Contemporary Contemporary

Financial ManagementFinancial Management

8th Edition 8th Edition byby

MoyerMoyer, McGuigan, and Kretlow, McGuigan, and Kretlow

Prepared byPrepared by

Tom PeacockTom Peacock

University of HoustonUniversity of Houston

© 2001 South-Western College Publishing

Chapter 1Chapter 1

The Role and ObjectiveThe Role and Objective

ofof

Financial ManagementFinancial Management

٣

��How is finance related to other fields of How is finance related to other fields of

study?study?

��What are the goals and objectives of What are the goals and objectives of

financial managers?financial managers?

��How has the finance field evolved?How has the finance field evolved?

��How is the finance field changing today?How is the finance field changing today?

Questions Faced in FinanceQuestions Faced in Finance

٤

Principal Forms of Business Principal Forms of Business

OrganizationsOrganizations

��Sole proprietorshipSole proprietorship

��PartnershipPartnership

��CorporationCorporation

٥

Sole ProprietorshipSole Proprietorship

��Owned by one personOwned by one person

��Easy formation Easy formation advantageadvantage

��Unlimited liability Unlimited liability disadvantagedisadvantage

��Difficulty raising funds Difficulty raising funds disadvantagedisadvantage

��Represent 75% of all businessesRepresent 75% of all businesses

��Account for < 6% of the $ volumeAccount for < 6% of the $ volume

٦

PartnershipPartnership

��Owned by two or more personsOwned by two or more persons

��Classified as general or limitedClassified as general or limited

��Partnership dissolves when a general Partnership dissolves when a general

partner diespartner dies

٧

Liability of PartnersLiability of Partners

��General PartnerGeneral Partner

Has unlimited liability for all obligations of the Has unlimited liability for all obligations of the

businessbusiness

��Limited PartnerLimited Partner

Liability limited to the partnership agreementLiability limited to the partnership agreement

٨

CorporationCorporation

��Limited liabilityLimited liability

��PermanencyPermanency

��FlexibilityFlexibility

��Ability to raise of Ability to raise of

capitalcapital

��Legal entityLegal entity

��Have a board of Have a board of

directorsdirectors

��Owners are Owners are

stockholdersstockholders

��Easy marketability of Easy marketability of

shares of ownershipshares of ownership

٩

Stockholders

elect a board

of directors

Board of

directors

then hire

management( officers )

١٠

Who Manages ?Who Manages ?

��Board of directors Board of directors

deals with broad deals with broad

policy policy

��Management makes Management makes

most of the decisionsmost of the decisions

١١

Stockholder RightsStockholder Rights

Corporate SecuritiesCorporate Securities

in Order or Priorityin Order or PriorityBonds ( highest)

Preferred stock

Common stock ( C/S ) ( lowest )

DividendDividend AssetAsset

VotingVoting PreemptivePreemptive

١٢

Optimal Form of Organization Optimal Form of Organization

Influenced byInfluenced by

��CostCost

��ComplexityComplexity

��LiabilityLiability

��ContinuityContinuity

��Raising capitalRaising capital

��Decision makingDecision making

��Tax considerationsTax considerations

١٣

ShareholderShareholderWealthWealthMaximizationMaximization

(SWM)(SWM)Objective of the Objective of the

financial managerfinancial manager

NOTNOTprofit maximizationprofit maximization

Does not considerDoes not consider

time value of moneytime value of money

ObjectiveObjective

ofof

Financial ManagementFinancial Management

( FM )( FM )

١٤

SWM SWM

��Considers the timing and risk of the benefits Considers the timing and risk of the benefits

from stock ownershipfrom stock ownership

��Determines that a good decision increases Determines that a good decision increases

the price of the firm's common stock (c/s)the price of the firm's common stock (c/s)

��Is an impersonal objectiveIs an impersonal objective

��Is concerned for social responsibilityIs concerned for social responsibility

١٥

Social ResponsibilitySocial Responsibility

��Ethical issues will constantly confront Ethical issues will constantly confront financial managers as they achieve the goal financial managers as they achieve the goal of the firm ( SWM ).of the firm ( SWM ).

��Avoid personal conflictsAvoid personal conflicts

��Maintain confidentialityMaintain confidentiality

��Be objectiveBe objective

��Act fairlyAct fairly

Managers MustManagers Must

١٦

Job securityJob security

��Management may maximizeManagement may maximize

its own welfare insteadits own welfare instead

of the owners wealthof the owners wealth

Owners (shareholders)Owners (shareholders)

