Copyright © 2009 Pearson Prentice Hall. All rights reserved. Chapter 1 The Role and Environment of Managerial Finance

Learning Goals What is finance? What do financial managers do? Relationships between finance & economics/accounting What is the goal of financial decisions? The agency issue. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-2

What is Finance? Finance can be defined as the art and science of managing ______________________________: it is the process of how organizations and individuals ___________________________ and ___________________________________. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-3

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-4 Major Areas & Opportunities in Finance: Financial Services Financial Services is the area of finance concerned with the design and delivery of advice and financial products to individuals, businesses, and government. Career opportunities include banking, personal financial planning, investments, real estate, and insurance.

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-5 Major Areas & Opportunities in Finance: Managerial Finance Managerial finance is concerned with the duties of the financial manager in any organization. The financial manager actively manages the financial affairs of any organization, whether private or public, large or small, profit-seeking or not-for-profit. They are also more involved in developing corporate strategy and improving the firm’s competitive position.

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-6 Figure 1.1 Corporate Organization

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-7 Table 1.3 Career Opportunities in Managerial Finance

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-8 The Managerial Finance Function The size and importance of the managerial finance function depends on the size of the firm. In small companies, the finance function may be performed by the company president or accounting department. As the business expands, finance typically evolves into a separate department linked to the president as was previously described in Figure 1.1.

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-9 The Managerial Finance Function: Relationship to Economics Finance is actually an outgrowth of economics. In fact, finance is sometimes referred to as financial economics. Financial managers must understand the economic framework within which they operate in order to react or anticipate to changes in conditions.

Copyright © 2009 Pearson Prentice Hall. All rights reserved The Managerial Finance Function: Relationship to Economics (cont.) The primary economic principal used by financial managers is marginal cost-benefit analysis which says that financial decisions should be implemented only when _____________________________________ _____________________________________.

Copyright © 2009 Pearson Prentice Hall. All rights reserved The Managerial Finance Function: Relationship to Accounting The firm’s finance (treasurer) and accounting (controller) functions are closely-related and overlapping. In smaller firms, the financial manager generally performs both functions.

Copyright © 2009 Pearson Prentice Hall. All rights reserved The Managerial Finance Function: Relationship to Accounting (cont.) One major difference in perspective and emphasis between finance and accounting is that accountants generally use the accrual method while in finance, the focus is on ____________________________________.

Copyright © 2009 Pearson Prentice Hall. All rights reserved The Managerial Finance Function: Relationship to Accounting (cont.) Finance and accounting also differ with respect to decision-making. While accounting is primarily concerned with the presentation of financial data, the financial manager is primarily concerned with analyzing and interpreting this information for decision-making purposes. The financial manager uses this data as a vital tool for making decisions about the financial aspects of the firm.

Goal of the Firm Goal of financial decisions: maximize shareholder wealth by maximizing the ________________________________. The market price of a firm’s stock reflects: –Expected ________________________ –________________________ of the cash flows Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-14

Copyright © 2009 Pearson Prentice Hall. All rights reserved The Role of Ethics: Ethics Defined Ethics is the standards of conduct or moral judgment—have become an overriding issue in both our society and the financial community Ethical violations attract widespread publicity Negative publicity often leads to negative impacts on a firm

Copyright © 2009 Pearson Prentice Hall. All rights reserved The Agency Issue: The Agency Problem Whenever a manager owns less than 100% of the firm’s equity, a potential agency problem exists. In theory, managers would agree with shareholder wealth maximization. However, managers are also concerned with their personal wealth, job security, fringe benefits, and lifestyle. This would cause managers to act in ways that do not always benefit the firm shareholders.

Copyright © 2009 Pearson Prentice Hall. All rights reserved The Agency Issue: Resolving the Problem Market Forces such as major shareholders and the threat of a hostile takeover act to keep managers in check. Agency Costs are the costs borne by stockholders to maintain a corporate governance structure that minimizes agency problems and contributes to the maximization of shareholder wealth.

Copyright © 2009 Pearson Prentice Hall. All rights reserved The Agency Issue: Resolving the Problem (cont.) A stock option is an incentive allowing managers to purchase stock at the market price set at the time of the grant. Performance plans tie management compensation to measures such as EPS growth; performance shares and/or cash bonuses are used as compensation under these plans.