An Overview of Managerial

Finance

© 2007 Thomson/South-Western 1
Essentials of
Chapter 1
What is finance, and why should you
understand basic financial concepts?
What are the different forms of business
organization?
What goals should firms pursue?
What is the role of ethics in successful
businesses?
How do foreign firms differ from U.S.
firms?

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What is Finance?
Finance is concerned with decisions about
money (Cash Flows)
Finance decisions deal with how money is
raised and used
Everything else being equal:
More value is preferred to less
The sooner cash is received the more value it
has
Less risky assets are more valuable than
riskier assets

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General Areas of Finance

Financial Markets and

Institutions
Banks, Insurance Companies, Saving & Loans, Credit Unions etc.

Investments
Stock Brokerage firms, Financial Institutions, Investment Companies,
Insurance Companies etc.

Financial Services
Financial Consultants, Auditing Firms etc

Managerial Finance
All type of Firms making Financial Decisions concerning cash flows

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Finance in the Organizational
Structure of the Firm •Manage cash & Marketable
Securities
•Plan how the firm is financed
•Manage Risk
Board of Directors •Oversee pension fund

President (CEO)

Vice-President: Vice-President: Vice-President: Vice-President:

Sales Operations (COO) Finance (CFO) Information Systems (CIO)

Director of Financial
Credit Inventory Tax
Capital Treasurer Controller and Cost
Manager Manager Department
Budgeting Accounting

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Alternative Forms of
Business Organization

Proprietorship

Partnership

Corporation

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Proprietorship
Advantages:
Ease of formation
Subject to few government regulations
No corporate income taxes
Limitations:
Unlimited personal liability
Limited life
Transferring ownership is difficult
Difficult to raise capital

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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:
Cost of set-up and report filing
Double taxation

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Hybrid Forms of Business

Limited Liability Partnership (LLP)

Limited Liability Company (LLC)

S Corporation

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Business Organized as a
Corporation: Value Maximized
Limited liability reduces risk
increasing market value
Ease of raising capital allows taking
advantage of growth opportunities
Ownership can be easily transferred
thus investors would be willing to pay
more for a corporation

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Goals of the Corporation

Primary goal:stockholder wealth

maximization—translates to
maximizing stock price.
Managerial incentives
Provide valuable incentives to keep the interest of management alive and inline with
stockholder wealth maximization.

Social responsibility
The concept that businesses should be actively concerned with the welfare of
society at large.

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Managerial Actions to
Maximize Stockholder Wealth
Capital Structure Decisions
Decision about how much and what types of debt and equity
should be used to finance the firm.

Capital Budgeting Decisions

Decision as to what types of assets should be purchased to help
generate future cash flows.

Dividend Policy Decisions

Decisions as to how much of current earnings to pay out as
dividends rather than to retain for reinvestment in the firm.

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Value of the Firm
Market Factors/Considerations
Economic Conditions
Government Regulations and
Rules
Competitive Environment
Firm Factors/Considerations Investor Factors/Considerations
Normal Operations (Revenues and Income/Savings
Expenses)
Age/Lifestyle
Financing Policy (Capital Structure)
Interest Rates
Investing Policy (Capital Budgeting)
Risk Attitude
Dividend Policy
Net Cash Flows, Rates of Return, r
CF
^ ^ N ^ ^
CF1 CF2 CFN CFt
= 1
+ 2
+...+ N
= Σ t
(1+r) (1+r) (1+r) (1+r)
t =1
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Factors Influenced by
Managers
that Affect Stock Price
Projected earnings per share
Timing of earnings streams
Risk of projected earnings
Use of debt (capital structure)
Dividend policy

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Agency Relationships

An agency relationship exists

whenever a principal hires an agent
to act on his or her behalf.
An agency problem results when the
agent makes decisions that are not in
the best interest of principals

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Stockholders versus Managers
Managers are naturally inclined to act
in their own best interests.
Mechanisms to motivate managers to
act in shareholder’s best interest
Managerial compensation (incentives)
Performance shares awarded on basis of EPS, executive stock purchased at future time at
given price, restricted stock grants to employees for some time in future.

The threat of firing

 Possible now due to ownership by few large institutions like pension fund, mutual funds etc
like cocacola, UA.

Shareholder intervention
 Big Funds now closely monitor firms and influence management decisions when ever needed.

Threat of takeover
 Hostile takeovers, management is fired.

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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

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Corporate Governance

The “set of rules’ that a firm follows

when conducting business
As a result of the Sarbanes-Oxley Act
of 2002, firms are revising their
corporate governance policies
Good corporate governance
generates higher returns to
stockholders

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Forms of Business in
Other Countries
Non-US firms have higher
concentrations of ownership
Nature of relationship with
financial institutions differs from
U.S.
U.S. firms have a more
dispersed ownership

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Multinational Corporations
Five reasons firms go
“international”
1. To seek new markets

2. To seek raw materials

3. To seek new technology
4. To seek production efficiency
5. To avoid political and
regulatory hurdles

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Multinational Versus
Domestic Managerial Finance

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Factors Distinguishing Domestic
Firms from Multinational Firms
Different currency denominations
Economic and legal ramifications
Language differences
Cultural differences
Role of governments
Political risk

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Chapter 1 Essentials
What is finance?
Finance deals with decisions about money
What are the forms of business organization?
Proprietorship, partnership, corporation
What goals should firms pursue?
Maximize stockholder’s wealth
What is the role of ethics in business?
“Ethical firms” survive; “non-ethical firms” do not
How do foreign firms differ from U.S. firms?
Non-US firms have more concentrated ownership

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Thank you

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