1 Contemporary Corporate Finance, 11th Edition ©2009 South-Western/Cengage By McGuigan, Kretlow, and Moyer Prepared by Rand Martin Bloomsburg University of Pennsylvania

1 The Role and Objective of Financial Management

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

4 Questions Faced by Financial Managers Will a particular investment be successful? Where will the funds come from to finance the investment? Does the firm have adequate cash or access to cash to meet its daily operating needs?

5 Principal Forms of Business Organizations Sole proprietorship Partnership Corporation

6 Sole Proprietorship Owned by one person Advantage: Easy formation Disadvantage: Unlimited liability Disadvantage: Difficulty raising funds Represent 75 percent of all businesses Account for less than 6 percent of total business revenues

7 Partnership Owned by two or more persons About 7 percent of US businesses, 5 percent of business revenues Classified as general or limited General partners work in the partnership Advantage: Limited partners’ liability is limited to what is specified in the agreement. Disadvantage: Partnership dissolves when a general partner dies Disadvantage: Unlimited liability for general partners

8 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

9 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

10 Who Does What? Board of directors deals with broad policy The board sets 3 to 5 year strategic plans Management makes most of the decisions Management makes day-to-day decisions following the strategic plan

11 Stockholder Rights Dividends Asset Voting for board members, major policy Preemptive rights on new shares

12 Priority of Corporate Securities Debt Securities (Bonds) (highest) Preferred stock (P/S) Common stock (C/S) (lowest)

13 Shareholder Wealth Maximization (SWM) NOT NOT Profit maximization! Primary objective of the financial manager Primary objective of financialmanagement Shareholder Wealth Maximization

14 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

15 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 Divergent Objectives create Agency Problems

16 Agency Problem: Second Type Problem created by separation of Owners Creditors Caused by conflicting interests concerning risk and returns Protective covenants in loan agreements

17 Agency Costs Corporate governance Management compensation Threat of takeovers Annual audit by accounting firm Recent Development: Sarbanes-Oxley Act

18 Shareholder Wealth Maximizing is a Market Concept and Results in  Maximizing PV of E(R) Important note!  Success is measured by Market Value of Common Stock---  Not by profit maximization!

19 Limitations of Profit Maximization Static nature of standard microeconomic model (Lack of time dimension) Variable definition of profit Provides no direct way for managers to consider the risk of alternative decisions

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

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22 Managers deal with these competitive forces New entrants Substitute products Bargaining power of buyers Bargaining power of suppliers Rivalry among current competitors

23 Cash flow generation

24 Cash Flow Concept central to: Financial analysis Planning Resource allocation CF does not equal accounting profit External sources Cash Internal sources

25 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.

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27 Controller’s Activities Financial accounting Cost accounting Taxes Data processing

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

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

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