Management and Management and

EmployeesEmployees

��Problem createdProblem created

by separation ofby separation of

Agency Relationships / ProblemsAgency Relationships / Problems

١٧

Job SecurityJob Security

��Management decisions based on retaining Management decisions based on retaining

management rather than SWMmanagement rather than SWM

��ExampleExample–A decision to retain suppliers A decision to retain suppliers

rather than selecting new suppliers rather than selecting new suppliers

providing higher quality or lower costproviding higher quality or lower cost

��WhyWhy–If the transition is mishandled If the transition is mishandled

management will be scrutinized but if no management will be scrutinized but if no

change is made the issue will be ignoredchange is made the issue will be ignored

١٨

Agency CostsAgency Costs

��Management incentivesManagement incentives

��Monitor performanceMonitor performance

��Owners protectionOwners protection

��Complex organization structuresComplex organization structures

Recent Trends

To flatten organization structures to cut costs

١٩

Problem created by Problem created by

separation ofseparation of

OwnersOwners

ManagementManagement

A similar problemA similar problem

OwnersOwners

CreditorsCreditors

Protective covenantsProtective covenants

in loan agreementsin loan agreements

٢٠

Examples of Protective CovenantsExamples of Protective Covenants

��Limitations of Common stock dividendsLimitations of Common stock dividends

��Limitations on additional debtsLimitations on additional debts

��Not entering into sale and lease back Not entering into sale and lease back

arrangementsarrangements

٢١

Shareholder Wealth Maximizing Is a Shareholder Wealth Maximizing Is a

Market Concept and Results inMarket Concept and Results in

��Maximizing PV of E(R)Maximizing PV of E(R)

��Measured by Market Value of C/SMeasured by Market Value of C/S

٢٢

3 Basic Factors Determine 3 Basic Factors Determine

C/S Market ValueC/S Market Value

��1) Amount of1) Amount of

��2) Timing of2) Timing of

��3) Risk of3) Risk of

Expected cash

flows

٢٣

Conditions Affecting Market ValueConditions Affecting Market Value

��Economic environment factorsEconomic environment factors

��Decisions under management controlDecisions under management control

��Conditions in financial marketsConditions in financial markets

��Expected cash flowsExpected cash flows

٢٤

Competitive Forces InfluencingCompetitive Forces Influencing

C/S Market ValueC/S Market Value

��New entrantsNew entrants

��Substitute productsSubstitute products

��Bargaining power of buyersBargaining power of buyers

��Bargaining power of suppliersBargaining power of suppliers

��Rivalry among current competitors Rivalry among current competitors

٢٥

Cash Flow Concept Used forCash Flow Concept Used for

��Financial analysisFinancial analysis

��PlanningPlanning

��Resource allocationResource allocation

External sources Cash

Internal sources

CF does not equal accounting profit

٢٦

NPV of an InvestmentNPV of an Investment

��NPV = PV of future cash flows NPV = PV of future cash flows

minus cash outlaysminus cash outlays

The NPV of an investment

represents the contributions of

that investment to the value of

the firm and passes on to SWM

٢٧

Different Size BusinessesDifferent Size Businesses

Small BusinessSmall Business

Vs.Vs.

Large CorporationsLarge CorporationsFundamental concepts are the sameFundamental concepts are the same

٢٨

Small BusinessSmall Business

��Not the dominant firm in the industryNot the dominant firm in the industry

��Tend to grow more rapidlyTend to grow more rapidly

��Limited access to financial marketLimited access to financial market

��Lack management resourcesLack management resources

��Have a high failure rateHave a high failure rate

��Stock is not publicly tradedStock is not publicly traded

��Poorly diversifiedPoorly diversified

��Owner/manager frequently the sameOwner/manager frequently the same

٢٩

ControllerController’’s Activitiess Activities

��Financial accountingFinancial accounting

��Cost accountingCost accounting

��TaxesTaxes

��Data processingData processing

٣٠

TreasurerTreasurer’’s Activitiess Activities

��Management of cash and marketable Management of cash and marketable

securitiessecurities

��Capital budgetingCapital budgeting

��Financial planningFinancial planning

��Credit analysisCredit analysis

��Investors relationsInvestors relations

��Pension fund managementPension fund management

٣١

EconomicsEconomics

AccountingAccounting

MarketingMarketing

ProductionProduction

Human ResourcesHuman Resources

Quantitative AnalysisQuantitative Analysis

Finance

Disciplines used in FinanceDisciplines used in Finance

٣٢

Professional OrganizationsProfessional Organizations

��Financial Executive InstituteFinancial Executive Institute

��Institute of Charted Financial AnalysisInstitute of Charted Financial Analysis

��Financial Management AssociationFinancial Management Association

��Institute of Management AccountingInstitute of Management Accounting

٣٣

Exciting Career Opportunities in Exciting Career Opportunities in

FinanceFinance

��VP of FinanceVP of Finance

��Director Director

Investor RelationsInvestor Relations

��Assistant TreasurerAssistant Treasurer

��Tax ManagerTax Manager

��Financial AnalystFinancial Analyst

��Account Executive Account Executive

Security BrokerSecurity Broker

��Mortgage AnalystMortgage Analyst

��BankingBanking