Chapter 1 - An Introduction to Financial Management 08/28/08

Financial Management  What is financial management? -- maintenance and creation of economic value -- maintenance and creation of economic value -- deal with all kinds of financial decisions, such as when to invest new assets, when to borrow… -- deal with all kinds of financial decisions, such as when to invest new assets, when to borrow…

Goal of the Firm 1) Profit Maximization? this goal ignores: a) TIMING of Returns b) Costs of shareholders

Goal of the Firm 2) Shareholder Wealth Maximization? this is the same as: a) Maximizing Firm Value b) Maximizing Stock Price

Legal Forms of Business 1) Sole Proprietorship  A business owned by a single individual.  Owner maintains title to the firm’s assets.  Owner has unlimited liability. 2) Partnership  Similar to a sole proprietorship, except that there are two or more owners.

2a) General Partnership  All partners have unlimited liability. 2b) Limited Partnership  Consists of one or more general partners, who have unlimited liability.  One or more limited partners (investors) whose liability is limited to the amount of their investment in the business. Legal Forms of Business

2c) Limited Liability Company (LLC)  Cross between a partnership and a corporation.  Owners have limited liability, but the firm runs and is taxed like a partnership. Legal Forms of Business

3) Corporation  A business entity that legally functions separate and apart from its owners.  Owners’ liability is limited to the amount of their investment in the firm.  Owners hold common stock certificates, and ownership can be transferred by selling the certificates. Legal Forms of Business

Comparison of Three Forms  Advantage of corporations: -- limited liability -- limited liability -- ease in raising capital -- ease in raising capital

Role of Financial Manager  CFO – Chief Financial Officer: oversees financial planning, corporate strategic planning, and control cash flow  Treasurer – handles the firm’s financial activities  Controller – manages the firm’s accounting duties

The Corporation and Financial Markets cash Investors Secondary markets Government securities Cash flow reinvest tax Corporation dividends, etc.

 Primary Market  Market in which new issues of a security are sold to initial buyers.  Secondary Market  Market in which previously issued securities are traded. The Corporation and Financial Markets

 Initial Public Offering (IPO)  The first time the firm’s stock is sold to the general public.  Seasoned New Issue  A new stock offering by a firm that already has stock that is traded in the secondary market. The Corporation and Financial Markets

Financial Management Axioms 1) Risk - return trade-off. 2) Time value of money. -- a dollar get today is worth more than a dollar get a year later -- a dollar get today is worth more than a dollar get a year later 3) Cash - not profits - is king. -- it is the cash that can be reinvested -- it is the cash that can be reinvested 4) Incremental cash flows count. 5) The curse of competitive markets. -- differentiation -- differentiation -- economies of scale -- economies of scale

Financial Management Axioms 6) Efficient capital markets. -- stock price adjust new information fast -- stock price adjust new information fast 7) The agency problem. -- managers don’t work for the interest of shareholders -- managers don’t work for the interest of shareholders -- get benefit from salary, private jet -- get benefit from salary, private jet -- avoid risk project -- avoid risk project

Financial Management Axioms 8) Taxes bias business decisions. -- after-tax incremental cash flow -- after-tax incremental cash flow 9) All risk is not equal. -- don’t put all eggs in one basket -- don’t put all eggs in one basket 10) Ethical dilemmas are everywhere in finance. -- Enron, Worldcom -- Enron, Worldcom -- loss of public’s confidence -- loss of public’s confidence