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Contemporary Financial Contemporary Financial Management, 12th EditionManagement, 12th Edition

by

Moyer, McGuigan, Rao, and Kretlow

Prepared by William T. Chittenden

Texas State University

Chapter 1The Role and Objective of

Financial Management

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Introduction

Questions Faced by Financial Managers Will a particular investment be successful? Where will the funds come from to finance the

investment? Does the firm have adequate cash or access

to cash to meet its daily operating needs? How much inventory should we hold? Is a merger or acquisition advisable?

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What is the primary goal of the firm?

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Maximizing Shareholder Wealth as a Primary Goal

The most widely accepted objective of the firm is to maximize shareholder wealth

Shareholder Wealth = Number of shares outstanding × Market price per share

Management should seek to maximize the present value of the expected future returns to the shareholders of the firm

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Stakeholders and their Concerns Stockholders Customers Employees Suppliers Communities in which the firm operates

Divergent Objectives

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Maximizing Shareholder Wealth as a Primary Goal

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Agency Problems Agency Relationships

Principals Agent

Stockholders and Creditors Stockholders and Managers

Agency Problems and Costs

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Maximizing Shareholder Wealth as a Primary Goal

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Agency Problems Corporate Governance

The board of directors of a corporation should have a majority of independent directors

The committee responsible for nominating members of the board of directors must be composed only of independent directors

The post of chairman of the board of directors should be split from the CEO position

All members of the audit and compensation committees must be independent directors

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Maximizing Shareholder Wealth as a Primary Goal

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Agency Problems Managerial Compensation

Properly designed compensation contracts can help to align shareholder–management conflicts Stock Options

Exercise Price Restriced Stock Performance Shares

Threat of Takeovers Takeovers can serve as an important deterrent to

shareholder-management conflicts

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Maximizing Shareholder Wealth as a Primary Goal

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Is maximizing profits the same as maximizing shareholder wealth?

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Maximization of Shareholder Wealth:

Managerial Strategies Profit Maximization Maximizing profits is typically not the

same as maximizing shareholder wealth. Profit maximization lacks a time dimension

(long-term versus short-term) GAAP results in hundreds of definitions of

profits (or earnings or income) Profit maximization ignores risk

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Determinants of Value Cash Flow Timing of Cash Flows Risk

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Maximization of Shareholder Wealth:

Managerial Strategies

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Managerial Actions to Influence Value Products and services offered for sale Production technology Marketing and distribution network Investment strategies Employment policies and compensation

packages for managers and other employees Ownership form Capital structure Working capital management policies Dividend policies

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Maximization of Shareholder Wealth:

Managerial Strategies

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Forms of Business Organizations

Sole proprietorship Partnership Corporation

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Forms of Business Organizations

Sole proprietorship Owned by one person Represent 75 percent of all businesses Account for less than 6 percent of total

business revenues Advantage

Easy formation Disadvantages

Unlimited liability Difficulty raising funds

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Forms of Business Organizations

Partnerships Owned by two or more persons About 7 percent of US businesses, 5 percent

of business revenues Classified as general or limited General partners work in the partnership

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Forms of Business Organizations

Partnerships Advantages

Limited partners’ liability is limited to what is specified in the agreement.

Disadvantages Partnership dissolves when a general partner dies Unlimited liability for general partners

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Forms of Business Organizations

Corporation Advantages

Limited Liability Permanency Flexibility Ability to Raise Capital

Disadvantages Ownership is often separated from management

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Forms of Business Organizations

Corporation Corporate Organization and Governance

Stockholders elect a board of directors Board of directors then elect the officers

Chairman of the board Chief executive officer (CEO) Chief operating officer (COO) President Chief financial officer (CFO) Vice presidents Treasurer Secretary

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Management

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Forms of Business Organizations

Corporation Corporate Securities

Priority of Corporate Securities Debt Securities Preferred Stock Common Stock

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Forms of Business Organizations

Other Types of Business Organizations Subchapter S Corporation Limited Liability Company Limited Liability Partnership

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Organization of the Financial Management

Function Chief Financial Officer Oversees:

Accounting Treasury Tax Audit

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Organization of the Financial Management

Function Controller

Oversees: Financial Accounting Cost Accounting Taxes Data Processing

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Organization of the Financial Management

Function Treasurer Oversees:

Cash and Marketable Securities Management Capital Budgeting Analysis Financial Planning Investor Relations Pension Fund Management

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Organization of the Financial Management

Function Financial Management and Other Disciplines Accounting

Financial managers are primarily concerned with a firm’s cash flow

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Organization of the Financial Management

Function Financial Management and Other Disciplines Economics

Microeconomics Financial managers use the concepts of setting

marginal cost equal to marginal revenue when making long-term investment decisions and when managing working capital

Macroeconomics Financial managers should recognize and understand

how monetary and fiscal policies affect the economy and the cost of funds and the availability of credit

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Organization of the Financial Management

Function Financial Management and Other Disciplines Marketing, Production, Quantitative

Methods, and Human Resources Management All are indirectly related to the key day-to-day

decisions made by financial managers

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Career Opportunities in Finance

Corporate Finance Commercial Banks Securities Brokers Investment Banks Mutual Funds Pension Funds Real Estate Companies Insurance Companies

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Professional Finance Affiliations and Certifications Organizations

Financial Executives Institute Institute of Chartered Financial Analysts Financial Management Association

Certifications Certified in Financial Management (CFM) Certified Financial Planner (CFP) Chartered Financial Analyst (CFA) Certified Treasury Professional (CTP)

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Questions?

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