Contemporary Contemporary Financial ManagementFinancial Management

8th Edition 8th Edition byby

Moyer, McGuigan, and KretlowMoyer, McGuigan, and Kretlow

Prepared byPrepared by

Tom PeacockTom PeacockUniversity of HoustonUniversity of Houston

© 2001 South-Western College Publishing

Chapter 1Chapter 1

The Role and ObjectiveThe Role and Objectiveofof

Financial Management Financial Management

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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

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Principal Forms of Business Principal Forms of Business OrganizationsOrganizations

Sole proprietorshipSole proprietorship PartnershipPartnership CorporationCorporation

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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

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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

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Liability of PartnersLiability of Partners

General PartnerGeneral PartnerHas unlimited liability for all obligations of the Has unlimited liability for all obligations of the

businessbusiness

Limited PartnerLimited PartnerLiability limited to the partnership agreementLiability limited to the partnership agreement

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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

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Stockholderselect a boardof directors

Board of directors then hire

management( officers )

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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

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Stockholder RightsStockholder Rights

Corporate SecuritiesCorporate Securitiesin Order or Priorityin Order or Priority

Bonds ( highest)

Preferred stockCommon stock ( C/S ) ( lowest )

DividendDividend AssetAsset

VotingVoting PreemptivePreemptive

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Optimal Form of Organization Optimal Form of Organization Influenced byInfluenced by CostCost ComplexityComplexity LiabilityLiability ContinuityContinuity

Raising capitalRaising capital Decision makingDecision making Tax considerationsTax considerations

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ShareholderShareholderWealthWealthMaximizationMaximization

(SWM)(SWM)Objective of the Objective of the financial managerfinancial manager

NOTNOTprofit maximizationprofit maximizationDoes not considerDoes not consider

time value of moneytime value of money

ObjectiveObjectiveofof

Financial ManagementFinancial Management( FM )( FM )

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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

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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 conflictsMaintain confidentialityMaintain confidentialityBe objectiveBe objectiveAct fairlyAct fairly

Managers MustManagers Must

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Job securityJob security

Management may maximizeManagement may maximize

its own welfare insteadits own welfare instead

of the owners wealthof the owners wealth

Owners Owners (shareholders)(shareholders)

Management and Management and

EmployeesEmployees

Problem createdProblem created by separation of by separation of

Agency Relationships / ProblemsAgency Relationships / Problems

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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

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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

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Problem created by Problem created by

separation ofseparation of

OwnersOwners

ManagementManagement

A similar problemA similar problemOwnersOwners

CreditorsCreditors

Protective Protective covenantscovenants

in loan agreementsin loan agreements

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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

arrangements arrangements

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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

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3 Basic Factors Determine 3 Basic Factors Determine C/S Market Value C/S Market Value

1) Amount of1) Amount of

2) Timing of2) Timing of

3) Risk of3) Risk of

Expected cash flows

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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

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Competitive Forces InfluencingCompetitive Forces InfluencingC/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

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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

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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

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Different Size BusinessesDifferent Size Businesses

Small BusinessSmall BusinessVs.Vs.

Large CorporationsLarge Corporations

Fundamental concepts are the sameFundamental concepts are the same

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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

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Controller’s ActivitiesController’s Activities

Financial accountingFinancial accounting Cost accountingCost accounting TaxesTaxes Data processingData processing

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Treasurer’s ActivitiesTreasurer’s 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

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EconomicsEconomics

AccountingAccounting

MarketingMarketing

ProductionProduction

Human ResourcesHuman Resources

Quantitative AnalysisQuantitative Analysis

Finance

Disciplines used in FinanceDisciplines used in Finance

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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

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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