Contemporary Financial Management 8 th Edition by Moyer

Contemporary Financial Management 8 th Edition by Moyer, Mc. Guigan, and Kretlow Prepared by Tom Peacock University of Houston © 2001 South-Western College Publishing

Chapter 1 The Role and Objective of Financial Management © 2001 South-Western College Publishing

Questions Faced in Finance u. How is finance related to other fields of study? u. What are the goals and objectives of financial managers? u. How has the finance field evolved? u. How is the finance field changing today? 3

Principal Forms of Business Organizations u. Sole proprietorship u. Partnership u. Corporation 4

Sole Proprietorship u. Owned by one person u. Easy formation advantage u. Unlimited liability disadvantage u. Difficulty raising funds disadvantage u. Represent 75% of all businesses u. Account for < 6% of the $ volume 5

Partnership u. Owned by two or more persons u. Classified as general or limited u. Partnership dissolves when a general partner dies 6

Liability of Partners u. General Partner Has unlimited liability for all obligations of the business u. Limited Partner Liability limited to the partnership agreement 7

Corporation u Limited liability u Legal entity u Permanency u Have a board of u Flexibility directors u Owners are stockholders u Easy marketability of shares of ownership u Ability to raise of capital 8

Stockholders elect a board of directors Board of directors then hire management ( officers ) 9

Who Manages ? u Board of directors deals with broad policy u Management makes most of the decisions 10

Stockholder Rights Dividend Asset Voting Preemptive Corporate Securities in Order or Priority Bonds Preferred stock Common stock ( C/S ) ( highest) ( lowest ) 11

Optimal Form of Organization Influenced by u Cost u Raising capital u Complexity u Decision making u Liability u Tax considerations u Continuity 12

Objective of Financial Management ( FM ) Objective of the financial manager Shareholder Wealth Maximization (SWM) NOT profit maximization Does not consider time value of money 13

SWM u. Considers the timing and risk of the benefits from stock ownership u. Determines that a good decision increases the price of the firm's common stock (c/s) u. Is an impersonal objective u. Is concerned for social responsibility 14

Social Responsibility u. Ethical issues will constantly confront financial managers as they achieve the goal of the firm ( SWM ). Managers Must u. Avoid personal conflicts u. Maintain confidentiality u. Be objective u. Act fairly 15

Agency Relationships / Problems Owners (shareholders) u Problem created by separation of Management and Employees u Management may maximize its own welfare instead of the owners wealth Job security 16

Job Security u. Management decisions based on retaining management rather than SWM u. Example–A decision to retain suppliers rather than selecting new suppliers providing higher quality or lower cost u. Why–If the transition is mishandled management will be scrutinized but if no change is made the issue will be ignored 17

Agency Costs u. Management incentives u. Monitor performance u. Owners protection u. Complex organization structures Recent Trends To flatten organization structures to cut costs 18

Problem created by separation of Owners Management Owners A similar problem Creditors Protective covenants in loan agreements 19

Examples of Protective Covenants u. Limitations of Common stock dividends u. Limitations on additional debts u. Not entering into sale and lease back arrangements 20

Shareholder Wealth Maximizing Is a Market Concept and Results in u. Maximizing PV of E(R) u. Measured by Market Value of C/S 21

3 Basic Factors Determine C/S Market Value u 1) Amount of u 2) Timing of Expected cash flows u 3) Risk of 22

Conditions Affecting Market Value u. Economic environment factors u. Decisions under management control u. Conditions in financial markets u. Expected cash flows 23

Competitive Forces Influencing C/S Market Value u. New entrants u. Substitute products u. Bargaining power of buyers u. Bargaining power of suppliers u. Rivalry among current competitors 24

Cash Flow Concept Used for u. Financial analysis u. Planning u. Resource allocation CF does not equal accounting profit Internal sources Cash External sources 25

NPV of an Investment u. NPV = PV of future cash flows minus cash outlays The NPV of an investment represents the contributions of that investment to the value of the firm and passes on to SWM 26

Different Size Businesses Small Business Vs. Large Corporations Fundamental concepts are the same 27

Small Business u Not the dominant firm in the industry u Tend to grow more rapidly u Limited access to financial market u Lack management resources u Have a high failure rate u Stock is not publicly traded u Poorly diversified u Owner/manager frequently the same 28

Controller’s Activities u. Financial accounting u. Cost accounting u. Taxes u. Data processing 29

Treasurer’s Activities u. Management of cash and marketable securities u. Capital budgeting u. Financial planning u. Credit analysis u. Investors relations u. Pension fund management 30

Disciplines used in Finance Economics Accounting Marketing Production Human Resources Quantitative Analysis 31

Professional Organizations u. Financial Executive Institute u. Institute of Charted Financial Analysis u. Financial Management Association u. Institute of Management Accounting 32

Exciting Career Opportunities in Finance u. VP of Finance u. Financial Analyst u. Director u. Account Executive Investor Relations u. Assistant Treasurer u. Tax Manager Security Broker u. Mortgage Analyst u. Banking 33