Chapter 1
An Overview of Financial
Management
Forms of Business Organization
Balancing Shareholder Value and Society Interests
Intrinsic Values, Stock Prices, and Managerial Incentives
Important Business Trends
Conflicts Between Managers, Stockholders, and
Bondholders
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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Finance Within the Organization
Board of Directors
Chief Executive Officer (CEO)
Chief Operating Officer
(COO)
Chief Financial Officer
(CFO)
Marketing, Production,
Human Resources, and Other
Operating Departments
Accounting, Treasury, Credit,
Legal, Capital Budgeting,
and Investor Relations
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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Forms of Business Organization
Proprietorship
Partnership
Corporation
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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Proprietorships and Partnerships
Advantages
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages
Difficult to raise capital
Unlimited liability
Limited life
Often set up through LLCs/LLPs.
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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Corporation
Advantages
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages
Double taxation
Cost of setup and report filing
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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Balancing Shareholder Value and Society
Interests
The primary financial goal of
management is shareholder wealth
maximization, which translates to
maximizing stock price.
Value of any asset is present value of cash
flow stream to owners.
Most significant decisions are evaluated in
terms of their financial consequences.
Stock prices change over time as
conditions change and as investors obtain
new information about a companys
prospects.
Managers recognize that being socially
responsible is not inconsistent with
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maximizing
shareholder
value.
2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Stock Prices and Intrinsic Value
In equilibrium, a stocks price should
equal its true or intrinsic value.
Intrinsic value is a long-run concept.
Ideally, managers should avoid actions
that reduce intrinsic value, even if those
decisions increase the stock price in the
short run.
To the extent that investor perceptions
are incorrect, a stocks price in the short
run may deviate from its intrinsic value.
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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Determinants of Intrinsic Values and
Stock Prices
Managerial Actions, the Economic
Environment, Taxes, and the Political
Climate
True
Investor Cash
Flows
True
Risk
Perceived
Investor Cash
Flows
Stocks
Intrinsic
Value
Perceived
Risk
Stocks
Market Price
Market Equilibrium:
Intrinsic Value = Stock
Price
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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 1: An Overview of Financial
Management
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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Some Important Business Trends
Corporate scandals have reinforced the
importance of business ethics, and have
spurred additional regulations and
corporate oversight.
Increased globalization of business.
Stockholders now have more control of
corporate governance.
The effects of ever-improving information
technology have had a profound effect on
all aspects of business finance.
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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Conflicts Between Managers and
Stockholders
Managers are naturally inclined to act in
their own best interests (which are not
always the same as the interest of
stockholders).
But the following factors affect
managerial behavior:
Managerial compensation packages
Direct intervention by shareholders
The threat of firing
The threat of takeover
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2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
Conflicts Between Stockholders and
Bondholders
Stockholders are more likely to prefer
riskier projects, because they receive
more of the upside if the project
succeeds. By contrast, bondholders
receive fixed payments and are more
interested in limiting risk.
Bondholders are particularly concerned
about the use of additional debt.
Bondholders attempt to protect
themselves by including covenants in
bond agreements that limit the use of
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additional
debt
and
constrain
managers
2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a
publicly accessible website, in whole or in part.
