Chapter 1

Contemporary Financial Management

Revolution of the Finance Function

• 1900-1920: Focus on legal issues surrounding capital markets

• 1920’s: Corporate expansion, new technologies (e.g TV), and new financial instruments (e.g mutual funds)

• Post-1945: Current focus on financial implications of business decisions (i.e. investment, value maximization)

Revolution of the Finance Function

• Big changes in the 1980s – 2000s– Disinflation– Revolution in telecommunications– Better macroeconomic management– Large-scale asset securitization: cash flows of

assets are repackaged and sold to investors through the capital markets

– Growth of so-called BRIC countries

Revolution of the Finance Function

• Major trends that continue to affect corporate financial management:1. Globalization of business and financial

management2. Fallout from the accounting and financial scandals

of the past several years (e.g. Enron, Worldcom). Recent bankruptcies (e.g. Lehman Brothers) are the result of excessive leverage and poor financial management.

Revolution of the Finance Function

• Critical components of success– Need new framework built on sound financial

principles and transparency to gain public trust– Well-informed business decisions based on

knowledge of financial management principles and techniques

– While there are no rules and regulations that guarantee success…

Goals of Financial Management

– Maximize the value of firm’s outstanding common stock

– Maximize earnings per share (not only total profits)

– Timing of increased earnings is important! Must consider the present value of future earnings

– Balance between business and financial risk

Goals of Financial Management

• Business risk: Risk imposed by business environment and economic cycle in which firm operates– Ex. Expected future demand for electricity is less

difficult to predict than expected future demand for most high-technology products

• Financial risk: Risk imposed by manner in which firm is financed– Ex. The more debt employed, the greater risk of

insolvency

Goals of Financial Management

• Overall objective:– Maximization of earnings per share of common

stock subject to consideration of business and financial risk, time of earnings, and impact of dividend policy.

Organization and Structure of the Book

1. Introduction2. Fundamentals of financial accounting3. Financial analysis4. Working capital management5. Long-term investment decisions6. Long-term financing decisions7. Special topics– Corporate governance and risk management – International finance– Mergers and acquisitions