Chapter 1 An Overview of Managerial Finance
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Transcript Chapter 1 An Overview of Managerial Finance
Chapter 1
An Overview of
Managerial
Finance
© 2005 Thomson/South-Western
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
Prosperous economy = business friendly
Poor economy = consumer/investor friendly
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Alternative Forms of
Business Organization
Proprietorship
71% of all businesses
90% have assets under $100,000
Partnership
9% of all businesses
Corporation
20% of all businesses
85% of all dollar value of sales
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Proprietorship
Advantages:
Ease of formation
Subject to few government regulations
No corporate income taxes
Limitations:
Unlimited personal liability
Difficult to raise capital
Transferring ownership is difficult
Limited 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 life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Double taxation
Earnings taxed at corporate level
Dividends taxed as income to stockholders
Cost of set-up and report filing
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Finance in the Organizational
Structure of the Firm
Board of Directors
President
Vice-President:
Sales
Vice-President:
Operations
Treasurer
Credit
Manager
Inventory
Manager
Director of
Capital
Budgeting
Vice-President:
Finance
Vice-President:
Information Systems
Controller
Cost
Financial
Tax
Accounting Accounting Department8
The Financial Manager’s
Responsibilities
Forecasting and planning
Major investment and financing decisions
Coordination and control
Dealing with financial markets
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Goals of the Corporation
Primary goal:
maximize stockholder wealth
= maximize stock price
Managerial incentives
controlled by competitive forces
Social responsibility
must be mandated initially to reduce
disadvantages
Stock price maximization and social welfare
Maximizing stock = benefiting society
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Managerial Actions to
Maximize Stockholder Wealth
Capital Structure Decisions
How much and what types of debt and equity should be
used to finance the firm?
Capital Budgeting Decisions
What types of assets should be purchased to help generate
cash flows?
Dividend Policy Decisions
What should be done with net cash flows generated by the
firm—reinvest or pay dividends?
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How Manager’s Actions Affect
Stock Price
Projected earnings per share
Net Income/# of shares
Timing of earnings streams
The sooner the better
Riskiness of projected earnings
The safer the better
Use of debt (capital structure)
Dividend policy
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Value of the Firm
Market Factors/Considerations
Economic Conditions
Government Regulations and Rules
Competitive Environment
Firm Factors/Considerations
Normal Operations
Financing Policy=Capital Structure
Investing Policy=Capital Budgeting
Dividend Policy
Investor Factors/Considerations
Income/Savings
Age/Lifestyle
Interest Rates
Risk Attitude
Net Cash Flows, CF
Rates of Return, k
Value of the Firm
=
^ +
CF
1
(1+k)1
N
^
^
^
CF2 + . . . + CFN = CF
t
(1=k)2
(1+k)N
t=1
(1+k)t
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Agency Relationships
An agency relationship = when a principal
hires an agent to act on their behalf
Within corporations, agency relationships
exist between:
Stockholders and managers
Stockholders 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 firing
The threat of takeover
Structuring managerial incentives
Performance Shares
Executive Stock Options
Restricted Stock Grants
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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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The External Environment
Summary of Major Factors Affecting Stock Prices
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
Level of Economic
Activity and
Corporate Taxes
Stock Market
Conditions
Expected
Profitability
Timing of Cash
Flows
Stock Price
Degrees of Risk
4. Dividend policy
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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
Sarbanes-Oxley Act of 2002
accounting standards
How is ethical behavior profitable?
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Forms of Business in
Other Countries
U.S. firms have a more dispersed ownership = “open”
Non-US firms have higher concentrations of ownership
Many firms are not publicly traded
Less ownership by individuals
Nature of relationship with financial institutions differs from U.S.
Banks are less regulated
Banks can finance large companies, keeping them private
Shareholders assign banks their proxy votes for the directors of
companies
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Multinational Corporations
Firms that operate in two or more countries
Five reasons firms go “international”
1.
2.
3.
4.
5.
To seek new markets—e.g., Coke
To seek raw material—e.g., Exxon Mobil
To seek new technology—e.g., Xerox
To seek production efficiency—e.g., GM
To avoid political and regulatory hurdles—
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e.g., Honda, Nissan, Toyota
Factors Distinguishing Domestic
Firms from Multinational Firms
1.
2.
3.
4.
5.
6.
Different currency denominations
Economic and legal ramifications
Language differences
Cultural differences
Role of governments
Political risk
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Next Class
Homework: Chapter 1 questions
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