1. CHAPTER 1 An Overview of Financial Management
Finance VS Economics & Accounting
Responsibility of CFO
Three areas of Finance
Goal of Corporations
Intrinsic Value and Stock Price
Agency Relationships

2. Finance VS Economics & Accounting
Finance can be defined as the science and art of managing money.
Finance grew out of Economics and Accounting
Economics suggested that assets value is based on it’s ability to generate cash now and in the future. (cost-benefit analysis)
Accountants provide information regarding the likely size of those cash flows.(accrual vs. cash, decision making)

3. Career Opportunities in Finance
Money and capital markets (e.g. Banks, insurance companies, mutual funds)
Investments (e.g. Brokerage House)
Financial management

4. Finance Within the Organization
Board of Directors
Chief Executive Officer (CEO)
Chief Operating Officer (COO)
Marketing, Production, Human Resources, and Other Operating Departments
Chief Financial Officer (CFO)
Accounting, Treasury, Credit, Legal, Capital Budgeting, and Investor Relations

5. Responsibility of the Financial Staff
Maximizing Shareholders’ Wealth by:
Forecasting and planning
Investment and financing decisions
Transactions in the financial markets
Managing risk
Coordination and Control

6. Three areas of Finance Financial Management Corporate Finance
Decisions regarding acquiring and funding for assets
How to maximize firm’s value
Capital Markets
Markets where interest rates, prices of bonds and stocks are determined
Financial institutions like banks, brokers, insurance companies are studied here
Also studied are government agencies relating to fiscal and monetary policies
Investments
Decisions to use money to generate more.
Most common types of investment is bonds and stocks
Includes: Security analysis, portfolio theory, market analysis, behavioral finance.

7. Equation of Accounting
ASSET = LIABILITIES + STOCKHOLDERS’ EQUITY

8. Alternative Forms of Business Organization
Sole proprietorship: An unincorporated business owned by one individual
Partnership: An unincorporated business owned by two or more persons.
Corporation: A legal entity created by a state, separate and distinct from it’s owners and managers.
Ownership is divided into several segments called shares/stocks and sold to the public, who become the shareholder.

9. Sole proprietorships & Partnerships
Advantages
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages
Difficult to raise capital
Unlimited liability
Limited life

10. Corporation Advantages Disadvantages Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages
Double taxation
Cost of set-up and report filing

11. Goal of Corporation
Because the ownership and management are separate in a corporation thus the goals of corporation are different from those of proprietorship and partnership.
The primary goal for managers of publicly owned corporation implies that decisions should be made to maximize the long-run value of the firm’s shares/stocks, within some constraints.

12. Financial Goals of the Corporation
The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price.
Should firms behave ethically?

13. Ethics in Financial Reporting
Standards of conduct by which one’s actions are judged as right or wrong, honest or dishonest, fair or not fair, are Ethics.
Recent financial scandals include: Enron, WorldCom, Xerox Corp. and others.
Effective financial reporting depends on sound ethical behavior.

14. Is stock price maximization the same as profit maximization?
No, despite a generally high correlation amongst stock price, EPS, and cash flow.
Current stock price relies upon current earnings, as well as future earnings and cash flow.
Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa).

15. Factors that affect stock price
Projected cash flows to shareholders
Timing of the cash flow stream
Riskiness of the cash flows

16. Factors that Affect the Level and Riskiness of Cash Flows
Decisions made by financial managers:
Investment decisions
Financing decisions (the relative use of debt financing)
Dividend policy decisions
The external environment

17. Intrinsic Value and Stock Price
Economists’ theory of valuing an asset can be applied to stocks as well. Thus a stock’s intrinsic value is determined by it’s ability to generate cash now and in the future.
Intrinsic value is an estimate of stock’s “true” value based on accurate risk and historical return data. This value is an estimate as future cash flows cannot be determined with certainty.

18. Intrinsic Value and Stock Price
Stock Prices are seldom equal to it’s intrinsic value. The prices of stocks in the market are determined by it’s demand and supply.
The investors’ demand of stocks are based on their “perceived” risk and return. “Perceived” means what the investors expect of the future.

19. Equilibrium
The situation in which the actual market price equals the intrinsic value so investors are indifferent between buying and selling a stock.

20. Determinants of Intrinsic Value and Stock Price
Managerial Actions, the Economic Environment, Taxes, and the Political Climate
“True” investor returns (cash flows)
“True” Risk
“Perceived” investor returns (cash flows)
“Perceived” Risk
Stock’s Intrinsic Value
Stock’s Market Price
Market Equilibrium:
Intrinsic Value = Market Price

21. Agency relationships
Corporate Governance are the rules, processes, and laws by which companies are operated, controlled, and regulated.
An agency relationship exists whenever a principal hires an agent to act on their behalf.
Within a corporation, agency relationships exist between:
Shareholders and managers
Shareholders and creditors

22. Shareholders versus Managers
Managers are naturally inclined to act in their own best interests. (agency problem)
But the following factors affect managerial behavior:
Managerial compensation plans
Direct intervention by shareholders
The threat of firing
The threat of takeover

23. Shareholders versus Bondholders
Stockholders are more likely to prefer riskier projects, because they receive more of the upside if the project succeeds. By contrast, bondholders receiving fixed payments are more interested in limiting risk.
Bondholders are particularly concerned about the use of additional debt.
Bondholders attempt to protect themselves by including covenants in bond agreements that limit the use of additional debt and constrain managers’ actions.

24. Some Core Principles of Finance…
The Risk-Return Trade off
The time value of Money
Cash – Not Profit – is our interest
Efficient Capital Market