Contemporary Financial Management, 9th Edition Copyright ©2003 South-Western/Thomson Learning by Moyer, McGuigan, Kretlow Prepared by Richard Gendreau Bemidji State University

Copyright ©2003 South-Western/Thomson Learning Chapter 1 The Role and Objective of Financial Management

Introduction This chapter introduces the financial management process of the typical firm. It looks at the financial manager, the field of finance, financial decisions and their implications, and the daily questions faced by the firm’s financial management.

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

Principal Forms of Business Organizations Sole proprietorship Partnership Corporation

Sole Proprietorship Owned by one person Easy formationadvantage Unlimited liability disadvantage Difficulty raising fundsdisadvantage Represent 75 percent of all businesses Account for less than 6% of the dollar volume Check out small business info from the SBA

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

Liability of Partners General Partner Has unlimited liability for all obligations of the business disadvantage Limited Partner Liability limited to the partnership agreement advantage

Corporation Limited liability Permanency Ability to raise capital Has a board of directors Owners are stockholders Flexibility Legal entity Easy marketability of shares of ownership All advantages

Board of Directors Stockholders elect a board of directors Board of directors then elect the officers –Chairman of the board –Chief executive officer (CEO) –Chief operating officer (COO) –President –Chief financial officer (CFO) –Vice presidents –Treasurer –Secretary Management

Who Manages? Board of directors deals with broad policy 3 to 5 year strategic plan Management makes most of the decisions Day-to-day decisions following the strategic plan

Stockholder Rights Dividend Voting Asset Preemptive

Priority of Corporate Securities Bonds (highest) Preferred stock Common stock (C/S) (lowest) Major corporate Web sites

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

Shareholder Wealth Maximization (SWM) NOT Profit maximization, which does not consider the time value of money Objective of the financial manager Objective of financialmanagement Shareholder Wealth Maximization

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

Social Responsibility Ethical issues will constantly confront financial managers as they achieve the goal of the firm (SWM). Avoid personal conflictsAvoid personal conflicts Maintain confidentialityMaintain confidentiality Be objectiveBe objective Act fairlyAct fairly Managers Must Check out

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

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

Agency Costs Management incentives Monitor performance Owners protection Complex organization structures Recent Trends Flatten organization structures to cut costs

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

Examples of Protective Covenants Limitations on –common stock dividends –the type of investments –divestitures –additional debts –poison puts

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

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

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

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

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

NPV of an Investment 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.

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

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

Controller’s Activities Financial accounting Cost accounting Taxes Data processing

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

Economics Accounting Marketing Production Human Resources Quantitative Analysis MIS Finance Disciplines Impacting Finance

Professional Organizations Financial Executive Institute Institute of Charted Financial Analysis Financial Management Association Institute of Management Accounting

Exciting Career Opportunities VP of Finance Director Investor Relations Assistant Treasurer Tax Manager Financial Analyst Account Executive Security Broker Mortgage Analyst Banking Check out

How to get at least a C Read the chapters as the material is covered in class. Mark/underline important parts of each chapter. Read each chapter twice. Try to get all the bonus points you can. Actually learn TVM calculation methods (Ch.4).

How to get at least a C (continued) Make thorough and concise notes for exams. Don’t rely on exam notes. Use them as a learning exercise. Work all homework problems. Come by my office if you don’t understand homework problem solutions. Review class notes, market portions of your text, and problem solutions the night before exams and quizzes.

How to Fail “All I want is a D.” Be a certified “non-worker.” Don’t read the textbook. Don’t do any homework. Expect exam notes to be a substitute for studying. Copy someone else’s exam notes.

How to Fail (continued) Cut class often. Wait until the last minute to study. Treat the first two exams like throwaways. Expect to pass based on the final exam. Expect “extra work” to be given for improving your grade. Expect a grading curve to save you.