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An Overview of Managerial Finance

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What is Finance?

Finance is concerned with decisions about money (Cash Flows)

Finance decisions deal with how money is raised and used

Everything else being equal:More value is preferred to lessThe sooner cash is received the more value it

hasLess risky assets are more valuable than riskier

assets

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General Areas of Finance

Financial Markets and InstitutionsBanks, Insurance Companies, Saving & Loans, Credit Unions etc.

Investments Stock Brokerage firms, Financial Institutions, Investment Companies, Insurance

Companies etc.

Financial ServicesFinancial Consultants, Auditing Firms etc

Managerial FinanceAll type of Firms making Financial Decisions concerning cash flows

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Finance in the Organizational Structure of the Firm

Board of Directors

President (CEO)

Treasurer ControllerCredit

ManagerInventoryManager

Director of Capital

Budgeting

Financialand Cost

Accounting

TaxDepartment

Vice-President: Finance (CFO)

Vice-President: Sales

Vice-President: Information Systems (CIO)

Vice-President: Operations (COO)

•Manage cash & Marketable Securities•Plan how the firm is financed•Manage Risk•Oversee pension fund

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Alternative Forms of Business Organization

Proprietorship

Partnership

Corporation

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Proprietorship

Advantages:Ease of formationSubject to few government regulationsNo corporate income taxes

Limitations:Unlimited personal liabilityLimited lifeTransferring ownership is difficultDifficult to raise capital

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Partnership

Like a proprietorship, except two or more owners

A partnership has roughly the same advantages and limitations as a proprietorship

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Corporation

Advantages:Unlimited lifeEasy transfer of ownershipLimited liabilityEase of raising capital

Disadvantages:Cost of set-up and report filing Double taxation

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Business Organized as a Corporation: Value Maximized

Limited liability reduces risk increasing market value

Ease of raising capital allows taking advantage of growth opportunities

Ownership can be easily transferred thus investors would be willing to pay more for a corporation

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Goals of the Corporation

Primary goal:stockholder wealth maximization—translates to maximizing stock price.

Managerial incentivesProvide valuable incentives to keep the interest of management alive and inline with stockholder wealth maximization.

Social responsibility The concept that businesses should be actively concerned with the welfare of

society at large.

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Managerial Actions to Maximize Stockholder Wealth

Capital Structure DecisionsDecision about how much and what types of debt and equity should be used to finance the firm.

Capital Budgeting DecisionsDecision as to what types of assets should be purchased to help generate future cash flows.

Dividend Policy DecisionsDecisions as to how much of current earnings to pay out as dividends rather than to retain for reinvestment in the firm.

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Value of the FirmMarket Factors/Considerations

Economic ConditionsGovernment Regulations and RulesCompetitive Environment

Firm Factors/Considerations Normal Operations (Revenues and Expenses)

Financing Policy (Capital Structure)

Investing Policy (Capital Budgeting)

Dividend Policy

Investor Factors/ConsiderationsIncome/SavingsAge/LifestyleInterest RatesRisk Attitude

Net Cash Flows, CF Rates of Return, r

CF1

(1 r)1CF 2

(1 r)2 ...

CFN

(1 r)N

N

t 1

CFt

(1 r)t

^^ ^ ^

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Factors Influenced by Managers

that Affect Stock PriceProjected earnings per share

Timing of earnings streams

Risk of projected earnings

Use of debt (capital structure)

Dividend policy

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Agency Relationships

An agency relationship exists whenever a principal hires an agent to act on his or her behalf.

An agency problem results when the agent makes decisions that are not in the best interest of principals

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Stockholders versus ManagersManagers are naturally inclined to act in their own best interests.

Mechanisms to motivate managers to act in shareholder’s best interestManagerial compensation (incentives) Performance shares awarded on basis of EPS, executive stock purchased at future time at given

price, restricted stock grants to employees for some time in future.

The threat of firing Possible now due to ownership by few large institutions like pension fund, mutual funds etc like

cocacola, UA.

Shareholder intervention Big Funds now closely monitor firms and influence management decisions when ever needed.

Threat of takeover Hostile takeovers, management is fired.

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Business Ethics

Webster: “A standard of conduct and moral behavior.”

Business Ethics: A company’s attitude and conduct toward its employees, customers, community, and stockholders

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1. To seek new markets

2. To seek raw materials

3. To seek new technology

4. To seek production efficiency

5. To avoid political and regulatory hurdles

Five reasons firms go “international”

Multinational Corporations

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Factors Distinguishing Domestic Firms from Multinational Firms

Different currency denominations

Economic and legal ramifications

Language differences

Cultural differences

Role of governments

Political risk

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