Transcript Chapter1.ppt

Financial Management (Ch. 1)
04/03/06
Cycle of money
• The primary function of finance is the moving of
money from lenders to borrowers and back
again. This is referred to as the cycle of
money.
• Institutions, such as banks, facilitate this process
by acting as the intermediary between lenders
and borrowers.
Financial management decisions
• Financial management is defined as the activities
that create or preserve the economic value of
assets.
Financial management decisions
• In the business context, this function is divided
into three areas
– Capital Budgeting – the selection of products or
services in which the company will invest its funds
– Capital Structure – identifying the sources and
amounts of funding
– Working Capital Management – ensuring that the
company has cash to maintain day-to-day operations
• Ex., the curious demise of Webvan
Forms of business organization
• Sole Proprietorship
– Owned and operated by a single individual
– Represents about 75% of all businesses in the US (more than 80% of
Oregonian businesses)
– Proprietor has unlimited liability – assets of the owner can be seized by
creditors if owner is in default of debt payments
• Partnership
– General partners operate the company and have unlimited liability
– Limited partners (if involved) may participate in certain aspects of the
business
– Silent partners (if involved) only provide capital
• Corporation
– Considered a separate legal entity
– Represents 80 – 90% of the business revenues
Organizational form differences
Prop
Partner
Corporation
Profits
Owner
General partners
Reinvested or paid
out as dividends
Liability
Raising Capital
Unlimited
Unlimited
Limited
Limited to owner’s
assets
Generally limited to
partner’s assets
Can tap into public
investor market by
sale of stock
Life
Owner’s life
General partner’s life
going concern
Transfer of
ownership
Difficult – succession Difficult – succession Easy –
issues
issues
purchase/sale of
stock
Taxation
At owner’s personal
income tax rate
At partner’s personal At corporate rate
tax rate
plus taxes on
dividends *
Information
Limited
Limited
Publicly reported
*Jobs and Growth Tax Relief Reconciliation Act of 2003 reduces dividend taxes
Corporate organizational chart
Stockholders
Board of Directors
Chief Executive Officer (CEO)
Chief Financial Officer (CFO)
Treasurer
Controller
Financial roles within a corporation
• Treasurer
– Financial manager responsible for capital expenditure,
capital raising and short-term asset management
• Controller
– Responsible for corporate accounting and tax management
• Larger firms may have the treasurer delegate
these responsibilities to subordinates
Corporate departmental interactions
CEO
Marketing
Manager
Treasurer
Finance
Manager
(CFO)
Controller
Manufacturing
Manager
Investor
Relations
Information
Manager
Human
Resource
Manager
Goal of the firm
• Which of the following is an appropriate
goal for a firm?
– Maximize sales
– Maximize profits
– Minimize costs
– Maintain steady growth
– Maximize the stock price
Enron’s earnings manipulation
• During the fourth quarter of 2000, senior
Enron and ENA accounting and
commercial managers artificially increased
the value of ENA's largest merchant asset,
Mariner Energy Inc., by approximately
$100 million to help cover an earnings
shortfall facing the Company that quarter
of approximately $200 million.
Goal of the firm
• The primary goal of the financial manager
is to maximize the current share price
(and thus market value) of the firm for
public firms and to maximize the equity
value for private firms.
– Share prices are based on future cash flows.
Owner’s wealth maximization
• A firm and financial manager should:
– Accept projects/make decisions that increase
the firm’s stock price.
– Maintain positive relationships with other
stakeholders – creditors, employees,
customers.
– Enter into actions that are consistent with the
code of ethics of the firm.
The agency model
• (def) Principal (shareholder) hires an agent
(CEO) to represent his/her interests.
• The agency problem is where there is a conflict
of interest between the two parties, i.e., the
goals of the principal differ from that of the
agent
• Recent well-publicized agency problem:
– Dennis Koslowski (TYCO)
Dennis’s indulgences…
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$17,100 traveling toilet box
$15,000 dog umbrella stand
$16.8 million apartment on Fifth Avenue
$3 million in renovations
$11 million in furnishings
$7 million apartment on Park Avenue for his former wife.
A $72,000 fee to Germán Frers, a yacht maker
A $6,300 sewing basket
A $6,000 shower curtain
$5,960 for two sets of sheets
A $2,900 set of coat hangers
A $2,200 gilt metal wastebasket
A $1,650 notebook
and a $445 pincushion
Agency problem remedies
• Internal
– Tie compensation to firm performance (stock
price)
• External
– Threat of takeover
Top management compensation
Company/CEO
Salary
Other comp
???
$1
$2.48b
???*
$600,000
$229m
???*
$2.78m
0
*Source: http://www.forbes.com/2005/04/20/05ceoland.html
Time value of money sneak peak
• Revisiting our day 1 example:
– You have the choice of taking $1000 today or
$1050 in one year.
– At what interest rate (or rate of return) would
you be indifferent between these two choices?
– What can you conclude about these two
choices at this interest rate?