THE CORPORATION n Legal entity created to sell goods and/or services. n Owned by shareholders who purchase its stock. n Possible returns to shareholders: –1) dividends –2) stock price appreciation

FINANCE DECISIONS n Investment n Financing n Dividend

Investment n What assets does the company need to accomplish its mission? n Buildings, machinery, equipment? (Ch 7 and Ch 8) n Cash, accounts receivable, inventory? (Ch 9)

Financing n How should firm’s assets be financed? n Liabilities (debt) or Equity (selling new stock or reinvesting profits)? n What is best mix of debt and equity? n Valuation (Ch 5); Cost of Capital (Ch 6)

Dividend n What to do with Earnings After Taxes (profit, net income)? n Pay dividends to stockholders? n Reinvest into company (retained earnings)? n Some combination of both?

Goal of Financial Management n Most people would say goal is to maximize profits n Profits when? - this quarter, this year, next 5 years… n Which measure of profit to use? - net income, income before extraordinary items, EPS…

Better Goal n Who owns firm? n Stockholders. n Why do they buy stock? n To gain financially when stock price goes up (buy low, sell high) n Goal: MAXIMIZE STOCK PRICE

Advantages of Stock Price Maximization as a Goal n Easy to measure n Readily available n Provides immediate feedback on how market values decisions of firm’s managers

Disadvantage of Stock Price Maximization as a Goal n Majority of stocks owned by institutional investors n Managers of institutional funds push for short-term returns n When corporate managers focus on short-term stock price maximization, they may make decisions harmful to the corporation in the long-run.

Examples of Institutional Investors n Mutual Funds n Hedge Funds n Private Equity Funds n Sovereign Wealth Funds n Pension Plans n Insurance Companies n Endowment Funds

Stakeholders in a corporation n Shareholders (individuals + institutions) n Employees, including managers n Customers n Suppliers n Community n Creditors n Government

Stakeholder Theory n Says that managers should make decisions that maximize interests of all stakeholders n Example: UAW got BIG 3 Auto Makers to give big concessions in 1970s n Look how that turned out in long-run for everyone!

Agency Theory n Managers are agents of stockholders (principal) n Managers sometimes act in own interest instead of stockholders’ n Adelphia, Enron, Global Crossing, Qwest, Tyco, WorldCom, to name a few n Agency costs – making sure that managers are acting appropriately; e.g. auditing

Long-term Decision Making n All stakeholders, including employees, managers, and stockholders, have an interest in the continued operation of a corporation n Managers should make decisions that maximize stock price in the long-run n Taking the long view benefits all stakeholders

3 Steps to Follow in Making Financial Decisions n Estimate impact of decision on future cash flows n Adjust future cash flows for time value of money (Ch 3) n Adjust future cash flows for risk (chance that actual cash flow will not be what is expected) (Ch 4)

Where We Are Headed n Ch 2: Overview of Financial Markets n Ch 3: Time Value of Money n Ch 4: Risk n Ch 5 and Ch 6 – Financing Decision n Ch 7, 8, 9 – Investment Decision n Ch 10 – Financial Statement Analysis n Ch 11 – Financial Planning