Contemporary

Financial Management
8th Edition
by
Moyer, McGuigan, and Kretlow
Prepared by
Tom Peacock
University of Houston

© 2001 South-Western College Publishing

 Chapter 1
The Role and Objective
of
Financial Management
Questions Faced in Finance

 How is finance related to other fields of

study?
 What are the goals and objectives of
financial managers?
 How has the finance field evolved?
 How is the finance field changing today?

3
Principal Forms of Business
Organizations
 Sole proprietorship
 Partnership
 Corporation

4
Sole Proprietorship

 Owned by one person

 Easy formation advantage
 Unlimited liability disadvantage
 Difficulty raising funds disadvantage
 Represent 75% of all businesses
 Account for < 6% of the $ volume

5
Partnership

 Owned by two or more persons

 Classified as general or limited
 Partnership dissolves when a general
partner dies

6
Liability of Partners

 General Partner
Has unlimited liability for all obligations of the
business
 Limited Partner
Liability limited to the partnership agreement

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Corporation
 Limited liability  Legal entity
 Permanency  Have a board of
 Flexibility directors
 Ability to raise of  Owners are
capital stockholders
 Easy marketability of
shares of ownership

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Stockholders
elect a board
of directors
Board of
directors
then hire
management
( officers ) 9
Who Manages ?
 Board of directors  Management makes
deals with broad most of the decisions
policy

10
Stockholder Rights
Dividend Asset
Voting Preemptive

Corporate Securities
in Order or Priority
Bonds ( highest)
Preferred stock
Common stock ( C/S ) ( lowest )

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Optimal Form of Organization
Influenced by
 Cost  Raising capital
 Complexity  Decision making
 Liability  Tax considerations
 Continuity

12
 Objective
of
Financial Management
Shareholder
( FM ) Wealth
Maximization
Objective of the (SWM)
financial manager

NOT
profit maximization
Does not consider
time value of money

13
SWM

 Considers the timing and risk of the benefits

from stock ownership
 Determines that a good decision increases
the price of the firm's common stock (c/s)
 Is an impersonal objective
 Is concerned for social responsibility

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Social Responsibility
 Ethical issues will constantly confront
financial managers as they achieve the goal
of the firm ( SWM ).

Managers Must
Avoid personal conflicts
Maintain confidentiality
Be objective
Act fairly

15
 Agency Relationships / Problems
Owners (shareholders)
 Problem created
by separation of
Management and
Employees
 Management may maximize
its own welfare instead
of the owners wealth

Job security

16
Job Security

 Management decisions based on retaining

management rather than SWM
 Example–
Example A decision to retain suppliers
rather than selecting new suppliers providing
higher quality or lower cost
 Why–
Why If the transition is mishandled
management will be scrutinized but if no
change is made the issue will be ignored
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Agency Costs

 Management incentives
 Monitor performance
 Owners protection
 Complex organization structures

Recent Trends
To flatten organization structures to cut costs
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 Owners
Problem created by
separation of Management

Owners
A similar problem
Creditors

Protective covenants
in loan agreements
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Examples of Protective Covenants

 Limitations of Common stock dividends

 Limitations on additional debts
 Not entering into sale and lease back
arrangements

20
Shareholder Wealth Maximizing Is a
Market Concept and Results in
 Maximizing PV of E(R)
 Measured by Market Value of C/S

21
3 Basic Factors Determine
C/S Market Value
 1) Amount of

 2) Timing of Expected cash flows

 3) Risk of

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Conditions Affecting Market Value

 Economic environment factors

 Decisions under management control
 Conditions in financial markets
 Expected cash flows

23
Competitive Forces Influencing
C/S Market Value
 New entrants
 Substitute products
 Bargaining power of buyers
 Bargaining power of suppliers
 Rivalry among current competitors

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Cash Flow Concept Used for

 Financial analysis
 Planning
 Resource allocation
CF does not equal accounting profit
Internal sources

Cash External sources

25
NPV of an Investment

 NPV = PV of future cash flows

minus cash outlays

The NPV of an investment

represents the contributions of
that investment to the value of
the firm and passes on to SWM

26
Different Size Businesses

Small Business
Vs.
Large Corporations
Fundamental concepts are the same

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Small Business
 Not the dominant firm in the industry
 Tend to grow more rapidly
 Limited access to financial market
 Lack management resources
 Have a high failure rate
 Stock is not publicly traded
 Poorly diversified
 Owner/manager frequently the same

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Controller’s Activities

 Financial accounting
 Cost accounting
 Taxes
 Data processing

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Treasurer’s Activities

 Management of cash and marketable

securities
 Capital budgeting
 Financial planning
 Credit analysis
 Investors relations
 Pension fund management
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Disciplines used in Finance

Economics
Accounting
Finance Marketing
Production
Human Resources
Quantitative Analysis

31
Professional Organizations

 Financial Executive Institute

 Institute of Charted Financial Analysis

 Financial Management Association

 Institute of Management Accounting

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Exciting Career Opportunities in
Finance
 VP of Finance  Financial Analyst
 Director  Account Executive
Investor Relations Security Broker
 Assistant Treasurer  Mortgage Analyst
 Tax Manager  Banking

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