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Financial Management. Housekeeping Attendance Roster Attendance Roster Textbook: www.mhhe.com/rwj Textbook: www.mhhe.com/rwjwww.mhhe.com/rwj Narrated.

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Presentation on theme: "Financial Management. Housekeeping Attendance Roster Attendance Roster Textbook: www.mhhe.com/rwj Textbook: www.mhhe.com/rwjwww.mhhe.com/rwj Narrated."— Presentation transcript:

1 Financial Management

2 Housekeeping Attendance Roster Attendance Roster Textbook: Textbook: Narrated Power PointNarrated Power Point Interactive Key ConceptsInteractive Key Concepts Excel Templates!!!Excel Templates!!! Key Term FlashcardsKey Term Flashcards Appendix B & D *** Do It RightAppendix B & D *** Do It Right Copy/Laminate/NO STRAY MARKS!!!! Copy/Laminate/NO STRAY MARKS!!!!

3 More Housekeeping Syllabus Syllabus OH projector OH projector Ethics Pledge Ethics Pledge

4 Chapter 1 Introduction to Financial Management

5 Key Concepts and Skills Know the basic types of financial management decisions and the role of the financial manager Know the basic types of financial management decisions and the role of the financial manager Know the financial implications of the different forms of business organization Know the financial implications of the different forms of business organization Know the goal of financial management Know the goal of financial management Understand the conflicts of interest that can arise between owners and managers Understand the conflicts of interest that can arise between owners and managers

6 Basic Areas Of Finance Corporate finance Corporate finance Investments Investments Financial institutions Financial institutions International finance International finance

7 Why Study Finance? Marketing Marketing Budgets, marketing research, marketing financial productsBudgets, marketing research, marketing financial products Accounting Accounting Dual accounting and finance function, preparation of financial statementsDual accounting and finance function, preparation of financial statements Management Management Strategic thinking, job performance, profitabilityStrategic thinking, job performance, profitability Personal finance Personal finance Budgeting, retirement planning, college planning, day-to-day cash flow issuesBudgeting, retirement planning, college planning, day-to-day cash flow issues

8 Business Finance Some important questions that are answered using finance Some important questions that are answered using finance What long-term investments should the firm take on?What long-term investments should the firm take on? Where will we get the long-term financing to pay for the investment?Where will we get the long-term financing to pay for the investment? How will we manage the everyday financial activities of the firm?How will we manage the everyday financial activities of the firm?

9 Financial Manager Financial managers try to answer some or all of these questions Financial managers try to answer some or all of these questions The top financial manager within a firm is usually the Chief Financial Officer (CFO) The top financial manager within a firm is usually the Chief Financial Officer (CFO) Treasurer – oversees cash management, credit management, capital expenditures, and financial planningTreasurer – oversees cash management, credit management, capital expenditures, and financial planning Controller – oversees taxes, cost accounting, financial accounting, and data processingController – oversees taxes, cost accounting, financial accounting, and data processing

10 Capital Budgeting The process of planning and managing a firms investments in fixed assets. The process of planning and managing a firms investments in fixed assets. The key concerns are the size, timing, and riskiness of future cash flows. The key concerns are the size, timing, and riskiness of future cash flows.

11 Capital Structure The mix of debt (borrowing) and equity (ownership interest) used by the firm. The mix of debt (borrowing) and equity (ownership interest) used by the firm. What are the least expensive sources of funds? What are the least expensive sources of funds? Is there an optimal mix of debt and equity? Is there an optimal mix of debt and equity? When & where should the firm raise funds? When & where should the firm raise funds?

12 Working Capital Mgt Mgt of short-term assets & liabilities. Mgt of short-term assets & liabilities. How much inventory should the firm carry? How much inventory should the firm carry? What credit policy is best? What credit policy is best? Where will the firm obtain its short- term loans? Where will the firm obtain its short- term loans?

13 Forms of Business Organization Three major forms in the united states Three major forms in the united states Sole proprietorshipSole proprietorship PartnershipPartnership General General Limited Limited CorporationCorporation S-Corp S-Corp C-Corp C-Corp Limited liability company - LLC Limited liability company - LLC

14 Sole Proprietorship Advantages Advantages Easiest to startEasiest to start Least regulatedLeast regulated Single owner keeps all the profitsSingle owner keeps all the profits Taxed once as personal incomeTaxed once as personal income Disadvantages Disadvantages Limited to life of owner Equity capital limited to owners personal wealth Unlimited liability Difficult to sell ownership interest

