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Introduction To Managerial Finance

Managerial finance deals with decisions concerning cash inflows and outflows for a company. The primary goal of financial managers is to maximize shareholder wealth by making decisions that maximize the present value of expected future cash flows. Financial managers must consider agency problems that can arise between managers and shareholders and aim to align manager incentives with shareholder interests. There are various forms of business organization with different structures of ownership and liability, including proprietorships, partnerships, corporations, and hybrid structures. Multinational corporations operate across borders to pursue new markets, resources, and efficiencies while managing additional complexities of different currencies, laws, cultures, and political risks versus domestic firms.

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37 views

Introduction To Managerial Finance

Managerial finance deals with decisions concerning cash inflows and outflows for a company. The primary goal of financial managers is to maximize shareholder wealth by making decisions that maximize the present value of expected future cash flows. Financial managers must consider agency problems that can arise between managers and shareholders and aim to align manager incentives with shareholder interests. There are various forms of business organization with different structures of ownership and liability, including proprietorships, partnerships, corporations, and hybrid structures. Multinational corporations operate across borders to pursue new markets, resources, and efficiencies while managing additional complexities of different currencies, laws, cultures, and political risks versus domestic firms.

Uploaded by

Akpknuako1
Copyright
© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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INTRODUCTION TO MANAGERIAL FINANCE

An Overview of Managerial Finance (Chapter 1)

What is Finance?
o Finance deals with decisions concerning cash inflows (financing) and cash outflows
(investing); thus, nearly every decision made in the firm is somehow related to finance.
o Everything else equal, you should prefer (1) more value to less, (2) to receive cash sooner
rather than later, and (3) less risk to more.

General Areas of Finance


o Financial Markets and Institutionsthe financial marketplace and the relationships of banking,
insurance, estate planning, and so forth.
o Investmentsevaluating financial assets, such as stocks and bonds, and determining which
investments to include in a portfolio of financial assets.
o Financial Servicesservice organizations and mechanisms related to the management of
money.
o Managerial Financeoften called corporate finance, includes decisions regarding types of real
investments (i.e., plant and equipment) that should be made and how such investments should
be financed (i.e., stocks or bonds), whether dividends should be paid, and so forth.
The Importance of Finance in Nonfinance Areasregardless of the area of business you study, an
understanding of finance is crucial; decisions about money are commonplace in every area of
business, thus financial decisions are required.

Alternative Forms of Business Organization


o Proprietorshipsingle owner who is personally responsible for all liabilities of the firm;
proprietorships represent about 70-75 percent of all businesses.
Advantages:
easy and relatively inexpensive to form
affected by few regulations
business is taxed as an individual rather than a corporation
Disadvantages
owner has unlimited personal liability for debts of the firm
firms life is limited
ownership transfer is similar to selling a house, which can be difficult
firms credit and its ability to raise funds is dependent on the financial strength of the
owner
o Partnershiptwo or more owners who are personally responsible for all liabilities of the firm;
advantages and disadvantages of a partnership are the same as for a proprietorship; partnerships
represent about 8-10 percent of all businesses.
o

Corporationlegal entity in which owners have limited responsibility for the liabilities of the
firm; corporations represent about 20 percent of all businesses, but generate nearly 85 percent
Introduction to Managerial Finance - 1

of all sales.
Advantages:
unlimited life
transfer of ownership is relatively simplestock represents ownership
limited liability of ownersgenerally limited to an investors initial investment in the
stock of the firm
Disadvantages:
earnings are can be taxed twice, once at the corporate level and once when (if)
distributed to stockholders as dividends
establishing a corporation is more complex than for a proprietorship or a partnership
Corporate charterinformation about the corporation, including its name, type of
business, amount of stock, and so forth.
Bylawshow the corporation will be governed
Hybrid Business Forms
Limited liability partnership (LLP)a partnership where at least one partner is fully
liablethe general partnerfor the firms debts, but the liability of the other partners
generally is limited to the amount they invest in the business.
Limited liability corporation (LLC)a business that offers limited liability to its owners
like a regular corporation, but its income is taxed like a partnership; the structure of an LLC
is very flexible with regard to ownership, governance, and so forth; unlike an S corporation,
an LLC can have more than 100 stockholders and still be taxed like a partnership.
S Corporationa corporation that has fewer than 100 stockholders can elect to be taxed as
a partnership such that the income passes through to the stockholders and is not taxed at
the corporate level.

