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Chapter 1 - An Introduction to Financial Management

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Chapter 1 - An Introduction to Financial Management

  1. 1. Chapter 1 - An Introduction to Financial Management <ul><li>08/28/08 </li></ul>
  2. 2. Financial Management <ul><li>What is financial management? </li></ul><ul><li>-- maintenance and creation of economic value </li></ul><ul><li>-- deal with all kinds of financial decisions, such as when to invest new assets, when to borrow… </li></ul>
  3. 3. Goal of the Firm <ul><li>1) Profit Maximization? </li></ul><ul><li>this goal ignores: </li></ul><ul><li>a) TIMING of Returns </li></ul><ul><li>b) Costs of shareholders </li></ul>
  4. 4. Goal of the Firm <ul><li>2) Shareholder Wealth Maximization? </li></ul><ul><li>this is the same as: </li></ul><ul><li>a) Maximizing Firm Value </li></ul><ul><li>b) Maximizing Stock Price </li></ul>
  5. 5. Legal Forms of Business <ul><li>1) Sole Proprietorship </li></ul><ul><li>A business owned by a single individual. </li></ul><ul><li>Owner maintains title to the firm’s assets. </li></ul><ul><li>Owner has unlimited liability. </li></ul><ul><li>2) Partnership </li></ul><ul><li>Similar to a sole proprietorship, except that there are two or more owners. </li></ul>
  6. 6. <ul><li>2a) General Partnership </li></ul><ul><li>All partners have unlimited liability. </li></ul><ul><li>2b) Limited Partnership </li></ul><ul><li>Consists of one or more general partners, who have unlimited liability. </li></ul><ul><li>One or more limited partners (investors) whose liability is limited to the amount of their investment in the business. </li></ul>Legal Forms of Business
  7. 7. <ul><li>2c) Limited Liability Company (LLC) </li></ul><ul><li>Cross between a partnership and a corporation. </li></ul><ul><li>Owners have limited liability, but the firm runs and is taxed like a partnership. </li></ul>Legal Forms of Business
  8. 8. <ul><li>3) Corporation </li></ul><ul><li>A business entity that legally functions separate and apart from its owners. </li></ul><ul><li>Owners’ liability is limited to the amount of their investment in the firm. </li></ul><ul><li>Owners hold common stock certificates, and ownership can be transferred by selling the certificates. </li></ul>Legal Forms of Business
  9. 9. Comparison of Three Forms <ul><li>Advantage of corporations: </li></ul><ul><li>-- limited liability </li></ul><ul><li>-- ease in raising capital </li></ul>
  10. 10. Role of Financial Manager <ul><li>CFO – Chief Financial Officer: oversees financial planning, corporate strategic planning, and control cash flow </li></ul><ul><li>Treasurer – handles the firm’s financial activities </li></ul><ul><li>Controller – manages the firm’s accounting duties </li></ul>
  11. 11. The Corporation and Financial Markets cash Investors Secondary markets Government securities Cash flow reinvest tax Corporation dividends, etc.
  12. 12. <ul><li>Primary Market </li></ul><ul><ul><li>Market in which new issues of a security are sold to initial buyers. </li></ul></ul><ul><li>Secondary Market </li></ul><ul><ul><li>Market in which previously issued securities are traded. </li></ul></ul>The Corporation and Financial Markets
  13. 13. <ul><li>Initial Public Offering (IPO) </li></ul><ul><ul><li>The first time the firm’s stock is sold to the general public. </li></ul></ul><ul><li>Seasoned New Issue </li></ul><ul><ul><li>A new stock offering by a firm that already has stock that is traded in the secondary market. </li></ul></ul>The Corporation and Financial Markets
  14. 14. Financial Management Axioms <ul><li>1) Risk - return trade-off. </li></ul><ul><li>2) Time value of money. </li></ul><ul><li>-- a dollar get today is worth more than a dollar get a year later </li></ul><ul><li>3) Cash - not profits - is king. </li></ul><ul><li>-- it is the cash that can be reinvested </li></ul><ul><li>4) Incremental cash flows count. </li></ul><ul><li>5) The curse of competitive markets. </li></ul><ul><li>-- differentiation </li></ul><ul><li>-- economies of scale </li></ul>
  15. 15. Financial Management Axioms <ul><li>6) Efficient capital markets. </li></ul><ul><li>-- stock price adjust new information fast </li></ul><ul><li>7) The agency problem. </li></ul><ul><li>-- managers don’t work for the interest of shareholders </li></ul><ul><li>-- get benefit from salary, private jet </li></ul><ul><li>-- avoid risk project </li></ul>
  16. 16. Financial Management Axioms <ul><li>8) Taxes bias business decisions. </li></ul><ul><li>-- after-tax incremental cash flow </li></ul><ul><li>9) All risk is not equal. </li></ul><ul><li>-- don’t put all eggs in one basket </li></ul><ul><li>10) Ethical dilemmas are everywhere in finance. </li></ul><ul><li>-- Enron, Worldcom </li></ul><ul><li>-- loss of public’s confidence </li></ul>

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