Contemporary Financial Management 8th Edition

by

Moyer, McGuigan, and Kretlow

Prepared by

Tom Peacock
University of Houston

2001 South-Western College Publishing

Chapter 1
The Role and Objective of Financial Management

Questions Faced in Finance

How is finance related to other fields of study? What are the goals and objectives of financial managers? How has the finance field evolved? How is the finance field changing today?

Principal Forms of Business Organizations

Sole proprietorship Partnership Corporation

Sole Proprietorship
Owned by one person Easy formation advantage Unlimited liability disadvantage Difficulty raising funds disadvantage Represent 75% of all businesses Account for < 6% of the $ volume

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

Liability of Partners
General Partner
Has unlimited liability for all obligations of the business

Limited Partner
Liability limited to the partnership agreement

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

Stockholders elect a board of directors Board of directors then hire management

( officers )

Who Manages ?
Board of directors deals with broad policy Management makes most of the decisions

Stockholder Rights
Dividend Voting Asset Preemptive

Corporate Securities in Order or Priority

Bonds Preferred stock Common stock ( C/S )
( highest) ( lowest )

Optimal Form of Organization Influenced by

Cost Complexity Liability Continuity Raising capital Decision making Tax considerations

Objective of Financial Management ( FM ) Objective of the financial manager

Shareholder Wealth Maximization (SWM)

NOT
profit maximization Does not consider time value of money

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 ).

Managers Must
Avoid personal conflicts Maintain confidentiality Be objective Act fairly

Agency Relationships / Problems

Problem created by separation of Owners (shareholders) Management and Employees

Management may maximize its own welfare instead of the owners wealth Job security

Job Security
Management decisions based on retaining management rather than SWM ExampleA decision to retain suppliers Example rather than selecting new suppliers providing higher quality or lower cost WhyIf the transition is mishandled Why 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
To flatten organization structures to cut costs

Problem created by separation of

Owners Management

Owners A similar problem Creditors Protective covenants in loan agreements

Examples of Protective Covenants

Limitations of Common stock dividends Limitations on additional debts Not entering into sale and lease back arrangements

Shareholder Wealth Maximizing Is a Market Concept and Results in

Maximizing PV of E(R) Measured by Market Value of C/S

3 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

Competitive Forces Influencing C/S Market Value

New entrants Substitute products Bargaining power of buyers Bargaining power of suppliers Rivalry among current competitors

Cash Flow Concept Used for

Financial analysis Planning Resource allocation
CF does not equal accounting profit Internal sources

Cash

External sources

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

Controllers Activities
Financial accounting Cost accounting Taxes Data processing

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

Disciplines used in Finance

Economics Accounting Marketing Production Human Resources Quantitative Analysis

Finance

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

Exciting Career Opportunities in Finance

VP of Finance Director Investor Relations Assistant Treasurer Tax Manager Financial Analyst Account Executive Security Broker Mortgage Analyst Banking