Chapter 1 - An Introduction to Chapter 1 - An Introduction to Financial ManagementFinancial Management

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Financial ManagementFinancial Management

What is financial management?What is financial management?

-- maintenance and creation of -- maintenance and creation of economic valueeconomic value

-- deal with all kinds of financial -- deal with all kinds of financial decisions, such as when to invest new decisions, such as when to invest new assets, when to borrow…assets, when to borrow…

Goal of the FirmGoal of the Firm

1) Profit Maximization?1) Profit Maximization?

this goal ignores:this goal ignores:

a) TIMING of Returnsa) TIMING of Returns

b) Costs of shareholdersb) Costs of shareholders

Goal of the FirmGoal of the Firm

2) Shareholder Wealth 2) Shareholder Wealth Maximization?Maximization?

this is the same as:this is the same as:

a) Maximizing Firm Valuea) Maximizing Firm Value

b) Maximizing Stock Priceb) Maximizing Stock Price

Legal Forms of BusinessLegal Forms of Business

1) Sole Proprietorship1) Sole Proprietorship A business owned by a single individual.A business owned by a single individual. Owner maintains title to the firm’s assets.Owner maintains title to the firm’s assets. Owner has unlimited liability.Owner has unlimited liability.

2) Partnership2) Partnership Similar to a sole proprietorship, except Similar to a sole proprietorship, except

that there are two or more owners.that there are two or more owners.

2a) General Partnership2a) General Partnership All partners have unlimited liability.All partners have unlimited liability.

2b) Limited Partnership2b) Limited Partnership Consists of one or more general partners, Consists of one or more general partners,

who have unlimited liability.who have unlimited liability. One or more limited partners (investors) One or more limited partners (investors)

whose liability is limited to the amount of whose liability is limited to the amount of their investment in the business.their investment in the business.

Legal Forms of BusinessLegal Forms of Business

2c) Limited Liability Company 2c) Limited Liability Company (LLC)(LLC)

Cross between a partnership and a Cross between a partnership and a corporation.corporation.

Owners have limited liability, but the Owners have limited liability, but the firm runs and is taxed like a firm runs and is taxed like a partnership.partnership.

Legal Forms of BusinessLegal Forms of Business

3) Corporation3) Corporation A business entity that legally functions A business entity that legally functions

separate and apart from its owners.separate and apart from its owners. Owners’ liability is limited to the amount Owners’ liability is limited to the amount

of their investment in the firm.of their investment in the firm. Owners hold common stock certificates, Owners hold common stock certificates,

and ownership can be transferred by and ownership can be transferred by selling the certificates.selling the certificates.

Legal Forms of BusinessLegal Forms of Business

Comparison of Three FormsComparison of Three Forms

Advantage of corporations:Advantage of corporations:

-- limited liability-- limited liability

-- ease in raising capital-- ease in raising capital

Role of Financial ManagerRole of Financial Manager

CFO – Chief Financial Officer: oversees CFO – Chief Financial Officer: oversees financial planning, corporate strategic financial planning, corporate strategic planning, and control cash flowplanning, and control cash flow

Treasurer – handles the firm’s financial Treasurer – handles the firm’s financial activitiesactivities

Controller – manages the firm’s Controller – manages the firm’s accounting dutiesaccounting duties

The Corporation and The Corporation and Financial MarketsFinancial Markets

cash Investors

Secondarymarkets

Government

securities

Cash flow

reinvest

tax

Corporation

dividends,etc.

Primary MarketPrimary Market Market in which new issues of a Market in which new issues of a

security are sold to initial security are sold to initial buyers.buyers.

Secondary MarketSecondary Market Market in which previously Market in which previously

issued securities are traded.issued securities are traded.

The Corporation and The Corporation and Financial MarketsFinancial Markets

Initial Public Offering (IPO)Initial Public Offering (IPO) The first time the firm’s stock is The first time the firm’s stock is

sold to the general public.sold to the general public.

Seasoned New IssueSeasoned New Issue A new stock offering by a firm A new stock offering by a firm

that already has stock that is that already has stock that is traded in the secondary market.traded in the secondary market.

The Corporation and The Corporation and Financial MarketsFinancial Markets

Financial Management AxiomsFinancial Management Axioms1) Risk - return trade-off.1) Risk - return trade-off.2) Time value of money.2) Time value of money. -- a dollar get today is worth more than a -- a dollar get today is worth more than a

dollar get a year laterdollar get a year later3) Cash - not profits - is king.3) Cash - not profits - is king. -- it is the cash that can be reinvested-- it is the cash that can be reinvested4) Incremental cash flows count.4) Incremental cash flows count.5) The curse of competitive markets.5) The curse of competitive markets. -- differentiation-- differentiation -- economies of scale-- economies of scale

Financial Management AxiomsFinancial Management Axioms

6) Efficient capital markets.6) Efficient capital markets. -- stock price adjust new information -- stock price adjust new information

fastfast7) The agency problem.7) The agency problem. -- managers don’t work for the interest -- managers don’t work for the interest

of shareholdersof shareholders -- get benefit from salary, private jet-- get benefit from salary, private jet -- avoid risk project-- avoid risk project

Financial Management AxiomsFinancial Management Axioms

8) Taxes bias business decisions.8) Taxes bias business decisions. -- after-tax incremental cash flow-- after-tax incremental cash flow9) All risk is not equal.9) All risk is not equal. -- don’t put all eggs in one basket-- don’t put all eggs in one basket10) Ethical dilemmas are everywhere in 10) Ethical dilemmas are everywhere in

finance. finance. -- Enron, Worldcom-- Enron, Worldcom -- loss of public’s confidence-- loss of public’s confidence