Instructor: Dr. Muhammad Azhar Khan Title: Financial Management and Policy Course Code: MGT 432

Recommended Books and References Fundamental of Financial Management by James C. Van Horne, (12th edition) Fundamentals of Financial Management by Eugene F. Brigham, Joel F. Houston, (12th or 13th Edition) Financial Management by P K Jain, M Y Khan, (5th edition) Instruction Material We will be following the book “Fundamental of Financial Management” during the lectures and will also be using the Pearson’s instructor’s manual along with the other sources like Wikipedia where ever necessary.

Course Contents Part 1 Introduction to Financial management Chapter 1 The Role Financial Management Chapter 2 The Business Tax and Financial Environment Part 2 Valuation Chapter 3 Time Value of Money Chapter 4 The Valuation Long Term Securities Chapter 5 Risk and Return

Course Contents Part 3 Tools of Financial Analysis and Planning Chapter 6 Financial Statement Analysis Chapter 7 Funds Analysis, Cash Flow Analysis, and Financial Planning Part 4 Working Capital Management Chapter 8 Overview of Working Capital management Chapter 9 Cash and Marketable Securities Management Chapter 10 Accounts Receivable and Inventory Management Chapter 11 Short Term Financing

Course Contents Part 5 Investment in Capital Assets Chapter 12 Capital Budgeting and Estimating Cash Flows Chapter 13 Capital Budgeting Techniques Chapter 14 Risk and Managerial (Real) Options in Capital Budgeting Part 6 The Cost of Capital Chapter 15 Required Returns and the Cost of Capital

The Role of Financial Management Chapter 1 The Role of Financial Management

Learning Outcomes After this lecture, you should be able to: Explain why the role of the financial manager today is so important. Describe "financial management" in terms of the three major decision areas that confront the financial manager. Identify the goal of the firm and understand why shareholders' wealth maximization is preferred over other goals. Understand the potential problems arising when management of the corporation and ownership are separated (i.e., agency problems). Demonstrate an understanding of corporate governance. Discuss the issues underlying social responsibility of the firm. Understand the basic responsibilities of financial managers and the differences between a "treasurer" and a "controller."

The Role of Financial Management What is Financial Management? The Goal of the Firm Corporate Governance Organization of the Financial Management Function

What is Financial Management? Primarily financial managers used to raise funds and manage their firms cash positions. Role of financial managers has become more important due to increasingly complex nature of transactions, e.g. Increased corporate competition Rapid technological changes Volatility in inflation and interest rates Worldwide economic uncertainty Fluctuating exchange rates Changing tax laws Ethical concerns over financial dealings

Decision Functions of Financial Management Financial management concerns the acquisition, financing, and management of assets with some overall goal in mind. There are three important decision functions of financial management: Investment decisions Financing decisions Asset management decision

Investment Decisions Most important of the three decisions functions. What is the optimal firm size? What specific assets should be acquired? What assets (if any) should be reduced or eliminated? Should the firm operations be expanded by introducing new products or services

Financing Decisions Determine how the assets (current and long term) will be financed (short term or long term debt and equity). What is the best type of financing? What is the best financing mix? What is the best dividend policy (e.g., dividend-payout ratio)? How will the funds be physically acquired?

Asset Management Decisions How do we manage existing assets efficiently? Financial Manager has varying degrees of operating responsibility over assets. Greater emphasis on current asset management than fixed asset management as the fixed assets are being operated by the operation mangers.

What is the Goal of the Firm? The goal of a firm is maximization of Shareholder Wealth. Value creation or wealth maximization occurs when we maximize the share price for current shareholders. Share price of a firm is the reflection of the firms investment, financing, and asset management decisions. Firms spending more on R&D and advertisement normally have higher value for their stocks.

Shortcomings of Alternative Perspectives Profit Maximization Maximizing a firm’s earnings after taxes. Problems Could increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy T-bills, etc.). Ignores changes in the risk level of the firm. Increased risk will result in loss of value for the shareholders as the prices of the stock will fall.

Shortcomings of Alternative Perspectives Earnings per Share Maximization Maximizing earnings after taxes divided by shares outstanding. Problems Does not specify timing or duration of expected returns. Ignores changes in the risk level of the firm. Calls for a zero payout dividend policy which may result in loss of share price.

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.

Corporate goals of Companies Cadbury Schweppes: “governing objective is growth in shareowner value” Credit Suisse Group: “achieve high customer satisfaction, maximize shareholder value and be an employer of choice” Dow Chemical Company: “maximize long-term shareholder value” ExxonMobil: “long-term, sustainable shareholder value”

The Modern Corporation Shareholders Management There exists a SEPARATION between owners and managers.

Role of Management Management acts as an agent for the owners (shareholders) of the firm. An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf.

Agency Theory Jensen and Meckling developed a theory of the firm based on agency theory. Agency Theory is a branch of economics relating to the behavior of principals and their agents.

Agency Theory Principals must provide incentives so that management acts in the principal’s best interests and then monitor results. Incentives include, stock options, perquisites, and bonuses.

Social Responsibility Wealth maximization does not preclude the firm from being socially responsible such as protecting the consumers, welfare of the employees, fair hiring practices and safe working conditions, supporting education, and becoming involved in environmental issues as clean air and water. Along with the share holders wealth maximization, the interests of the stakeholders must also be protected, i.e. creditors, employees, customers, suppliers, communities and others. Then shareholder wealth maximization remains the appropriate goal in governing the firm.

Corporate Governance Corporate governance: represents the system by which corporations are managed and controlled. Includes shareholders, board of directors (BOD), and senior management. Three categories of individuals are thus key to corporate governance success: First, the common shareholders, who elect the BODs; second, the BODs themselves; and third, the top executive offices led by the CEO

The Role of the Board of Directors Typical responsibilities: Set company-wide policy; Advise the CEO and other senior executives; Hire, fire, and set the compensation of the CEO; Review and approve strategy, significant investments, and acquisitions; and Oversee operating plans, capital budgets, and financial reports to common shareholders. CEO/Chairman roles commonly same person in US, but separate in Britain.

Sarbanes-Oxley Act of 2002 Sarbanes-Oxley Act of 2002 (SOX): addresses corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information Imposes new penalties for violations of securities laws Established the Public Company Accounting Oversight Board (PCAOB) to adopt auditing, quality control, ethics, disclosure standards for public companies and their auditors, and policing authority Generally increasing the standards for corporate governance

Organization of the Financial Management Function Board of Directors President (Chief Executive Officer) Vice President Finance Vice President Operations Vice President Marketing

Organization of the Financial Management Function VP of Finance Treasurer Capital Budgeting Cash Management Credit Management Dividend Disbursement Fin Analysis/Planning Pension Management Insurance/Risk Management Tax Analysis/Planning Controller Cost Accounting Cost Management Data Processing General Ledger Government Reporting Internal Control Preparing Fin Statements Preparing Budgets Preparing Forecasts

Summary Role of the financial manager Financial management in terms of the three major decision areas that confront the financial managers. Identify the goal of the firm and understand why shareholders' wealth maximization is preferred over other goals. Potential problems where management of the corporation and ownership are separated (i.e., agency problems). Corporate governance. Social responsibility of the firm. Understand the basic responsibilities of financial managers and the differences between a "treasurer" and a "controller."