Primary Goal of the Corporation


o Maximize wealthshould be the primary goal of the financial manager. Unlike profit (earnings
per share, EPS) maximization, wealth maximization considers the impact of current decisions
on the long-term financial health of the firm.
o Social Responsibilityfirms should be socially responsible at the same time they earn
normal profits; otherwise they probably will go out of business.
o Wealth Maximization and Social Responsibilityactions that maximize the value of the firm
also are beneficial to society; wealth maximization improves the standard of living.

Shareholder Wealth Maximizationmake decisions that maximize the current value of the cash
flows that will be received in the future; the value of a firm can be computed as follows:

Value = Current (present) value of expected cash flows ( CF s) based on the return
demanded by investors (r)

CF1
CF 2
CF N
=
+
+L+
1
2
(1 + r )
(1 + r )
(1 + r ) N

Introduction to Managerial Finance - 2

Decisions that affect cash flows affect the value of the firm. Financial decisions are based on the
impact a behavior will have on the firms expected future cash flows. Such decisions include
determining how to finance the firm (capital structure decisions), what assets to purchase (capital
budgeting decisions), and whether to pay stockholders dividends or reinvest earnings in the firm
(dividend policy decisions).

Agency Relationshipspersons who make decisions that affect the firm are agents who are
responsible for acting in the best interests of the owners (stockholders) of the firm.
o Agency problems arise when managers satisfy their own interests rather than the interests of
the ownersthat is, the common stockholders. Methods that help managers act in the best
interests of owners include:
Managerial compensation (incentives)reward managers for acting in the best interests of
owners
Shareholder interventionsuggest remedies to problems, sponsor proposals/ changes to the
governance of the firm, threaten to change the board of directors
Takeover threatupper management generally is let go when a firm is taken over by
another firm
o There is no agency problem/relationship in a proprietorship form of business, because the
firms owner also makes the firms decisions; thus, he or she will make decisions that are in his
or her best interest

Business EthicsStandards of conduct or moral behavior; ethical businesses act morally;


generally ethical businesses are valued higher than similar business that are perceived to be
unethical.

Corporate Governancehow the firm is run/managed when doing business; the rules that the
corporation follows when conducting business

Forms of Business in Other Countries


o Foreign businesses are generally more closed than U.S. businessesthat is, foreign businesses
are generally owned by fewer stockholders than U.S. businesses; ownership is more closely
held
o Industrial groupsbusinesses in different industries that have common ownership; often the
businesses complement each othere.g., financing and marketing organizations might be
aligned with manufacturers; in some cases suppliers, manufacturers, distributors, and retailers
have common ownership.

Multinational Corporationsfirms that operate in more than one country


o Firms become more global to:
seek new markets
seek new sources of raw materials
seek new technological advances
seek more efficient production opportunities
avoid political and regulatory hurdles that apply to foreign manufacturers

Introduction to Managerial Finance - 3

o Factors that differentiate managerial finance in purely domestic firms and in multinational
organizations include:
different currency denominations
economic and legal ramifications
language differences
cultural differences
government involvement
political risk

Chapter 1 Summary QuestionsYou should answer these questions as a summary for the chapter
and to help you study for the exam.
o What is finance?
o What are the basic forms of business? What are the advantages and disadvantages of each?
o What should be the primary goal of a financial manager? Why?
o What is an agency relationship? How can shareholders reduce the potential for agency
problems?
o How do businesses in the United State differ in general from businesses in other countries?
o Why do firms go global?

Introduction to Managerial Finance - 4

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