Chapter 1

An Overview of Managerial Finance

© 2005 Thomson/South-Western

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Career Opportunities in Finance

Financial Markets and Institutions

Investments

Managerial Finance

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Managerial Finance in the Twentieth Century

Business globalization

Information technology

Regulatory attitude of the government

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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 liabilityDifficult to raise capitalTransferring ownership is difficultLimited life

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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:Double taxationCost of set-up and report filing

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Finance in the Organizational Structure of the Firm

Board of Directors

President

Treasurer Controller

CreditManager

InventoryManager

Director of Capital

Budgeting

CostAccounting

FinancialAccounting

TaxDepartment

Vice-President: Finance

Vice-President: Sales

Vice-President: Information Systems

Vice-President: Operations

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The Financial Manager’s Responsibilities

Forecasting and planningMajor investment and financing

decisionsCoordination and controlDealing with financial markets

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Goals of the Corporation

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

Managerial incentives Social responsibility Stock price maximization and social

welfare

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Managerial Actions to Maximize Stockholder Wealth

Capital Structure Decisions

Capital Budgeting Decisions

Dividend Policy Decisions

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Factors Influenced by Managers that Affect Stock Price

Projected earnings per shareTiming of earnings streamsRiskiness of projected earningsUse of debt (capital structure)Dividend policy

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Value of the FirmMarket Factors/Considerations

Economic ConditionsGovernment Regulations and RulesCompetitive Environment

Firm Factors/ConsiderationsNormal OperationsFinancing PolicyInvesting PolicyDividend Policy

Investor Factors/ConsiderationsIncome/SavingsAge/LifestyleInterest RatesRisk Attitude

Net Cash Flows, CF Rates of Return, k

Value of the Firm

N= CF1 + CF2 + . . . + CFN = CFt

(1+k)1 (1=k)2 (1+k)N (1+k)t

t=1^ ^ ^ ^

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Agency Relationships

An agency relationship exists whenever a principal hires an agent to act on their behalf.

Within corporations, agency relationships exist between:Stockholders and managers, andStockholders and creditors.

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Stockholders versus Managers

Managers are naturally inclined to act in their own best interests.

But the following factors affect managerial behavior:The threat of firingThe threat of takeoverStructuring managerial incentives

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Stockholders versus Creditors

Stockholders (through managers) could take actions to maximize stock price that are detrimental to creditors.

In the long run, such actions will raise the cost of debt and ultimately lower stock price.

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External Constraints:

1. Antitrust Laws

2. Environmental Regulations

3. Product and Workplace Safety Regulations

4. Employment Practices Rules

5. Federal Reserve Policy

6. International Developments

Strategic Policy Decisions Controlled by Management

1. Types of Products and Services Produced

2. Production Methods Used

3. Relative Use of Debt Financing

4. Dividend policy

Level of Economic Activity and

Corporate Taxes

Stock Market Conditions

Expected Profitability

Timing of Cash Flows

Degrees of Risk

Summary of Major Factors Affecting Stock Prices

Stock Price

The External Environment

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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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Forms of Business in Other Countries

Non-US firms have higher 19concentrations of ownershipNature of relationship with financial

institutions differs from U.S.U.S. firms have a more dispersed

ownership

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Multinational CorporationsFirms that operate in two or more countries

1. To seek new markets2. To seek raw materials3. To seek new technology4. To seek production efficiency5. To avoid political and regulatory

hurdles

Five reasons firms go “international”

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Multinational VersusDomestic Managerial Finance

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Factors Distinguishing Domestic Firms from Multinational Firms

1. Different currency denominations2. Economic and legal ramifications3. Language differences4. Cultural differences5. Role of governments6. Political risk

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End of Chapter 1

An Overview of Managerial Finance