th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

11Chapt

er

Chapt

er

The Field of FinanceThe Field of Finance

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Chapter 1 – Outline

• Definition of Finance• Short-Term vs. Long-Term Financing Decisions• Risk-Return Trade-Off• Financial vs. Real Capital• Stocks vs. Bonds• Forms of Organization

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Finance is closely related to Economics

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Economics provides a structure for decision making in areas such as

– Risk analysis

– Pricing theory

– Comparative return analysis

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Economics gives us a broad picture of economic environment, which includes

– Federal Reserve and banking system

– Economic variables• Gross Domestic Product• Industrial Production• Disposable Income• Unemployment• Inflation• Interest rates• Taxes

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Finance is closely related to Accounting

• Accounting provides the financial data we use

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

There are many careers in Finance• Corporate finance officer

• Banker

• Stockbroker

• Financial analyst

• Portfolio manager

• Investment banker

• Financial consultant

• Personal financial planner

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Finance has evolved over time (next)

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Finance emerged at the turn of the century

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

1930s—the depression caused finance to focus on

– preservation of capital

– maintenance of liquidity

– Corporate reorganizations

– Bankruptcy process

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Mid 1950s—finance became more analytical

– Allocating financial capital (money)

– For the purchase of real capital (long-term plant and equipment)

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Financial capital vs. Real capital

Financial Capital (or Accounting Capital) = money

Real Capital (or Economic Capital) = plant and equipment

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Recent Issues in Finance

• The risk-return relationship

• Capital structure theory (Merton and Miller)

• Effects of inflation and disinflation

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Trade-off

Daily

Credit managementInventory controlReceipt and disburse-ment of funds

Occasional

Stock issueBond issueCapital budgetingDividend decision

Profitability

Risk

Goal:Maximizeshareholderwealth

T 1-1

Figure 1-1Functions of the Financial Manager—Page 8

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Forms of Organization

Sole Proprietorship (largest in actual number but smallest in total sales revenue)

• Partnership

• Corporation (smallest in actual number but largest in total sales revenue)

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Goals of Financial Management (next several slides)

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Agency Theory—examines the relation between owners and managers of the firm.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Institutional Investors—own larger fractions of firms over time.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

The ultimate measure of performance is NOT what the firm earns, but how the earnings are valued by the investor.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

While many goals are possible, the official goal of the financial manager is TO MAXIMIZE SHAREHOLDER WEALTH.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

As investor attitudes and preferences change, managers must focus on different things to maximize shareholder wealth.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Here are reasons for management to maximize shareholder wealth.• Poor stock price performance can

lead to undesirable takeovers and proxy fights

• Management often has incentives such as stock and options.

• Powerful institutional investors force management to be responsible.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Social Responsibility and Ethical Behavior

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

In most cases, wealth maximization is consistent with social responsibility.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Sometimes, wealth maximization leads to socially undesirable results:• Pollution• Equitable hiring practices• Insider trading

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

The Role of Financial Markets

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Financial markets are meeting places for people, corporations and institutions to lend or invest money.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Public financial markets—markets for national, state, and local governments.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Corporate financial markets—markets for businesses to raise money.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Short-Term vs. Long-Term Financing

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Working Capital is concerned with short-term (S/T) financing decisions <1 year (money markets)ex., managing cash and other current assets

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Capital Budgeting is concerned with long-term (L/T) financing decisions >1 year (capital markets)ex., purchasing a new machine in the future

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Primary Markets—Refers to the market when private individuals purchase securities from the corporation—corporations raise funds.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Secondary Markets—When investors trade among themselves.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Institutions force many types of restructuring.• Changes in capital structure

• Selling lower-profit business entities.

• Removal of ineffective management.

• Mergers and acquisitions.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Internalization of the Financial Markets

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Increasingly, we are seeing the emergence of international trade.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Many companies are truly global companies today.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

Students should be aware of this trend and adjust their educations:• Learn one or more foreign

languages.• Take courses in international

business.• Learn about other cultures and

people.• Look for work experience that

teaches global business.

th9

©The McGraw-Hill Companies, Inc. 2000

Foundations of Financial ManagementE D I T I O N

N I N

T H

Irwin/McGraw-Hill

BlockHirt

THE END