Chapter 1 An Overview of Managerial Finance © 2005 Thomson/South-Western

2 Career Opportunities in Finance  Financial Markets and Institutions  Investments  Managerial Finance

3 Managerial Finance in the Twentieth Century  Business globalization  Information technology  Regulatory attitude of the government  Prosperous economy = business friendly  Poor economy = consumer/investor friendly

4 Alternative Forms of Business Organization  Proprietorship  71% of all businesses  90% have assets under $100,000  Partnership  9% of all businesses  Corporation  20% of all businesses  85% of all dollar value of sales

5 Proprietorship  Advantages:  Ease of formation  Subject to few government regulations  No corporate income taxes  Limitations:  Unlimited personal liability  Difficult to raise capital  Transferring ownership is difficult  Limited life

6 Partnership  Like a proprietorship, except two or more owners  A partnership has roughly the same advantages and limitations as a proprietorship

7 Corporation  Advantages:  Unlimited life  Easy transfer of ownership  Limited liability  Ease of raising capital  Disadvantages:  Double taxation  Earnings taxed at corporate level  Dividends taxed as income to stockholders  Cost of set-up and report filing

8 Finance in the Organizational Structure of the Firm Board of Directors President TreasurerController Credit Manager Inventory Manager Director of Capital Budgeting Cost Accounting Financial Accounting Tax Department Vice-President: Finance Vice-President: Sales Vice-President: Information Systems Vice-President: Operations

9 The Financial Manager’s Responsibilities  Forecasting and planning  Major investment and financing decisions  Coordination and control  Dealing with financial markets

10 Goals of the Corporation  Primary goal: maximize stockholder wealth = maximize stock price  Managerial incentives  controlled by competitive forces  Social responsibility  must be mandated initially to reduce disadvantages  Stock price maximization and social welfare  Maximizing stock = benefiting society

11 Managerial Actions to Maximize Stockholder Wealth  Capital Structure Decisions  How much and what types of debt and equity should be used to finance the firm?  Capital Budgeting Decisions  What types of assets should be purchased to help generate cash flows?  Dividend Policy Decisions  What should be done with net cash flows generated by the firm—reinvest or pay dividends?

12 How Manager’s Actions Affect Stock Price  Projected earnings per share  Net Income/# of shares  Timing of earnings streams  The sooner the better  Riskiness of projected earnings  The safer the better  Use of debt (capital structure)  Dividend policy

13 Value of the Firm Market Factors/Considerations Economic Conditions Government Regulations and Rules Competitive Environment Firm Factors/Considerations Normal Operations Financing Policy =Capital Structure Investing Policy =Capital Budgeting Dividend Policy Investor Factors/Considerations Income/Savings Age/Lifestyle Interest Rates Risk Attitude Net Cash Flows, CF Rates of Return, k Value of the Firm N = CF 1 + CF CF N =  CF t (1+k) 1 (1=k) 2 (1+k) N (1+k) t t=1 ^^^^

14 Agency Relationships  An agency relationship = when a principal hires an agent to act on their behalf  Within corporations, agency relationships exist between:  Stockholders and managers  Stockholders and creditors

15 Stockholders versus Managers  Managers are naturally inclined to act in their own best interests.  But the following factors affect managerial behavior:  The threat of firing  The threat of takeover  Structuring managerial incentives  Performance Shares  Executive Stock Options  Restricted Stock Grants

16 Stockholders versus Creditors  Stockholders (through managers) could take actions to maximize stock price that are detrimental to creditors.  In the long run, such actions will raise the cost of debt and ultimately lower stock price.

17 External Constraints: 1.Antitrust Laws 2. Environmental Regulations 3. Product and Workplace Safety Regulations 4.Employment Practices Rules 5. Federal Reserve Policy 6.International Developments Strategic Policy Decisions Controlled by Management 1.Types of Products and Services Produced 2. Production Methods Used 3. Relative Use of Debt Financing 4.Dividend policy Level of Economic Activity and Corporate Taxes Stock Market Conditions Expected Profitability Timing of Cash Flows Degrees of Risk Summary of Major Factors Affecting Stock Prices Stock Price The External Environment

18 Business Ethics  Webster: “A standard of conduct and moral behavior.”  Business Ethics: A company’s attitude and conduct toward its employees, customers, community, and stockholders  Sarbanes-Oxley Act of 2002  accounting standards  How is ethical behavior profitable?

19 Forms of Business in Other Countries  U.S. firms have a more dispersed ownership = “open”  Non-US firms have higher concentrations of ownership  Many firms are not publicly traded  Less ownership by individuals  Nature of relationship with financial institutions differs from U.S.  Banks are less regulated  Banks can finance large companies, keeping them private  Shareholders assign banks their proxy votes for the directors of companies

20 Multinational Corporations Firms that operate in two or more countries 1.To seek new markets—e.g., Coke 2.To seek raw material—e.g., Exxon Mobil 3.To seek new technology—e.g., Xerox 4.To seek production efficiency—e.g., GM 5.To avoid political and regulatory hurdles— e.g., Honda, Nissan, Toyota Five reasons firms go “international”

21 Factors Distinguishing Domestic Firms from Multinational Firms 1.Different currency denominations 2.Economic and legal ramifications 3.Language differences 4.Cultural differences 5.Role of governments 6.Political risk

22 Next Class Homework: Chapter 1 questions