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Chapter 1Introduction toManagerial Finance

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Learning Outcomes Chapter 1

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

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

Identify (1) major goals that rms pursue and (2) what a rmsprimary goal should be.

Explain the role that ethics and good governance play insuccessful businesses.

Describe how foreign rms differ from U.S. rms and identifyfactors that affect nancial decisions in multinational rms.

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What is Finance?

Finance is concerned with decisions aboutmoney (Cash Flows)Finance decisions deal with how money israised and usedEverything else being equal:

More value is preferred to less

The sooner cash is received the more value it hasLess risky assets are more valuable than riskierassets

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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 ControllerCredit

ManagerInventoryManager

Director of CapitalBudgeting

Financialand CostAccounting

TaxDepartment

Vice-President:Finance (CFO)

Vice-President:Sales

Vice-President:Information Systems (CIO)

Vice-President:Operations (COO)

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Alternative Forms of Business Organization

Proprietorship

Partnership

Corporation

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Proprietorship

Advantages:Ease of formationSubject to few government regulationsNo corporate income taxes

Limitations:Unlimited personal liability

Limited lifeTransferring ownership is difficultDifficult to raise capital

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Partnership

Like a proprietorship, except two or moreowners

A partnership has roughly the sameadvantages and limitations as aproprietorship

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Corporation

Advantages:Unlimited lifeEasy transfer of ownershipLimited liabilityEase of raising capital

Disadvantages:

Cost of set-up and report filingDouble 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 marketvalueEase of raising capital allows takingadvantage of growth opportunitiesOwnership can be easily transferred thusinvestors 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 incentivesSocial responsibility

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Managerial Actions toMaximize 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 Managersthat 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 aprincipal hires an agent to act on his or herbehalf.

An agency problem results when the agentmakes decisions that are not in the bestinterest of principals

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Stockholders versus Managers

Managers are naturally inclined to act in theirown best interests.Mechanisms to motivate managers to act inshareholders best interest

Managerial compensation (incentives)Shareholder intervention

Threat of takeover

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Business Ethics

Webster: A standard of conduct and moralbehavior.

Business Ethics: A companys attitude andconduct toward its employees, customers,community, and stockholders

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Corporate Governance

The set of rules that a firm follows whenconducting business

As a result of the Sarbanes-Oxley Act of 2002, firms are revising their corporategovernance policiesGood corporate governance generates higher

returns to stockholders

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Forms of Business inOther Countries

Non-US firms have higher concentrations of ownership

Nature of relationship with financialinstitutions 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 technology4. To seek production efficiency

5. To avoid political and regulatory hurdles

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Five reasons firms go international

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Factors Distinguishing DomesticFirms from Multinational Firms

Different currency denominations

Economic and legal ramifications

Language differencesCultural differences

Role of governments

Political risk

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