Presentation on theme: "1-1 What is the Goal of the Company? Maximization of Shareholder Wealth!"— Presentation transcript:
1-1 What is the Goal of the Company? Maximization of Shareholder Wealth!
1-2 CREATION OF VALUE u Company’s objective is to create value for its shareholders; u Value means market price of the company’s share; u Value creation can be achieved by i. Investing ii. Financing and iii. Dividend/Share repurchase decisions.
1-3 Shortcomings of Alternative Perspectives u Could increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy T-bills (govt. securities), etc.). u Ignores changes in the risk level of the firm. Profit Maximization u Maximizing a firm’s earnings after taxes.Problems
1-4 Shortcomings of Alternative Perspectives u Does not specify timing or duration of expected returns. u Ignores changes in the risk level of the firm. u Calls for a zero payout dividend policy. Earnings per Share Maximization u Maximizing earnings after taxes divided by shares outstanding.Problems
1-5 Strengths of Shareholder Wealth Maximization current and future profits and EPSthe timing, duration, and risk of profits and EPS dividend policy u Takes account of: current and future profits and EPS; the timing, duration, and risk of profits and EPS; dividend policy; and all other relevant factors. share price u Thus, share price serves as a barometer for business performance.
1-6 The Modern Corporation There exists a SEPARATION between owners and managers. Modern Corporation ShareholdersManagement
1-7 Role of Management agent u An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf. agent Management acts as an agent for the owners (shareholders) of the firm.
1-8 Agency Theory u Agency Theory u Agency Theory is a branch of economics relating to the behavior of principals and their agents. agency theory u Jensen and Meckling developed a theory of the firm based on agency theory.
1-9 Agency Theory stock options, perquisites, bonuses u Incentives include, stock options, perquisites, and bonuses. incentives monitor u Principals must provide incentives so that management acts in the principals’ best interests and then monitor results.
1-10 Social Responsibility socially responsible u Wealth maximization does not preclude the firm from being socially responsible. u Assume we view the firm as producing both private and social goods. shareholder wealth maximization u Then shareholder wealth maximization remains the appropriate goal in governing the firm.
1-11 FUNCTIONS OF FINANCE u Investment Decisions u Financing Decisions u Dividend/Share repurchase Decisions “An optimal combination of these three will create value”
1-12 Investment Decision u Allocation of capital to future investment proposals (evaluated by expected return and Risk); u Reallocation of capital when an asset no longer economically justifies the capital committed to it; u Managing existing assets efficiently, especially current assets. Most important of the three decisions when it comes to the creation of value.
1-13 Financing Decision u What is the best type of financing (Debt or Equity)? u What is the best financing mix (capital structure)? u Implications of variation in capital structure on the valuation of firm. Determine how the assets (LHS of balance sheet) will be financed (RHS of balance sheet).
1-14 Dividend/Share Repurchase Decision u Excess cash to distribute to stockholders; u Cash Dividends (directly) and Share repurchase (indirectly); u Best Dividend policy (e.g. Dividend payout ratio)
1-15 Organization of the Financial Management Function Board of Directors President (Chief Executive Officer) Vice President Operations Vice President Marketing VP of Finance
1-16 Treasurer Capital Budgeting Cash Management Credit Management Dividend Disbursement Fin Analysis/Planning Pension Management Insurance/Risk Mngmt Tax Analysis/Planning Organization of the Financial Management Function VP of Finance Controller Cost Accounting Cost Management Data Processing General Ledger Government Reporting Internal Control Preparing Fin Stmts Preparing Budgets Preparing Forecasts
1-17 What is Financial Management? Financial Management endeavors to make optimal investment, financing, and dividend/share repurchase decisions.
1-18 Summary of Investing, Financing, & Dividend/Share repurchase decisions To acquire assets and invest in new products and services where expected return exceeds their cost; to finance with those instruments where expected return exceeds their cost, tax or otherwise, and to undertake a meaningful dividend policy for shareholders.