An overview of Financial Management (chapter 1)

1. An overview of Financial Management (chapter 1)

2. Career Opportunities in Finance • Financial management/ Corporate finance • Investments • Money and capital markets Check out the file Careers in Finance posted on the course’s web site

3. Alternative Forms of Business Organization: Sole proprietorships & Partnerships • Sole proprietorship: un unincorporated business owned by one individual • Partnership: un unincorporated business owned by two or more individuals • Advantages • Ease of formation • Subject to few regulations • No corporate income taxes • Disadvantages • Difficult to raise capital • Unlimited liability • Limited life

4. Alternative Forms of Business Organization: Corporation • Advantages • Unlimited life • Easy transfer of ownership • Limited liability • Ease of raising capital • Disadvantages • Double taxation • Cost of set-up and report filing

5. Stock Prices and Shareholder Value • The primary financial goal of management is shareholder wealth maximization, which translates to maximizing stock price. • Value of any asset is present value of cash flow stream to owners. • Most significant decisions are evaluated in terms of their financial consequences. • Stock prices change over time as conditions change and as investors obtain new information about a company’s prospects.

6. Factors that affect stock prices • Projected cash flows to shareholders • Timing of the cash flow stream • Riskiness of the cash flows

7. Stock Prices and Intrinsic Value • In equilibrium, a stock’s price should equal its “true” or intrinsic value. • To the extent that investor perceptions are incorrect, a stock’s price in the short run may deviate from its intrinsic value. • It’s a BUY if the market stock price is below the investor’s intrinsic value • It’s a SELL if the market stock price is above the investor’s intrinsic value

8. Is stock price maximization the same as profit maximization? • No, despite a generally high correlation amongst stock price, EPS, and cash flow. • Current stock price relies upon current earnings, as well as future earnings and cash flow. • Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa).

9. Conflicts Between Managers and Stockholders • Managers are naturally inclined to act in their own best interests (which are not always the same as the interest of stockholders). • But the following factors affect managerial behavior: • Managerial compensation packages • Direct intervention by shareholders • The threat of firing • The threat of takeover

10. Conflicts Between Stockholders and Bondholders • Stockholders are more likely to prefer riskier projects, because they receive more of the upside if the project succeeds. By contrast, bondholders receiving fixed payments are more interested in limiting risk. • Bondholders are particularly concerned about the use of additional debt. • Bondholders attempt to protect themselves by including covenants in bond agreements that limit the use of additional debt and constrain managers’ actions.

11. Learning objectives • What are the key differences between sole proprietorship, partnerships, LLC, LLP and corporations? • What is the primary goal of a corporation? Shareholder wealth maximization (text page 8-9) • What is the difference between a stock’s current market price and its intrinsic value? (text pages 10 to 13) • What are some mechanisms that encourage managers to act in the best interest of stockholders? Executive compensation (text pages 10 to 13) • Business ethics (text p. 15-18) • Conflicts Between Managers and Stockholders (text p. 18-20) • Conflicts Between Managers and Bondholders (text p. 20) • No calculations required for this chapter • Recommended practice questions: ST-1, 1-1, 2, 3, 4, 6, 8, 10, 11,