Chapter 1

Introduction to
Managerial Finance

1
Learning Outcomes
Chapter 1
 Explain what finance entails and why everyone should have an
understanding of basic financial concepts
 Identify different forms of business organization as well as the
advantages and disadvantages of each.
 Identify major goals that firms pursue and what a firm’s primary
goal should be.
 Explain the role that ethics and good governance play in
successful businesses.
 Describe how foreign firms differ from U.S. firms and identify
factors that affect financial decisions in multinational firms.

2
What is Finance?

 Finance is concerned with decisions about

money (Cash Flows)
 Finance decisions deal with how money is
raised and used
 Everything else being equal:
 More value is preferred to less
 The sooner cash is received the more value it has
 Less risky assets are more valuable than riskier
assets

3
General Areas of Finance

 Financial Markets and Institutions

 Investments

 Financial Services

 Managerial Finance

4
Finance in the Organizational Structure of
the Firm
Board of Directors

President (CEO)

Vice-President: Vice-President: Vice-President: Vice-President:

Sales Operations (COO) Finance (CFO) Information Systems (CIO)

Director of Financial
Credit Inventory Tax
Capital Treasurer Controller and Cost
Manager Manager Department
Budgeting Accounting

5
Alternative Forms of
Business Organization

 Proprietorship

 Partnership

 Corporation

6
Proprietorship

 Advantages:
 Ease of formation
 Subject to few government regulations
 No corporate income taxes
 Limitations:
 Unlimited personal liability
 Limited life
 Transferring ownership is difficult
 Difficult to raise capital

7
Partnership

 Like a proprietorship, except two or more

owners
 A partnership has roughly the same
advantages and limitations as a
proprietorship

8
Corporation

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

9
Hybrid Forms of Business

 Limited Liability Partnership (LLP)

 Limited Liability Company (LLC)

 S Corporation

10
Business Organized as a Corporation:
Value Maximized
 Limited liability reduces risk increasing market
value
 Ease of raising capital allows taking
advantage of growth opportunities
 Ownership can be easily transferred thus
investors would be willing to pay more for a
corporation

11
Goals of the Corporation

 Primary goal: stockholder wealth maximization

— translates to maximizing stock price.
 Managerial incentives
 Social responsibility

12
Managerial Actions to
Maximize Stockholder Wealth
 Capital Structure Decisions

 Capital Budgeting Decisions

 Dividend Policy Decisions

13
Value of the Firm

14
Factors Influenced by Managers
that Affect Stock Price
 Projected cash flows
 Timing of cash flow streams
 Risk of projected cash flows (earnings)
 Use of debt (capital structure)
 Dividend policy

15
Agency Relationships

 An agency relationship exists whenever a

principal hires an agent to act on his or her
behalf.
 An agency problem results when the agent
makes decisions that are not in the best
interest of principals

16
Stockholders versus Managers

 Managers are naturally inclined to act in their

own best interests.
 Mechanisms to motivate managers to act in
shareholder’s best interest
 Managerial compensation (incentives)
 Shareholder intervention
 Threat of takeover

17
Business Ethics

 Webster: “A standard of conduct and moral

behavior.”
 Business Ethics: A company’s attitude and
conduct toward its employees, customers,
community, and stockholders

18
Corporate Governance

 The “set of rules’ that a firm follows when

conducting business
 As a result of the Sarbanes-Oxley Act of
2002, firms are revising their corporate
governance policies
 Good corporate governance generates higher
returns to stockholders

19
Forms of Business in
Other Countries
 Non-US firms have higher concentrations of
ownership
 Nature of relationship with financial
institutions differs from U.S.
 U.S. firms have a more dispersed ownership

20
Multinational Corporations
Five reasons firms go “international”
1. To seek new markets
2. To seek raw materials
3. To seek new technology
4. To seek production efficiency
5. To avoid political and regulatory hurdles

21
Factors Distinguishing Domestic
Firms from Multinational Firms
 Different currency denominations
 Economic and legal ramifications
 Language differences
 Cultural differences
 Role of governments
 Political risk

22