1. Chapter 1

• The Roles and Objectives of Financial Management

2. Introduction

This chapter introduces the financial management process of the typical firm. It looks at the financial manager, the field of finance, financial decisions and their implications, and the daily questions faced by the firms financial management.

3. A GENERAL LOOK ATFINANCE

Finance is the art and science of managing money

4.

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?

Questions Faced in Finance 5. THERE ARE THREE MAJOR AREAS OF FINANCE

• Investments -- Concerned with analyzing potential investments (including Real Estate) in order to achieve a certain rate of return consistent with a desired level of risk. Return on Investment

• Financial institutions and markets -- Concerned with the management of financial institutions like commercial banks, insurance companies, etc.Also concerned with analyzing financial markets and predicting interest rates.

6. AREAS OF FINANCE --continued

• Business finance or corporate finance or managerial finance which is concerned with the management of the non-financial corporation.Primarily concerned with the for profit organization, but same principles apply to the not for profit organization.

This course is concerned with managerial finance, but we will get into the other areas. That is, at times, we will assume the role of a banker or investor .

7. What Activities are Involved in Managerial Finance

Investmentof funds or capital budgeting

• Risk versus Return

• Real Options

Working capital management

• Amount of cash to hold

• Amount of credit to grant

• Amount of inventory to hold

• Where to obtain short term capital

Acquisition of funds -Financing

• Debt versus equity

• Long term debt versus short term debt

• Lease versus own

8. Activities in Finance -continued

Distributionor Dividend Decision

Financial planning

Others

• Mergers and acquisitions

• Bankruptcies

• Spin-offs

• Leverage buy-outs (LBO)

• Valuations

• • EVA and MVA

9. In Making Financial Management Decisions, What is Our Goal?

Some Possibilities

• Maximize revenue

• Maximize profits

• Maximize EPS

• Minimize losses

• Others

10. Owners Wealth Maximization (OWM) or Stockholders Wealth Maximization (SWM) Objective of thefinancial manager NOT profit maximization Does not consider time value of money or cash flows or risk Objective of Financial Management ( FM ) 11. Principal Forms of Business Organizations are:

Sole proprietorship

Partnership

Corporation

12. Sole Proprietorship

Owned by one person

Easy formation advantage

Unlimited liabilitydisadvantage

Difficulty raising funds disadvantage

Represent 75 percent of all businesses

Account for less than 6% of the dollar volume

Check out small business info from the SBA

http://www.sba.gov/

13. Partnership

Owned by two or more persons

Classified as general or limited

Partnership dissolves when a general partner dies

General partner has unlimited liability

Limited partners liability limited by partnership agreement

14. Corporation

Limited liability

Permanency

Flexibility

Ability to raise capital

Legal entity

Have a board of directors

Owners are stockholders

Easy marketability ofshares of ownership

Dartmouth College Case 15. Optimal Form of Organization Influenced by

Cost

Complexity

Liability

Continuity

Raising capital

Decision making

Tax considerations

16. 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 17. Major Advantage of Corporation is Limited Liability

We will assume in this course that we are working with corporations

Ownership is represented by common stock (CS)

Our objective is to maximize thelong termvalue of the common stock (this is the same as OWM or SWM)

• MVA and EVA

18. Three Basic Factors DetermineC/SMarket Value

1) Amount of

2) Timing of

3) Risk of

Expected cash flows Also, interest rates and tenor of the market 19. Risk-Return Tradeoff

We will assume that firms and investors are risk averse

There is no such thing as a free lunch

Do you want to sleep well or eat well?

20. 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 and ethics

21. Social Responsibility

Ethical issues will constantly confront financial managers as they achieve the goal of the firm ( SWM ).

