Chapter 1
Introduction to Managerial
Finance
1
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
2
General Areas of Finance
Financial Markets and Institutions
Investments
Financial Services
Managerial Finance
3
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
4
Alternative Forms of
Business Organization
Proprietorship
Partnership
Corporation
5
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
6
Partnership
Like a proprietorship, except two or
more owners
A partnership has roughly the same
advantages and limitations as a
proprietorship
7
Corporation
Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Cost of set-up and report filing
Double taxation
8
Hybrid Forms of Business
Limited Liability Partnership (LLP)
Limited Liability Company (LLC)
S Corporation
9
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
10
Finance 323
Finance versus accounting
Profits versus shareholder wealth
11
Relationship to Accounting
One major difference in perspective and
emphasis between finance and accounting is
that accountants generally use the accrual
method while in finance, the focus is on
cash flows.
The significance of this difference can be
illustrated using the following simple
example.
12
Relationship to Accounting (cont’d)
The Aztec Corporation last year sold one
yacht for $100,000 that remained uncollected
at the end of the year. Costs associated with
building this yacht amounted to $80,000 that
were paid in full, under the supplier terms,
during the year the yacht was built.
Now contrast the differences in performance
under the accounting method versus the
CASH method.
13
Relationship to Accounting (cont’d)
INCOME STATEMENT SUMMARY
ACCRUAL CASH
Sales $100,000 $ 0
Less: Costs (80,000) (80,000)
Net Profit/(Loss) $ 20,000 $(80,000)
14
Relationship to Accounting (cont’d)
Finance and accounting also differ with
respect to decision-making.
While accounting is primarily concerned with
the presentation of financial data, the
financial manager is primarily concerned with
analyzing and interpreting this
information for decision-making purposes.
The financial manager uses this data as a
vital tool for making decisions about the
financial aspects of the firm.
15
Profits versus shareholder wealth
Is the goal of the firm to increase profits or
maximize shareholder wealth/value?
Maximizing shareholder wealth properly
considers the amount of the cash flows, the
timing of these cash flows, and the risk of
these cash flows; merely increasing profits
does not.
16
Goal of the Corporation
Primary goal: stockholder wealth
maximization — translates to maximizing
stock price.
Managerial incentives
Social responsibility
17
Managerial Actions to
Maximize Stockholder Wealth
Capital Structure Decisions
Capital Budgeting Decisions
Dividend Policy Decisions
18
Value of the Firm
19
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
20
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
21
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
22
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
23
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
24
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
25
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
26
Factors Distinguishing Domestic
Firms from Multinational Firms
Different currency denominations
Economic and legal ramifications
Language differences
Cultural differences
Role of governments
Political risk
27
