introduction to financial management chapter 1 forms of business organization stock prices and...
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Introduction to Financial Management
Chapter 1
Forms of Business Organization Stock Prices and Shareholder
Value Intrinsic Values, Stock Prices, and
Executive Compensation Important Business Trends Conflicts Between Managers,
Stockholders, and Bondholders 1-1
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Finance Within the Organization
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Forms of Business Organization
Proprietorship
Partnership
Corporation
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Proprietorships and Partnerships
Advantages Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages Difficult to raise capital
Unlimited liability
Limited life
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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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Stock Prices and Shareholder Value
The primary financial goal of management is shareholder wealth maximization, which translates to maximizing stock price. Value of any asset is present value of cash
flow stream to owners.
Most significant decisions are evaluated in terms of their financial consequences.
Stock prices change over time as conditions change and as investors obtain new information about a company’s prospects.
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Stock Prices and Intrinsic Value
In equilibrium, a stock’s price should equal its “true” or intrinsic value.
Intrinsic value is a long-run concept.
To the extent that investor perceptions are incorrect, a stock’s price in the short run may deviate from its intrinsic value.
Ideally, managers should avoid actions that reduce intrinsic value, even if those decisions increase the stock price in the short run.
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Determinants of Intrinsic Values and Stock Prices
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“True” Risk
“Perceived” Investor Returns
“Perceived” Risk
Managerial Actions, the Economic Environment, Taxes, and the Political
Climate
Stock’s Intrinsic Value
Stock’s Market Price
Market Equilibrium:Intrinsic Value = Stock
Price
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Some Important Business Trends
Recent corporate scandals have reinforced the importance of business ethics, and have spurred additional regulations and corporate oversight.
Increased globalization of business.
The effects of ever-improving information technology have had a profound effect on all aspects of business finance.
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Conflicts Between Managers and Stockholders
Managers are naturally inclined to act in their own best interests (which are not always the same as the interest of stockholders).
But the following factors affect managerial behavior: Managerial compensation packages
Direct intervention by shareholders
The threat of firing
The threat of takeover1-10
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Conflicts Between Stockholders and Bondholders
Stockholders are more likely to prefer riskier projects, because they receive more of the upside if the project succeeds. By contrast, bondholders receiving fixed payments are more interested in limiting risk.
Bondholders are particularly concerned about the use of additional debt.
Bondholders attempt to protect themselves by including covenants in bond agreements that limit the use of additional debt and constrain managers’ actions.
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