1 Chapter 1: Goal and Functions of Finance Objective of the Firm – the primary goal of the firm is to maximize stockholder wealth Wealth Maximization versus Profit Maximization Timing – profit maximization does not take into account the timing of earnings, while wealth maximization does. Risk – wealth maximization takes risk into account profit maximization does not. Dividend payments – if profit maximization was the goal, a firm would never pay dividends.

2 Chapter 1: Goal and Functions of Finance Wealth Maximization versus Profit Maximization (cont) Qualitative factors – profit maximization does not take into account future activities such as sales growth, stability and diversification. Stock price maximization – since investors want to maximize their own wealth, they prefer the firm adopt strategies that will maximize stock price.

3 Chapter 1: Goal and Functions of Finance Management versus Stockholders Management serves as an agent to the stockholders (owner) Stockholders delegate authority to management to act on their behalf and are expected to act in their best interest. Management’s objectives may differ from those of stockholers. In many large corporations, where ownership is largely diversified, the situation arises where management may act in their own best interests rather than in the best interests of the stockholders.

4 Chapter 1: Goal and Functions of Finance Management versus Stockholders (cont) Management may attempt to amass income, power and prestige Appropriate incentives such as stock options, bonuses and perquisites, should be given to managers to ensure they act in the best interest of the stockholders.

5 Chapter 1: Goal and Functions of Finance Functions of Financial Management Financial Planning and Control – the financial manager establishes standards and creates budgets that are used for monitoring performance. Allocation of funds – the financial manager must decide where the firm’s capital will further the firm’s objective of stockholder wealth maximization. Acquisition of funds – the financial manager must determine the most cost effective and efficient means of obtaining funds that will coincide with the firm’s financing needs.

6 Chapter 1: Goal and Functions of Finance Principles of Finance Risk-Return Tradeoff – the more risk one is willing to accept, the more return that should be expected. Time Value of Money – a dollar in hand today is worth more than a dollar that is due at some point in the future. The obvious reason is that a dollar today could be invested in some interest bearing account. Leverage – refers to the degree of fixed costs utilized by the firm. A firm with high fixed costs will suffer a substantial loss in earnings with only a small change in sales.

7 Chapter 1: Goal and Functions of Finance Principles of Finance (cont) Liquidity versus profitability - liquidity illustrates the firm’s ability to pay its bill as they come due. Too much liquidity will reduce profitability. Matching Principle – concept that short-term assets should be financed with short term liabilities and long-term assets should be financed with long term funds. Portfolio Effect (Diversification) – the concept that as more assets are added to the portfolio, the risk of the total portfolio decreases. Valuation – the economic value of an asset is equal to the present value of future (expected) cashflows.

8 Chapter 1: Goal and Functions of Finance Summary