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Learning OutcomesChapter 1

Explain what finance entails and why everyone should have an understanding of basic financial conceptsIdentify different forms of business organization as well as the advantages and disadvantages of each.Identify (1) major goals that firms pursue and (2) 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.

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What is Finance?

Finance is concerned with decisions about money (Cash Flows)Finance decisions deal with how money is raised and usedEverything else being equal:More value is preferred to lessThe sooner cash is received the more value it hasLess risky assets are more valuable than riskier

assets

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General Areas of Finance

Financial Markets and Institutions

Investments

Financial Services

Managerial Finance

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Finance in the Organizational Structure of the Firm

Board of Directors

President (CEO)

Treasurer ControllerCredit

ManagerInventoryManager

Director of Capital

Budgeting

Financialand Cost

Accounting

TaxDepartment

Vice-President: Finance (CFO)

Vice-President: Sales

Vice-President: Information Systems (CIO)

Vice-President: Operations (COO)

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Alternative Forms of Business Organization

Proprietorship

Partnership

Corporation

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Proprietorship

Advantages:Ease of formationSubject to few government regulationsNo corporate income taxes

Limitations:Unlimited personal liabilityLimited lifeTransferring ownership is difficultDifficult to raise capital

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Partnership

Like a proprietorship, except two or more ownersA partnership has roughly the same advantages and limitations as a proprietorship

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Corporation

Advantages:Unlimited lifeEasy transfer of ownershipLimited liabilityEase of raising capital

Disadvantages:Cost of set-up and report filing Double taxation

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Hybrid Forms of Business

Limited Liability Partnership (LLP)

Limited Liability Company (LLC)

S Corporation

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Business Organized as a Corporation: Value Maximized

Limited liability reduces risk increasing market valueEase of raising capital allows taking advantage of growth opportunitiesOwnership can be easily transferred thus investors would be willing to pay more for a corporation

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Goals of the Corporation

Primary goal: stockholder wealth maximization — translates to maximizing stock price.Managerial incentivesSocial responsibility

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Managerial Actions to Maximize Stockholder Wealth

Capital Structure Decisions

Capital Budgeting Decisions

Dividend Policy Decisions

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Value of the Firm

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Factors Influenced by Managers that Affect Stock Price

Projected cash flowsTiming of cash flow streamsRisk of projected cash flows (earnings)Use of debt (capital structure)Dividend policy

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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

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Stockholders versus Managers

Managers are naturally inclined to act in their own best interests.Mechanisms to motivate managers to act in shareholder’s best interestManagerial compensation

(incentives)Shareholder interventionThreat of takeover

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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

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Corporate Governance

The “set of rules’ that a firm follows when conducting businessAs a result of the Sarbanes-Oxley Act of 2002, firms are revising their corporate governance policiesGood corporate governance generates higher returns to stockholders

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Forms of Business in Other Countries

Non-US firms have higher concentrations of ownershipNature of relationship with financial

institutions differs from U.S.U.S. firms have a more dispersed ownership

Multinational Corporations

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1. To seek new markets2. To seek raw materials3. To seek new technology4. To seek production efficiency5. To avoid political and regulatory

hurdles

Five reasons firms go “international”

Different currency denominationsEconomic and legal ramificationsLanguage differencesCultural differencesRole of governmentsPolitical risk

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Factors Distinguishing Domestic Firms from Multinational Firms