Chapter 1

Introduction to Financial
Management
Forms of Business Organization
Stock Prices and Shareholder Value
Intrinsic Values, Stock Prices, and
Executive Compensation
Important Business Trends
Conflicts Between Managers,
Stockholders, and Bondholders 1-1
Finance Within the Organization

Board of Directors

Chief Executive Officer (CEO)

Chief Operating Officer (COO) Chief Financial Officer (CFO)

Marketing, Production, Human Accounting, Treasury, Credit,

Resources, and Other Operating Legal, Capital Budgeting, and
Departments Investor Relations

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Forms of Business Organization

Proprietorship
Partnership
Corporation

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Proprietorships and Partnerships

Advantages
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages
Difficult to raise capital
Unlimited liability
Limited life

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Corporation

Advantages
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages
Double taxation
Cost of set-up and report filing

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Stock Prices and Shareholder Value

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.

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Stock Prices and Intrinsic Value

In equilibrium, a stocks price should equal its

true or intrinsic value.
Intrinsic value is a long-run concept.
To the extent that investor perceptions are
incorrect, a stocks price in the short run may
deviate from its intrinsic value.
Ideally, managers should avoid actions that
reduce intrinsic value, even if those decisions
increase the stock price in the short run.

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 Determinants of Intrinsic Values and
Stock Prices
Managerial Actions, the Economic
Environment, Taxes, and the Political Climate

True Investor True Perceived Perceived

Returns Risk Investor Returns Risk

Stocks Stocks
Intrinsic Value Market Price

Market Equilibrium:
Intrinsic Value = Stock Price
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Some Important Business
Trends
Recent corporate scandals have reinforced
the importance of business ethics, and have
spurred additional regulations and corporate
oversight.
Increased globalization of business.
The effects of ever-improving information
technology have had a profound effect on all
aspects of business finance.

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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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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 receiving fixed payments 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 additional debt and
constrain managers actions.
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