FOUR BASIC AREAS IN FINANCE

Managerial Finance
Investments Financial Institutions International Finance

FOUR BASIC AREAS IN FINANCE

Investments
Deals with financial assets such as stocks and bonds What determines the price of a financial asset such as a share or stock? What are the potential risks and rewards associated with investing in financial assets? What is the best mixture of the different types of financial assets to hold?

FOUR BASIC AREAS IN FINANCE

Financial Institutions
Financial institutions are basically businesses that deal primarily in financial matters. For example, banks and insurance companies.

FOUR BASIC AREAS IN FINANCE

International Finance
Generally involves the international aspects of either corporate finance, investments, or financial institutions.

For example, many businesses have extensive overseas operations and need employees familiar with such international topics such as exchange rates and political risks.

FOUR BASIC AREAS IN FINANCE

Managerial Finance
What long term investments should you take on? (That is, what lines of business will you be in and what sorts of buildings, machinery, and equipment will you need? Where will you get long term financing to pay for your investment? Will you bring other owners or will you borrow the money? How will you manage your everyday financial activities such as collecting from customers and paying suppliers?

AREAS IN MANAGERIAL FINANCE

Capital Budgeting Capital Structure

Working Capital Management

AREAS IN MANAGERIAL FINANCE

Capital Budgeting
The process of planning and managing a firms long-term investments Financial managers try to identify investment opportunities that are worth more to the firm than they cost to acquire

Evaluating the size, timing, and risk of future cash flows is the essence of capital budgeting

AREAS IN MANAGERIAL FINANCE

Capital Structure
Refers to the specific mixture of long term debt and equity the firm uses to finance its operations. How much should borrow? What are the least expensive sources of funds for the firm?

How and where to raise money?

AREAS IN MANAGERIAL FINANCE

Working Capital Management

The term working capital refers to a firms short term assets, such as inventory, and its short term liabilities, such as money owed to the suppliers. Ensures the firm has sufficient resources to continue its operations and avoid costly interruptions.

CHAPTER 1 Introduction to Financial Management

Forms of Businesses Goals of the Corporation Stock Prices and Intrinsic Value Some Recent Trends Conflicts Between Managers and Shareholders

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Alternative Forms of Business Organization

Proprietorship Partnership Corporation

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Proprietorships & Partnerships

Advantages

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

Corporation

Advantages

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

Financial Goals of the Corporation

The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price. In a Shareholder Wealth Maximization model, a firm should strive to maximize the return to shareholders, as measured by the sum of capital gains and dividends, for a given level of risk. Alternatively, the firm should minimize the level of risk to shareholders for a given rate of return.

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Financial Goals of the Corporation

Do firms have any responsibilities to society at large? Is stock price maximization good or bad for society? Should firms behave ethically?

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Factors that affect stock price

Projected cash flows to shareholders Timing of the cash flow stream Riskiness of the cash flows
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Three Determinants of Cash Flows

Sales

Current level Short-term growth rate in sales Long-term sustainable growth rate in sales

Operating expenses

Capital expenses

Factors that Affect the Level and Risk of Cash Flows

Decisions made by financial managers:

Investment decisions (product lines, production processes, geographic market, use of technology, marketing strategy) Financing decisions (choice of debt policy and dividend policy)

The external environment

Stock Prices and Intrinsic Value

In equilibrium, a stocks price should equal its true or intrinsic value. 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 Value and Stock Prices (Figure 1-1)

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Some Important Trends

Recent corporate scandals have reinforced the importance of business ethics, and have spurred additional regulations and corporate oversight. The effects of changing information technology have had a profound effect on all aspects of business finance. The continued globalization of business.
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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 plans Direct intervention by shareholders The threat of firing The threat of takeover
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Agency theory

A theory explaining the relationship between principals, such as a shareholders, and agents, such as a company's executives. In this relationship the principal delegates or hires an agent to perform work. The theory attempts to deal with two specific problems: first, that the goals of the principal and agent are not in conflict (agency problem), and second, that the principal and agent reconcile different tolerances for risk.
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Responsibility of the Financial Staff

Maximize stock value by:

Forecasting and planning Investment and financing decisions Coordination and control Transactions in the financial markets Managing risk

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Corporate governance

The set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled. An important theme of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem.

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Cronyism

Many of the most prominent firms are owned by families or the government, or by the relatives or friends of top government officials (so-called cronyism). They are often overstaffed because of nepotism and political payoffs. They are often over-financed by banks that are also owned by the same elite group. The emerging market crisis, starting in Asia in 1997 may have shaken this situation considerably, leading to more shareholder-friendly behavior.
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