CHAPTER 1: Introduction to managerial finance
Learning objectives:
1. Define finance and the managerial finance function.
2. Describe the goal of the firm, and explain why maximizing the value of the firm is an
appropriate goal for a business.
3. Identify the primary activities of the financial manager.
4. Explain the key principles that financial managers use when making business
decisions.
5. Describe the legal forms of business organization.
6. Describe the nature of the principal–agent relationship between the owners and
managers of a corporation, and explain how various corporate governance
mechanisms attempt to manage agency problems.
1.1 Finance and the firm
Firm: A business organization that sells goods or services
● The goal of a firm can be:
○ Maximize shareholder profit / Maximizing stock price
■ This is measured with earnings per share (EPS).How much you
earn, per period, per share.
○ Maximize owner profit
○ Satisfy customers
○ Inspire and motivate employees
● Managers within this firm need to determine a course of asking. Managing return and
risk.
Wealth maximization is not always consistent with profit maximization for the following
reasons:
1. The difference in short term and long term focus, profit is short term and wealth is
long term.
2.
Business ethics: Standards of conduct or moral judgment that apply to persons engaged in
commerce.
● Robert A. Cooke’s ethical viability of proposed action:
○ Is the action arbitrary or capricious? Does it unfairly single out an individual or
group?
○ Does the action violate the moral or legal rights of any individual or group?
○ Does the action conform to accepted moral standards?
○ Are there alternative courses of action that are less likely to cause actual or
potential harm?
1.2 Managing the firm
Company finances can be viewed in multiple ways
, 1. Investment decisions: How a company will spend their financial resources to create
future value.
2. Capital budgeting: Technique that helps managers decide which projects create the
most value for shareholders.
3. Financing decisions: Decisions that determine how companies raise the money
they need to pursue investment opportunities.
4. Working capital decisions: Decisions that refer to short term resources.
Principles that guide managers decision:
1. The time value of money: Time your investments, having money now is better than
to have it in the future.
2. The tradeoff between return and risk: Greater risk = Greater potential profits
3. Cash is king: Ultimately the cash flow that investors receive or expect to determine
the firm's value
4. Competitive financial markets:
5. Incentives are important: Managers being properly aligned with the interests of
shareholders
○ Principal-agent problem: Owners and managers are not the same people
which causes difference in interests.
Positions within a company:
1. Treasurer: Key financial manager, manages the firm’s cash, oversees pension plans
and manages key risks.
2. Director of risk management: Works with the treasurer to manage risks that the
firm faces related to movements in exchange rates, commodity prices and interest
rates.
3. Controller: Chief accountant, who is responsible for the firm’s accounting activities,
such as corporate accounting, tax management, financial accounting, and cost
accounting.
○ Primary function is to develop and report data for measuring financial firm
performance. This is done on an accrual basis, this recognizes revenue at
time of sale and when they are incurred..
4. Director of investor relations: The conduit of information between the firm and the
investment community.
5. Director of internal audit: Leads a team charged with making sure that all business
units follow internal policies and comply with government regulations.
6. Foreign exchange manager: The manager responsible for managing and
monitoring the firm’s exposure to loss from currency fluctuations.
,Marginal cost-benefit analysis: Economic principle that states that financial decisions
should be made and actions taken only when the marginal benefits exceed the marginal
costs.
Ordinary income: Income earned by a business through the sale of goods or services.
Capital gain: Income earned by selling an asset for more than it cost.
Stock options: Securities that allow managers to buy shares of stock at a fixed price.
Restricted stock: Shares of stock paid out as a part of a compensation package that do not
fully transfer from the company to the employee until certain conditions are met.
1.3 Organizational Forms, Taxation, and the Principal–Agent Relationship
Legal structure of a business:
● A sole proprietorship is a business owned by one person and operated for his or
her own profit.
● A partnership is a business owned by two or more people and operated for profit.
● A corporation is an entity created by law. Corporations have the legal powers of an
individual in that it can sue and be sued, make and be party to contracts, and acquire
property in its own name.
Advantages of to Inc.:
○ Protect Your Personal Assets
Incorporating your business is one of the best ways you can protect your
personal assets. A corporation can own property, carry on business, incur
liabilities, and sue or be sued.
○ Have Easier Access to Capital
Raising capital is generally easier for a corporation, since a corporation can
issue shares of stock. This may make it easier for your business to grow and
develop.
○ Enhance Your Business’ Credibility
The benefits of incorporating go beyond finances. Suppliers, customers and
business associates often perceive corporations as being more stable than
unincorporated businesses. In a sense, having “Inc.” or “Corp.” after your
business name conveys permanence, credibility, and stability, and
communicates your commitment to the ongoing success of your business
venture.
○ Perpetual Existence
Corporations are the most enduring legal business structure. A corporation
can continue indefinitely, regardless of what happens to its individual
directors, officers, managers, or shareholders.
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