Chapter 1 Introduction to Managerial Finance

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Learning Outcomes Chapter 1

Explain what finance entails and why everyone should have an understanding of basic financial concepts

Identify different forms of business organization as well as the advantages and disadvantages of each.

Identify (1) major goals that firms pursue and (2) what a firm’s primary goal should be.

Explain the role that ethics and good governance play in successful businesses.

Describe how foreign firms differ from U.S. firms and identify factors that affect financial decisions in multinational firms.

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What is Finance?

Finance is concerned with decisions about money (Cash Flows)

Finance decisions deal with how money is raised and used

Everything else being equal: More value is preferred to less The sooner cash is received the more value it has Less risky assets are more valuable than riskier

assets

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General Areas of Finance

Financial Markets and Institutions

Investments

Financial Services

Managerial Finance

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Finance in the Organizational Structure of the Firm

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Board of Directors

President (CEO)

Treasurer Controller Credit

Manager Inventory Manager

Director of Capital

Budgeting

Financial and Cost

Accounting

Tax Department

Vice-President: Finance (CFO)

Vice-President: Sales

Vice-President: Information Systems (CIO)

Vice-President: Operations (COO)

Alternative Forms of Business Organization

Proprietorship

Partnership

Corporation

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Proprietorship

Advantages: Ease of formation Subject to few government regulations No corporate income taxes

Limitations: Unlimited personal liability Limited life Transferring ownership is difficult Difficult to raise capital

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Partnership

Like a proprietorship, except two or more owners

A partnership has roughly the same advantages and limitations as a proprietorship

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Corporation

Advantages: Unlimited life Easy transfer of ownership Limited liability Ease of raising capital

Disadvantages: Cost of set-up and report filing Double taxation

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Hybrid Forms of Business

Limited Liability Partnership (LLP)

Limited Liability Company (LLC)

S Corporation

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Business Organized as a Corporation: Value Maximized

Limited liability reduces risk increasing market value

Ease of raising capital allows taking advantage of growth opportunities

Ownership can be easily transferred thus investors would be willing to pay more for a corporation

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Goals of the Corporation

Primary goal: stockholder wealth maximization — translates to maximizing stock price.

Managerial incentives Social responsibility

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Managerial Actions to Maximize Stockholder Wealth

Capital Structure Decisions

Capital Budgeting Decisions

Dividend Policy Decisions

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Value of the Firm

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Factors Influenced by Managers that Affect Stock Price Projected cash flows

Timing of cash flow streams

Risk of projected cash flows (earnings)

Use of debt (capital structure)

Dividend policy

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Agency Relationships

An agency relationship exists whenever a principal hires an agent to act on his or her behalf.

An agency problem results when the agent makes decisions that are not in the best interest of principals

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Stockholders versus Managers

Managers are naturally inclined to act in their own best interests.

Mechanisms to motivate managers to act in shareholder’s best interest Managerial compensation (incentives) Shareholder intervention Threat of takeover

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Business Ethics

Webster: “A standard of conduct and moral behavior.”

Business Ethics: A company’s attitude and conduct toward its employees, customers, community, and stockholders

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Corporate Governance

The “set of rules’ that a firm follows when conducting business

As a result of the Sarbanes-Oxley Act of 2002, firms are revising their corporate governance policies

Good corporate governance generates higher returns to stockholders

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Forms of Business in Other Countries

Non-US firms have higher concentrations of ownership

Nature of relationship with financial institutions differs from U.S.

U.S. firms have a more dispersed ownership

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Multinational Corporations 1. To seek new markets

2. To seek raw materials

3. To seek new technology

4. To seek production efficiency

5. To avoid political and regulatory hurdles

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Five reasons firms go “international”

Factors Distinguishing Domestic Firms from Multinational Firms

Different currency denominations

Economic and legal ramifications

Language differences

Cultural differences

Role of governments

Political risk

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