15 Partnership Advantages Advantages Two or more ownersTwo or more owners More capital availableMore capital available Relatively easy to startRelatively easy to start Income taxed once as personal incomeIncome taxed once as personal income Disadvantages Disadvantages Unlimited liability General partnership Limited partnership Partnership dissolves when one partner dies or wishes to sell Difficult to transfer ownership

16 Corporation Advantages Advantages Limited liabilityLimited liability Unlimited lifeUnlimited life Separation of ownership and managementSeparation of ownership and management Transfer of ownership is easyTransfer of ownership is easy Easier to raise capitalEasier to raise capital Disadvantages Disadvantages Separation of ownership and management (agency problem) Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate) (except sub-S & LLC)

17 Goal Of Financial Management What should be the goal of a corporation? What should be the goal of a corporation? Maximize profit?Maximize profit? Minimize costs?Minimize costs? Maximize market share?Maximize market share? Maximize the current value of the companys stock?Maximize the current value of the companys stock? Does this mean we should do anything and everything to maximize owner wealth? Does this mean we should do anything and everything to maximize owner wealth? Sarbanes-Oxley Act Sarbanes-Oxley Act

18 The Agency Problem Agency relationship Agency relationship Principal hires an agent to represent their interestPrincipal hires an agent to represent their interest Stockholders (principals) hire managers (agents) to run the companyStockholders (principals) hire managers (agents) to run the company Agency problem Agency problem Conflict of interest between principal and agentConflict of interest between principal and agent Management goals and agency costs Management goals and agency costs

19 Managing Managers Managerial compensation Managerial compensation Incentives can be used to align management and stockholder interestsIncentives can be used to align management and stockholder interests The incentives need to be structured carefully to make sure that they achieve their goalThe incentives need to be structured carefully to make sure that they achieve their goal Corporate control Corporate control The threat of a takeover may result in better managementThe threat of a takeover may result in better management Other stakeholders Other stakeholders

20 Figure 1.2

21 Financial Markets Cash flows to the firm Cash flows to the firm Primary vs. secondary markets Primary vs. secondary markets Dealer vs. auction marketsDealer vs. auction markets Listed vs. over-the-counter securitiesListed vs. over-the-counter securities NYSE NYSE NYSE NASDAQ NASDAQ NASDAQ

22 Quick Quiz What are the four basic areas of finance? What are the four basic areas of finance? What are the three types of financial management decisions and what questions are they designed to answer? What are the three types of financial management decisions and what questions are they designed to answer? What are the three major forms of business organization? What are the three major forms of business organization? What is the goal of financial management? What is the goal of financial management? What are agency problems and why do they exist within a corporation? What are agency problems and why do they exist within a corporation?

23 Homework Now Chapter 1 Now Chapter 1 Answer Questions 1.1, 1.2, 1.3, 1.5, 1.6, 1.7, 1.9, 1.10, 1.15 …. 1.2 Answer Questions 1.1, 1.2, 1.3, 1.5, 1.6, 1.7, 1.9, 1.10, 1.15 …. 1.2 Read Chapter 2 Read Chapter 2 Concepts: 2.1, 2.1, 2.2, 2.4, 2.5, 2.7 Concepts: 2.1, 2.1, 2.2, 2.4, 2.5, 2.7 Problems: 1, 2, 3, 4, 6, 7, 14, 21 Problems: 1, 2, 3, 4, 6, 7, 14, 21

24 Answers to Concepts Review and Critical Thinking Questions 1.Capital budgeting (deciding on whether to expand a manufacturing plant), capital structure (deciding whether to issue new equity and use the proceeds to retire outstanding debt), and working capital management (modifying the firms credit collection policy with its customers). 1.Capital budgeting (deciding on whether to expand a manufacturing plant), capital structure (deciding whether to issue new equity and use the proceeds to retire outstanding debt), and working capital management (modifying the firms credit collection policy with its customers). 2.Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise capital funds. Some advantages: simpler, less regulation, the owners are also the managers, sometimes personal tax rates are better than corporate tax rates. 2.Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise capital funds. Some advantages: simpler, less regulation, the owners are also the managers, sometimes personal tax rates are better than corporate tax rates.

