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Finance tries to help financial managers to answer (i.e. make decisions about) the following
questions made within a risk-return framework:
1. What long-term investments or projects the firm
should undertake? (capital budgeting decision)
2. How the firm should pay for these assets? By issuing
equity or debt? (capital structure decision)
3. How much cash or inventory the firm should carry?
How much trade credit the firm should provide or
use? (working capital management decision).
• The goal of maximizing shareholder wealth may conflict with interests of management
(their compensation) and social/ethical goals.
• Agency theory is about the potential conflict between shareholders and managers.
• Tradeoffs exist among the agency costs of monitoring management actions, allowing
sufficient discretion for management and designing compensation packages to motivate
management.
• The goal of shareholder wealth maximization can be consistent with a concern for social
responsibility.
• Firms should take socially desirable actions even if certain actions like pollution control
may at times conflict with this goal.
• Managers should strictly follow the rules of fairness and honesty.
• Insider trading and manipulation of financial results have been proven to serve the
firm/shareholders as well as the management no good.
Functions of Financial Management
Forms of Organisation
• Sole Proprietorship (one owner) - largest in actual number but smallest in total sales
revenue.
• Partnership - (two or more owners)
• Corporation (legal entity unto itself) - smallest in actual number but largest in total
sales revenue.
Advantages
• More Capital
• Greater Talent Pool
• Ease of Formation
• Tax Benefits
Disadvantages
• Unlimited Liability
• Lack of Continuity
• Ownership transfer is difficult
• Possibility of Conflicts
Advantages
• Limited Liability
• Continuity
• Greater Likelihood of Professional Management
• Easier Access to Capital
Disadvantages
• Higher Start-Up Costs
• More Regulations
• Double Taxation
• Potential Shareholder Conflicts
Risk-Return Tradeoff