Avoid personal conflicts

Maintain confidentiality

Be objective

Act fairly

(essentially, treat others as you would have

them treat you)

Managers Must 22. Conditions Affecting Market Value

Economic environment factors

Managerial Decisions -- Which will determine

• Expected cash flows

• Risk of expected cash flows

• Timing of expected cash flows

Conditions in financial markets

• Interest rates

• Tenor of the market

23. Stockholders elect a board of directors Board of directors then hire management ( officers ) 24. Who Manages?

Board of directors deals with broad policy

3 to 5 year strategic plan

Management makes most of the decisions

Day-to-day decisions following the strategic plan

25. Stockholder Rights

Dividend

Voting

Asset

Preemptive

26. Priority of Corporate Securities

Bonds(highest)

Preferred stock

Common stock(C/S) (lowest)

Major corporate Web sites

http://www. bankofamerica .com/

http://www. ge .com/

http://www. ibm .com/us/

http://www. wachovia .com

27.

Problem createdby separation of

Management maximizes

their own welfare instead

of the owners wealth

Owners (shareholders) ManagementandEmployees Job Security One Agency Relationships / Problems 28. Job Security

Management decisions based on retaining management rather than SWM

ExampleA decision toretain suppliers rather than selecting new suppliers providing higher quality or lower cost

WhyIf the transition is mishandled management will be scrutinized but if no change is made the issue will be ignored

29. Agency Costs

A. Management incentives (e.g. stock options)

B. Monitor performance (e.g. auditing)

C. Owners protection(e.g. bonding)

D. Complex Organizational Structures

Pervasive Trends Flatten organization structures to cut costs Incorporate Technology in Managing Eliminate Back Office Operations 30.

Agency Problem created byseparation of

Owners

Management A second and similar Agency problem Owners Creditors Protective covenants in loan agreements 31. Agency Problem between Stockholders and Creditors

Creditors return is limited (fixed) by interest rate on debt

Stockholders have limited liability and potential for unlimited returns.They are willing and rewarded for taking risks.

32. Examples of Protective Covenants

Limitations on

• common stock dividends

• the type of investments

• divestitures

• additional debts

• poison puts

33. Competitive Factors Influencing C/S Market Value

New entrants

Substitute products

Bargaining power of buyers

Bargaining power of suppliers

Rivalry among current competitors

34. Cash Flow Concept Used for

Financial analysis

Planning

Resource allocation

External sourcesCash Internal sources CF does not equal accounting profit 35. Shareholder Wealth Maximizing Is a Market Concept and Results in

Maximizing PV of E(R)

Measured by Market Value of C/S

36. NPV of an Investment

NPV=PV of future cash inflows minusPV of cash outflows

The NPV of an investment represents the contributions of that investment to the value of the firm and affects the Stockholders Wealth Maximization (SWM)

• EVA and MVA

37. Small Business Vs. Large Corporations Fundamental concepts are the same 38. Small Business

1) Not the dominant firm in the industry

2) Tend to grow more rapidly

3) Limited access to financial markets

4) Lack management resources

5) Have a high failure rate

6) Stock is not publicly traded

7) Poorly diversified

8) Owner/manager frequently the same

39. Treasurers Activities

Management of cash and marketable securities

Capital Budgeting

Financial Planning

Credit Analysis

Investor Relations

Pension Fund Management

40. Controllers Activities

Financial Accounting

Cost Accounting

Taxes

Data Processing

41.

Economics

Accounting

Marketing

Production

Human Resources

Quantitative Analysis

MIS

Disciplines Impacting Finance Finance 42. Professional Organizations

Financial Executives International

Institute of Chartered Financial Analysts

Financial Management Association

Credit Management Association

Institute of Certified Financial Planners

Institute of Management Accountants

43. Exciting Career Opportunities in Finance

Certified Cash Manager

Credit Manager

Vice President of Finance (CFO)

Director, Investor Relations

Assistant Treasurer

Tax Manager

Financial Planner

Banker

Financial Analyst

Mutual Fund Manager

Account Executive, Security Broker

Mortgage Analyst

Investment Banker

Real Estate Analyst

Insurance Broker

Check out http://www. careerpath .com/