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CHAPTER 1 An Overview of Financial
Career Opportunities Issues of the New Millennium Forms of Businesses Goals of the Corporation Agency Relationships
Career Opportunities in Finance
• Money and capital markets • Investments • Financial management
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
Role of Finance in a Typical Business Organization
Board of Directors
VP: Sales VP: Finance VP: Operations
Capital Budgeting Director
Financial Management Issues of the New Millennium
• The effect of changing technology
• The globalization of business
Percentage of Revenue and Net Income from Overseas Operations for 10 Well‐Known
Company % of Revenue from overseas
% of Net Income from overseas
Coca-Cola 60.8 35.9
Exxon Mobil 69.4 60.2
General Electric 32.6 25.2
General Motors 26.1 60.6
IBM 57.9 48.4
JP Morgan Chase & Co. 35.5 51.7
McDonald’s 63.1 61.7
Merck 18.3 58.1
3M 52.9 47.0
Sears, Roebuck 10.5 7.8
Alternative Forms of Business Organization
• Sole proprietorship • Partnership • Corporation
Sole proprietorships & Partnerships
• Advantages – Ease of formation – Subject to few regulations – No corporate income taxes
• Disadvantages – Difficult to raise capital – Unlimited liability – Limited life
• Advantages – Unlimited life – Easy transfer of ownership – Limited liability – Ease of raising capital
• Disadvantages – Double taxation – Cost of set‐up and report filing
Financial Goals of the Corporation
• The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price. – Do firms have any responsibilities to society at large?
– Is stock price maximization good or bad for society?
– Should firms behave ethically?
Is stock price maximization the same as profit maximization?
• No, despite a generally high correlation amongst stock price, EPS, and cash flow.
• Current stock price relies upon current earnings, as well as future earnings and cash flow.
• Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa).
• An agency relationship exists whenever a principal hires an agent to act on their behalf.
• Within a corporation, agency relationships exist between:
– Shareholders and managers
– Shareholders and creditors
Shareholders versus Managers
• Managers are naturally inclined to act in their own best interests.
• But the following factors affect managerial behavior: – Managerial compensation plans – Direct intervention by shareholders – The threat of firing – The threat of takeover
Shareholders versus Creditors
• Shareholders (through managers) could take actions to maximize stock price that are detrimental to creditors.
• In the long run, such actions will raise the cost of debt and ultimately lower stock price.
Factors that affect stock price
• Projected cash flows to shareholders
• Timing of the cash flow stream
• Riskiness of the cash flows
Basic Valuation Model
• To estimate an asset’s value, one estimates the cash flow for each period t (CFt), the life of the asset (n), and the appropriate discount rate (k)
• Throughout the course, we discuss how to estimate the inputs and how financial management is used to improve them and thus maximize a firm’s value.
Factors that Affect the Level and Riskiness of Cash Flows
• Decisions made by financial managers: – Investment decisions – Financing decisions (the relative use of debt financing)
– Dividend policy decisions
• The external environment