Introduction to Financial Management Chapter 1 Introduction to Financial Management

Finance Vs. Econ and Acct What is Finance? Finance Vs. Econ and Acct Capital Budgeting Capital Structure Working Capital Management

Finance Financial Management (Corporate Finance). Capital Markets. Investments. Security Analysis Portfolio Theory Market Analysis

Finance Within the Organization Board of Directors Chief Executive Officer (CEO) Chief Operating Officer (COO) Marketing, Production, Human Resources, and Other Operating Departments Chief Financial Officer (CFO) Accounting, Treasury, Credit, Legal, Capital Budgeting, and Investor Relations

Stock Prices and Shareholder Value The primary financial goal of management is shareholder wealth maximization, which translates to maximizing stock price. Value of any asset is present value of cash flow stream to owners. Investors expect CF’s. Risky or not? Most significant decisions are evaluated in terms of their financial consequences. Production (Machine) Marketing (Celebrity)

Stock Prices and Intrinsic Value In equilibrium, a stock’s price should equal its “true” or intrinsic value. Intrinsic value is a long-run concept. To the extent that investor perceptions are incorrect, a stock’s price in the short run may deviate from its intrinsic value. Ideally, managers should avoid actions that reduce intrinsic value, even if those decisions increase the stock price in the short run.

Determinants of Intrinsic Values and Stock Prices Managerial Actions, the Economic Environment, Taxes, and the Political Climate “True” Investor Returns “True” Risk “Perceived” Investor Returns “Perceived” Risk Stock’s Intrinsic Value Stock’s Market Price Market Equilibrium: Intrinsic Value = Stock Price

Some Important Business Trends Recent corporate scandals have reinforced the importance of business ethics, and have spurred additional regulations and corporate oversight. Increased globalization of business. The effects of ever-improving information technology Corporate Governance

Business Ethics How should employees deal with unethical behavior? Fudging the books or holding back important info. Refuse to obey or report to a higher authority Bankruptcies of Enron and WorldCom Negative effect on the industry Conflicts of profits and ethics Norfolk Southern coal trains pollution Merck and Vioxx pain medicine

Conflicts Between Managers and Stockholders Managers are naturally inclined to act in their own best interests (which are not always the same as the interest of stockholders). But the following factors affect managerial behavior: Managerial compensation packages Direct intervention by shareholders The threat of firing The threat of takeover

Conflicts Between Stockholders and Bondholders Stockholders are more likely to prefer riskier projects, because they receive more of the upside if the project succeeds. By contrast, bondholders receiving fixed payments are more interested in limiting risk. Bondholders are particularly concerned about the use of additional debt. Bondholders attempt to protect themselves by including covenants in bond agreements that limit the use of additional debt and constrain managers’ actions.

Forms of Business Organization Proprietorship Partnership Corporation LLC and LLP

Proprietorships and Partnerships Advantages Ease of formation Subject to few regulations No corporate income taxes Disadvantages Difficult to raise capital Unlimited liability Limited life

Corporation Advantages Disadvantages Unlimited life Easy transfer of ownership Limited liability Ease of raising capital Disadvantages Double taxation Cost of set-up and report filing