Chap 1 - Goals & Governance of Firm
Chap 1 - Goals & Governance of Firm
Chap 1 - Goals & Governance of Firm
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The Role of Financial Management
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What is Financial Management?
Financial management is concerned with
the duties of the financial manager in the
business firm. Its important to comprehend
the financial decision-making process
since most business decisions ultimately
involve financial considerations.
Acquisition
Management To achieve goal
Assets
Financing
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What is Financial Management?
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Investment Decisions
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Financing Decisions
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Asset Management Decisions
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Real Assets & Financial Assets
When the firm invests, it acquires real assets , which are then used
to produce the firm’s products and services
The firm finances its investment in real assets by issuing financial
assets to investors. A share of stock is a financial asset, which has
value as a claim on the firm’s real assets and on the income that
those assets will produce. A bank loan is a financial asset also. It
gives the bank the right to get its money back plus interest. If the
firm’s operations can’t generate enough income to pay what the
bank is owed, the bank can force the firm into bankruptcy and
stake a claim on its real assets. Shares of stock and other financial
assets that can be purchased and traded by investors are called
securities.
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The Goal of the Firm?
Sales Maximization?
Maximization of Shareholder
Wealth!
Value creation occurs when we maximize the share price for
current shareholders.
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Relationship between FM &
supportive disciplines
Financial Decision areas
Primary Discipline
•Accounting
•Macroeconomics
Support
Investment analysis •Microeconomics
Working capital management
Dividend policy
Support
Other related disciplines
•Marketing
•Production
•Quantitative methods
Resulting in
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Financial Managers
Chief Financial Officer: Sets overall financial strategy he is
deeply involved in financial policy and financial planning and
is in constant contact with the chief executive officer (CEO)
and other top management. The CFO is the most important
financial voice of the corporation and explains earnings
results and forecasts to investors and the media.
Treasurer: Looks after the firm’s cash, raises new capital, and
maintains relationships with banks and other investors that
hold the firm’s securities.
Controller: prepares the financial statements, manages the
firm’s internal budgets and accounting, and looks after its tax
affairs
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Strengths of Shareholder Wealth
Maximization
Takes account of: current and future profits and EPS; the timing, duration, and risk of profits and EPS; dividend policy; and all other relevant factors.
Thus, share price serves as a barometer for business performance and any activity that is expected to increase a firm’s share price should be pursued.
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An overview of Financial
Management
Financial Management
Financial Decision
Investment Financing
Assets
Decision decision Management
Trade-off
Return Risk
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What About Other Stakeholders
Stakeholders include all groups of individuals who have a
vested/financial interest in the firm including:
Employees
Customers
Suppliers
Creditors
Owners
Government
The "Stakeholder View" prescribes that the firm make a conscious
effort to avoid actions that could be detrimental to the wealth
position of its stakeholders.
Such a view is considered to be "socially responsible."
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Social Responsibility
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Corporate Social responsibility
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Responsibility of the Financial Staff
Maximize stock value by:
Forecasting and planning
Managing risk
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Role of Finance in a Typical Business
Organization
Board of Directors
President
Treasurer Controller
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Alternative Forms of Business
Organization
Sole proprietorship
Partnership
Corporation
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Sole Proprietorship
Unincorporated business owned by one individual (1
owner)
Advantages:
Easily and inexpensively formed
Subject to few regulations
Its income is not subject to corporate taxation but
it is taxed only as a part of the proprietor’s income
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Sole Proprietorship
Disadvantages:
Difficult to raise capital
It is difficult for a single owner to obtain the capital needed for
growth
Unlimited liability
The proprietor has unlimited personal liability for the business’s
debts
Limited life
The life of a proprietorship is limited to the life of its founder
Used primarily for small businesses
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Partnership
More than 1 owner
Exists whenever two or more persons associate to conduct a
business for profit
Partnership agreements
Formal or informal
Define the ways any profits and losses are shared between
partners
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Partnership
Major advantage
Its low cost and ease of formation
Partnership’s income is not subject to corporate taxation but is
taxed only as a part of the partner’s personal income
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Partnership
Disadvantages
Unlimited liability
Limited life of the organization
Difficulty transferring ownership
Difficulty raising large amounts of capital
Regarding liability
The partners can potentially lose all of their personal assets,
even assets not invested in the business
Under partnership law, each partner is liable for the business’s
debts
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Partnership
Disadvantages
Unlimited liability
Limited life of the organization
Difficulty transferring ownership
Difficulty raising large amounts of capital
Regarding liability
The partners can potentially lose all of their personal assets,
even assets not invested in the business
Under partnership law, each partner is liable for the business’s
debts
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Partnership
It is possible to limit the liabilities of some of the partners by
establishing a limited partnership
Certain partners are designated general partners and others
limited partners
Limited partners are liable only for the amount of their investment in the
partnership
Limited partners typically have no control
General partners have unlimited liability
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Partnership
In both regular and limited partnership, at least one
partner is liable for the debts of the partnership
In a limited liability partnership (LLP), or
limited liability company (LLC)
All partners enjoy limited liability with regard to the business’s
liabilities
Their potential losses are limited to their investment
This increase the risk faced by an LLP’s lender, customers, and
suppliers
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Corporation
Is a distinct permanent legal entity
Many owners (shareholder or stockholders)
Legal entity created by a state, and it is separate and distinct
from its owners and managers
Management & control through board of Directors
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Corporation
Advantages:
Unlimited life
A corporation can continue after its original owners and
managers are deceased
Easy transfer of ownership
Ownership interests can be divided into shares of stock, which
can be transferred easily
Limited liability
Losses are limited to the actual funds invested
Ease of raising capital
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Corporation
Disadvantages:
Corporate earnings may be subject to double taxation
The earnings of the corporation are taxed at the corporate level,
and then
earnings paid out as dividends are taxed again as income to the
stock holders
Cost of set-up and report filing
Setting up a corporation involves preparing a charter, writing a
set of bylaws and filling the many required reports
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Corporation
Charter: Establishing Separate Legal Entity
Name
Activities
Amount of Capital Stock
Number of Directors
Names & Addresses of Directors
Bylaws: Rules for conduct of Activities
How Directors will be elected
Preemptive Right to new stock issues
Procedures for changing Bylaws, if required
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Financial Goals of the Corporation
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Is stock price maximization the same
as profit maximization?
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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
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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
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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.
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Factors that affect stock price
Projected cash flows to
shareholders
Timing of the cash flow
stream
Riskiness of the cash
flows
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Factors that Affect the Level and
Riskiness of Cash Flows
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END
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