CHAPTER 1
An Overview of Financial
Management
Finance in general
Career Opportunities
Issues of the New Millennium
Forms of Businesses
Goals of the Corporation
Agency Relationships 1-1
Finance consists of three
interrelated areas:
Money and capital markets
Investments
Financial management
1-2
Career Opportunities in
Finance
Money and capital markets
financial institutions, including banks, insurance
companies, mutual funds, and investment banking
firms.
Investments
work for a brokerage house either in sales or as a
security analyst or as financial planners
Financial management
Finance support staff, executives or managers
1-3
Role of Finance in a Typical
Business Organization
n Board of Directors
n President
n VP: Sales n VP: Finance n VP: Operations
n Treasurer n Controller
n Credit Manager n Cost Accounting
n Inventory Manager n Financial Accounting
n Capital Budgeting Director n Tax Department
1-4
Financial Management Issues
of the New Millennium
The effect of
changing
technology
The globalization
of business
1-5
Alternative Forms of Business
Organization
Sole proprietorship
Partnership
Corporation
1-6
Sole proprietorships &
Partnerships
Advantages
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages
Difficult to raise capital
Unlimited liability
Limited life
1-7
Corporation
Advantages
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages
Double taxation
Cost of set-up and report filing
1-8
Financial Goals of the Corporation
The primary financial 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?
1-9
Is stock price maximization the
same as profit maximization?
No, despite a generally high correlation
amongst stock price, EPS, and cash flow.
Current stock price relies upon current
earnings, as well as future earnings and
cash flow.
Some actions may cause an increase in
earnings, yet cause the stock price to
decrease (and vice versa).
1-10
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
1-11
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
1-12
Shareholders versus Creditors
Shareholders (through managers) could
take actions to maximize stock price
that are detrimental to creditors.
In the long run, such actions will raise
the cost of debt and ultimately lower
stock price.
1-13
Factors that affect stock price
Projected cash flows
to shareholders
Timing of the cash
flow stream
Riskiness of the cash
flows
1-14
Basic Valuation Model
CF1 CF2 CFn
Value 1
2
(1 k) (1 k) (1 k)n
n
CFt
t
.
t 1 (1 k)
To estimate an asset’s value, one estimates the
cash flow for each period t (CFt), the life of the
asset (n), and the appropriate discount rate (k)
Throughout the course, we discuss how to
estimate the inputs and how financial management
is used to improve them and thus maximize a
firm’s value. 1-15
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
1-16
