Copyright © 2006 McGraw Hill Ryerson Limited1-1 prepared by: Sujata Madan McGill University Fundamentals of Corporate Finance Third Canadian Edition

Copyright © 2006 McGraw Hill Ryerson Limited1-2 Chapter 1 The Firm and the Financial Manager Organizing a Business The Role of the Financial Manager Who is the Financial Manager? Goals of the Corporation

Copyright © 2006 McGraw Hill Ryerson Limited1-3 Organizing a Business Types of business organizations:  Sole Proprietorships  Partnerships  Corporations  Hybrid forms  Limited Partnerships  LLP  LLC  PC

Copyright © 2006 McGraw Hill Ryerson Limited1-4 Organizing a Business

Copyright © 2006 McGraw Hill Ryerson Limited1-5 Organizing a Business Corporations  A business which is legally distinct from its owners, who are called shareholders.  One of the key features of a corporation is the separation of ownership and management.  This allows a corporation more flexibility and permanence than other types of business organization.

Copyright © 2006 McGraw Hill Ryerson Limited1-6 Role of the Financial Manager Financial Manager Firm's operations Investors (2) Cash invested in firm (2) (3) Cash generated by operations (3) (4a) Cash reinvested (4a) (4b) Cash returned to investors (4b) Real assets ( 1) Cash raised from investors (1)

Copyright © 2006 McGraw Hill Ryerson Limited1-7 Role of the Financial Manager The role of the financial manager is to determine:  What operating assets to invest in? - Capital Budgeting decision  How to pay for those assets? - Financing decision

Copyright © 2006 McGraw Hill Ryerson Limited1-8 Role of the Financial Manager Capital Budgeting Decision The financial manager is concerned with: 1. The size; 2. The timing; and 3. The risks associated with realizing the future benefits produced by the asset

Copyright © 2006 McGraw Hill Ryerson Limited1-9 Role of the Financial Manager Financing Decision The financial manager can use:  Internal financing – purchase the assets using the firm’s own funds.  External financing - purchase the assets by raising money from financial institutions or markets.

Copyright © 2006 McGraw Hill Ryerson Limited1-10 Who is the Financial Manager? Chief Financial Officer TreasurerController Anyone responsible for the capital budgeting and/or the financing decision is known as a financial manager

Copyright © 2006 McGraw Hill Ryerson Limited1-11 Goals of the Corporation The goal of any corporation is to maximize shareholder wealth  Increasing market value increases shareholder wealth….  …Thus, the objective is to maximize current share price….  ….But not at the cost of unethical behavior!

Copyright © 2006 McGraw Hill Ryerson Limited1-12 Goals of the Corporation Agency Problems  Conflicts of interest between the firm’s owners (principals) and its managers (agents) are known as agency problems.

Copyright © 2006 McGraw Hill Ryerson Limited1-13 Goals of the Corporation Agency Problems Agency problems can be reduced in several ways:  Compensation plans  options  Board of Directors  Threat of take-overs  Specialist monitoring

Copyright © 2006 McGraw Hill Ryerson Limited1-14 Summary of Chapter 1  Businesses may be organized as:  Proprietorships  Partnerships  Corporations  A corporation is legally distinct from its owners (shareholders).  It shareholders have limited liability.  Ownership and management are usually separate.

Copyright © 2006 McGraw Hill Ryerson Limited1-15 Summary of Chapter 1  A firm’s financial managers are responsible for:  Capital Budgeting Decision – what assets to invest in.  Financing Decision – how to pay for those assets.  The financial manager’s objective is to make decisions which maximize the value of the company’s shares.  Conflicts of interest, called Agency Problems, may arise in large firms between the owners and managers.