Chap1 Lecture
Chap1 Lecture
Financial Management
1) Profit Maximization?
this goal ignores:
a) TIMING of Returns
(Time Value of Money - Ch. 5)
b) UNCERTAINTY of Returns
(Risk - Ch. 6)
Goal of the Firm
2) Shareholder Wealth
Maximization?
this is the same as:
a) Maximizing Firm Value
b) Maximizing Stock Price
Legal Forms of Business
1) Sole Proprietorship
A business owned by a single individual and that
has a minimum amount of legal structure
Advantages:
Easily established with few complications
Minimal organizational costs
Does not have to share profits or control with others
Disadvantages:
Unlimited liability of the owner
Owner must absorb all losses
Equity capital limited to the owner’s personal
investment
Business terminates immediately upon death of owner
Legal Forms of Business
2) Partnership
An association of two or more
individuals joining together as co-
owners to operate a business for
profit.
Legal Forms of Business
Corporation Investors
Government
The Corporation and
Financial Markets
Government
The Corporation and
Financial Markets
Secondary
markets
Government
The Corporation and
Financial Markets
Corporation cash Investors
Raising capital
securities
reinvest
Secondary
markets
dividends,
Cash flow
int., etc.
tax
Government
The Corporation and
Financial Markets
Primary Market
Market in which new issues of a
security are sold to initial
buyers.
Secondary Market
Market in which previously
issued securities are traded.
The Corporation and
Financial Markets
Initial Public Offering (IPO)
The first time the firm’s stock is
sold to the general public.
Seasoned New Issue
A new stock offering by a firm
that already has stock that is
traded in the secondary market.
Ten Principles of Financial Management
Principle 1:
Risk-return tradeoff - we won't take
additional risk unless we expect to be
compensated with additional return.
Ten Principles of Financial Management
Principle 2:
Time value of money - a dollar received
today is worth more than a dollar received
in the future.
Ten Principles of Financial Management
Principle 3:
Cash -- Not Profits -- is King
- In measuring value we will use cash flows
rather than accounting profits because it
is only cash flows that the firm receives
and is able to reinvest.
Ten Principles of Financial Management
Principle 4:
Incremental cash flows count - In making
business decisions we will only concern
ourselves with what happens as a result
of that decision.
Ten Principles of Financial Management
Principle 5:
The curse of competitive markets
- In competitive markets, extremely large profits
cannot exist for very long because of
competition moving in to exploit those large
profits. As a result, profitable projects can only
be found if the market is made less competitive,
either through product differentiation or by
achieving a cost advantage.
Ten Principles of Financial Management
Principle 6:
Efficient Capital Markets
- The markets are quick and the prices are
right.
Ten Principles of Financial Management
Principle 7:
The agency problem - managers won't
work for the owners unless it's in their
best interest. The agency problem is a
result of the separation between the
decision makers and the owners of the
firm. As a result managers may make
decisions that are not in line with the goal
of maximization of shareholder wealth.
Ten Principles of Financial Management
Principle 8:
Taxes bias business decisions.
Ten Principles of Financial Management
Principle 9:
All risk is not equal - since some risk can
be diversified away and some cannot.
The process of diversification can reduce
risk, and as a result, measuring a
project’s or an asset's risk is very
difficult.
Ten Principles of Financial Management
Principle 10:
Ethical dilemmas are everywhere in finance.
Ethical behavior is doing the right thing, and it
is important in financial management, just as
it is important in everything we do.
Unfortunately, precisely how we define what
is and what is not ethical behavior is
sometimes difficult. Nevertheless, we should
not give up the quest.