25 3.The primary disadvantage of the corporate form is the double taxation to shareholders of distributed earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to raise capital, and unlimited life. 3.The primary disadvantage of the corporate form is the double taxation to shareholders of distributed earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to raise capital, and unlimited life. 4.The treasurers office and the controllers office are the two primary organizational groups that report directly to the chief financial officer. The controllers office handles cost and financial accounting, tax management, and management information systems. The treasurers office is responsible for cash and credit management, capital budgeting, and financial planning. Therefore, the study of corporate finance is concentrated within the functions of the treasurers office. 4.The treasurers office and the controllers office are the two primary organizational groups that report directly to the chief financial officer. The controllers office handles cost and financial accounting, tax management, and management information systems. The treasurers office is responsible for cash and credit management, capital budgeting, and financial planning. Therefore, the study of corporate finance is concentrated within the functions of the treasurers office. 5.To maximize the current market value (share price) of the equity of the firm (whether its publicly traded or not). 5.To maximize the current market value (share price) of the equity of the firm (whether its publicly traded or not). 6.In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect the directors of the corporation, who in turn appoint the firms management. This separation of ownership from control in the corporate form of organization is what causes agency problems to exist. Management may act in its own or someone elses best interests, rather than those of the shareholders. If such events occur, they may contradict the goal of maximizing the share price of the equity of the firm. 6.In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect the directors of the corporation, who in turn appoint the firms management. This separation of ownership from control in the corporate form of organization is what causes agency problems to exist. Management may act in its own or someone elses best interests, rather than those of the shareholders. If such events occur, they may contradict the goal of maximizing the share price of the equity of the firm.

26 7.A primary market transaction. 7.A primary market transaction. 8.In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to buy and sell their assets. Dealer markets like Nasdaq represent dealers operating in dispersed locales who buy and sell assets themselves, usually communicating with other dealers electronically or literally over the counter. 8.In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to buy and sell their assets. Dealer markets like Nasdaq represent dealers operating in dispersed locales who buy and sell assets themselves, usually communicating with other dealers electronically or literally over the counter. 9.Since such organizations frequently pursue social or political missions, many different goals are conceivable. One goal that is often cited is revenue minimization; i.e., providing their goods and services to society at the lowest possible cost. Another approach might be to observe that even a not-for-profit business has equity. Thus, an appropriate goal would be to maximize the value of the equity. 9.Since such organizations frequently pursue social or political missions, many different goals are conceivable. One goal that is often cited is revenue minimization; i.e., providing their goods and services to society at the lowest possible cost. Another approach might be to observe that even a not-for-profit business has equity. Thus, an appropriate goal would be to maximize the value of the equity. 10.An argument can be made either way. At one extreme, we could argue that in a market economy, all of these things are priced. This implies an optimal level of ethical and/or illegal behavior and the framework of stock valuation explicitly includes these. At the other extreme, we could argue that these are non-economic phenomena and are best handled through the political process. The following is a classic (and highly relevant) thought question that illustrates this debate: A firm has estimated that the cost of improving the safety of one of its products is $30 million. However, the firm believes that improving the safety of the product will only save $20 million in product liability claims. What should the firm do? 10.An argument can be made either way. At one extreme, we could argue that in a market economy, all of these things are priced. This implies an optimal level of ethical and/or illegal behavior and the framework of stock valuation explicitly includes these. At the other extreme, we could argue that these are non-economic phenomena and are best handled through the political process. The following is a classic (and highly relevant) thought question that illustrates this debate: A firm has estimated that the cost of improving the safety of one of its products is $30 million. However, the firm believes that improving the safety of the product will only save $20 million in product liability claims. What should the firm do? 11.The goal will be the same, but the best course of action toward that goal may require adjustments due different social, political, and economic climates. 11.The goal will be the same, but the best course of action toward that goal may require adjustments due different social, political, and economic climates.

27 12.The goal of management should be to maximize the share price for the current shareholders. If management believes that it can improve the profitability of the firm so that the share price will exceed $35, then they should fight the offer from the outside company. If management believes that this bidder or other unidentified bidders will actually pay more than $35 per share to acquire the company, then they should still fight the offer. However, if the current management cannot increase the value of the firm beyond the bid price, and no other higher bids come in, then management is not acting in the interests of the shareholders by fighting the offer. Since current managers often lose their jobs when the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers in situations such as this. 12.The goal of management should be to maximize the share price for the current shareholders. If management believes that it can improve the profitability of the firm so that the share price will exceed $35, then they should fight the offer from the outside company. If management believes that this bidder or other unidentified bidders will actually pay more than $35 per share to acquire the company, then they should still fight the offer. However, if the current management cannot increase the value of the firm beyond the bid price, and no other higher bids come in, then management is not acting in the interests of the shareholders by fighting the offer. Since current managers often lose their jobs when the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers in situations such as this. 13.We would expect agency problems to be less severe in other countries, primarily due to the relatively small percentage of individual ownership. Fewer individual owners should reduce the number of diverse opinions concerning corporate goals. The high percentage of institutional ownership might lead to a higher degree of agreement between owners and managers on decisions concerning risky projects. In addition, institutions may be better able to implement effective monitoring mechanisms on managers than can individual owners, given an institutions deeper resources and experiences with their own management. The increase in institutional ownership of stock in the United States and the growing activism of these large shareholder groups may lead to a reduction in agency problems for U.S. corporations and a more efficient market for corporate control. 13.We would expect agency problems to be less severe in other countries, primarily due to the relatively small percentage of individual ownership. Fewer individual owners should reduce the number of diverse opinions concerning corporate goals. The high percentage of institutional ownership might lead to a higher degree of agreement between owners and managers on decisions concerning risky projects. In addition, institutions may be better able to implement effective monitoring mechanisms on managers than can individual owners, given an institutions deeper resources and experiences with their own management. The increase in institutional ownership of stock in the United States and the growing activism of these large shareholder groups may lead to a reduction in agency problems for U.S. corporations and a more efficient market for corporate control.

