insurance Companies and Pension Funds

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Regulations of Financial Institutions

 Investment Funds
Mutual Funds.
Hedge Funds.
Private Equity Funds.
 Life Insurance Companies and Pension Funds

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