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Transcript of 1 Contemporary Corporate Finance, 11th Edition ©2009 South-Western/Cengage By McGuigan, Kretlow,...
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Contemporary Corporate Contemporary Corporate Finance, 11th EditionFinance, 11th Edition
©2009 South-Western/Cengage
By
McGuigan, Kretlow, and Moyer
Prepared by
Rand MartinBloomsburg University of Pennsylvania
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1
The Role and Objective of
Financial Management
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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.
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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?
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Principal Forms of Business Organizations
Sole proprietorship
Partnership
Corporation
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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
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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
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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
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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
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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
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Stockholder Rights
Dividends
Asset
Voting for board members, major policy
Preemptive rights on new shares
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Priority of Corporate SecuritiesDebt Securities (Bonds) (highest)
Preferred stock (P/S)
Common stock (C/S) (lowest)
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ShareholderShareholderWealthWealthMaximizationMaximization
(SWM)(SWM)
NOTNOTProfit maximization!
Primary objective of the Primary objective of the financial managerfinancial manager
Primary objective ofPrimary objective offinancial financial
managementmanagement
Shareholder Wealth Maximization
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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
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Job securityJob 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
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Agency Problem: Second Type
Problem created by
separation of
Owners
Creditors
Caused by conflicting interests concerning risk and returns
Protective covenants
in loan agreements
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Agency Costs
Corporate governance Management compensation Threat of takeovers Annual audit by accounting firm
Recent Development:
Sarbanes-Oxley Act
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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!
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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
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Three Basic Factors Determine C/S Market Value 1) Amount of
2) Timing of
3) Risk of
Expected cash flows
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Managers deal with these competitive forces New entrants
Substitute products
Bargaining power of buyers
Bargaining power of suppliers
Rivalry among current competitors
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Cash flow generation
Acquire Assets-Long-term
-Working capital
Produce and SellProducts/Services
Funds for investmentsFunds to distribute
Raise Funds -External-Internal
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Cash Flow Concept central to: Financial analysis Planning Resource allocation
CF does not equal accounting profit
External sources Cash
Internal sources
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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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Controller’s Activities
Financial accounting
Cost accounting
Taxes
Data processing
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Treasurer’s Activities
Management of cash and marketable
securities
Capital budgeting
Financial planning
Credit analysis
Investor relations
Pension fund management
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Professional Organizations Financial Executive Institute
Institute of Charted Financial Analysis
Financial Management Association
Institute of Management Accounting
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Exciting Career Opportunities
VP of Finance
Director Investor Relations
Assistant Treasurer
Tax Manager
Financial Analyst
Account Executive Security Broker
Mortgage Analyst
Banking
Check out http://www.careerpath.com/