28 14.How much is too much? Who is worth more, Lee Raymond or Tiger Woods? The simplest answer is that there is a market for executives just as there is for all types of labor. Executive compensation is the price that clears the market. The same is true for athletes and performers. Having said that, one aspect of executive compensation deserves comment. A primary reason executive compensation has grown so dramatically is that companies have increasingly moved to stock-based compensation. Such movement is obviously consistent with the attempt to better align stockholder and management interests. In recent years, stock prices have soared, so management has cleaned up. It is sometimes argued that much of this reward is simply due to rising stock prices in general, not managerial performance. Perhaps in the future, executive compensation will be designed to reward only differential performance, i.e., stock price increases in excess of general market increases. 14.How much is too much? Who is worth more, Lee Raymond or Tiger Woods? The simplest answer is that there is a market for executives just as there is for all types of labor. Executive compensation is the price that clears the market. The same is true for athletes and performers. Having said that, one aspect of executive compensation deserves comment. A primary reason executive compensation has grown so dramatically is that companies have increasingly moved to stock-based compensation. Such movement is obviously consistent with the attempt to better align stockholder and management interests. In recent years, stock prices have soared, so management has cleaned up. It is sometimes argued that much of this reward is simply due to rising stock prices in general, not managerial performance. Perhaps in the future, executive compensation will be designed to reward only differential performance, i.e., stock price increases in excess of general market increases. 15.The biggest reason that a company would go dark is because of the increased audit costs associated with Sarbanes-Oxley compliance. A company should always do a cost-benefit analysis, and it may be the case that the costs of complying with Sarbox outweigh the benefits. Of course, the company could always be trying to hide financial issues of the company! This is also one of the costs of going dark: Investors surely believe that some companies are going dark to avoid the increased scrutiny from SarbOx. This taints other companies that go dark just to avoid compliance costs. This is similar to the lemon problem with used automobiles: Buyers tend to underpay because they know a certain percentage of used cars are lemons. So, investors will tend to pay less for the company stock than they otherwise would. It is important to note that even if the company delists, its stock is still likely traded, but on the over- the-counter market pink sheets rather than on an organized exchange. This adds another cost since the stock is likely less to be liquid now. All else the same, investors pay less for an asset with less liquidity. Overall, the cost to the company is likely a reduced market value. Whether this is good or bad for investors depends on the individual circumstances of the company. It is also important to remember that there are already many small companies that file only limited financial information already. 15.The biggest reason that a company would go dark is because of the increased audit costs associated with Sarbanes-Oxley compliance. A company should always do a cost-benefit analysis, and it may be the case that the costs of complying with Sarbox outweigh the benefits. Of course, the company could always be trying to hide financial issues of the company! This is also one of the costs of going dark: Investors surely believe that some companies are going dark to avoid the increased scrutiny from SarbOx. This taints other companies that go dark just to avoid compliance costs. This is similar to the lemon problem with used automobiles: Buyers tend to underpay because they know a certain percentage of used cars are lemons. So, investors will tend to pay less for the company stock than they otherwise would. It is important to note that even if the company delists, its stock is still likely traded, but on the over- the-counter market pink sheets rather than on an organized exchange. This adds another cost since the stock is likely less to be liquid now. All else the same, investors pay less for an asset with less liquidity. Overall, the cost to the company is likely a reduced market value. Whether this is good or bad for investors depends on the individual circumstances of the company. It is also important to remember that there are already many small companies that file only limited financial information already.

29 HAVE A GREAT WEEK!


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