THE CORPORATION  Legal entity created to sell goods and/or services.

 Owned by shareholders who purchase its stock.

 Possible returns to shareholders: – 1) dividends – 2) stock price appreciation

FINANCE DECISIONS  Investment  Financing  Dividend

Investment  What assets does the company need to accomplish its mission?

 Buildings, machinery, equipment? (Ch 7 and Ch 8)  Cash, accounts receivable, inventory? (Ch 9)

Financing  How should firm’s assets be financed?

 Liabilities (debt) or Equity (selling new stock or reinvesting profits)?

 What is best mix of debt and equity?

 Valuation (Ch 5); Cost of Capital (Ch 6)

Dividend  What to do with Earnings After Taxes (profit, net income)?

 Pay dividends to stockholders?

 Reinvest into company (retained earnings)?

 Some combination of both?

Goal of Financial Management  Most people would say goal is to maximize profits  Profits when? - this quarter, this year, next 5 years…  Which measure of profit to use? - net income, income before extraordinary items, EPS…

Better Goal  Who owns firm?

 Stockholders.

 Why do they buy stock?

 To gain financially when stock price goes up (buy low, sell high)  Goal: MAXIMIZE STOCK PRICE

Advantages of Stock Price Maximization as a Goal  Easy to measure  Readily available  Provides immediate feedback on how market values decisions of firm’s managers

Disadvantage of Stock Price Maximization as a Goal  Majority of stocks owned by institutional investors  Managers of institutional funds push for short-term returns  When corporate managers focus on short-term stock price maximization, they may make decisions harmful to the corporation in the long-run.

Examples of Institutional Investors  Mutual Funds  Hedge Funds  Private Equity Funds  Sovereign Wealth Funds  Pension Plans  Insurance Companies  Endowment Funds

Stakeholders in a corporation  Shareholders (individuals + institutions)  Employees, including managers  Customers  Suppliers  Community  Creditors  Government

Stakeholder Theory  Says that managers should make decisions that maximize interests of all stakeholders  Example: UAW got BIG 3 Auto Makers to give big concessions in 1970s  Look how that turned out in long-run for everyone!

Agency Theory  Managers are agents of stockholders (principal)  Managers sometimes act in own interest instead of stockholders’  Adelphia, Enron, Global Crossing, Qwest, Tyco, WorldCom, to name a few  Agency costs – making sure that managers are acting appropriately; e.g. auditing

Long-term Decision Making  All stakeholders, including employees, managers, and stockholders, have an interest in the

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operation of a corporation  Managers should make decisions that maximize stock price in the

long-run

 Taking the long view benefits all stakeholders

3 Steps to Follow in Making Financial Decisions  Estimate impact of decision on future cash flows  Adjust future cash flows for time value of money (Ch 3)  Adjust future cash flows for risk (chance that actual cash flow will not be what is expected) (Ch 4)

Where We Are Headed  Ch 2: Overview of Financial Markets  Ch 3: Time Value of Money  Ch 4: Risk     Ch 5 and Ch 6 – Financing Decision Ch 7, 8, 9 – Investment Decision Ch 10 – Financial Statement Analysis Ch 11 – Financial Planning