Vicentiu Covrig FIN303

An overview of Financial
Management
(chapter 1)

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What is Finance?
Finance is about
- money
- savings/investments
- revenue, costs, profits of companies
Finance grew from Economics and
Accounting
Economics provided the models and the
accounting the company level information

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Areas and Career Opportunities in Finance
Financial management/ Corporate finance
Investments
Money and capital markets

Check out the file Careers in Finance posted

on the courses web site

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Finance Within the Organization

Board of Directors

Chief Executive Officer (CEO)

Chief Operating Officer (COO) Chief Financial Officer (CFO)

Marketing, Production, Human Accounting, Treasury, Credit,

Resources, and Other Operating Legal, Capital Budgeting, and
Departments Investor Relations

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Alternative Forms of Business Organization: Sole
proprietorships & Partnerships
Sole proprietorship: un unincorporated business owned by one individual
Partnership: un unincorporated business owned by two or more individuals

Advantages
- Ease of formation
- Subject to few regulations
- No corporate income taxes
Disadvantages
- Difficult to raise capital
- Unlimited liability
- Limited life

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Alternative Forms of Business Organization:
Corporation
Advantages
- Unlimited life
- Easy transfer of ownership
- Limited liability
- Ease of raising capital

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

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Vicentiu Covrig FIN303
Stock Prices and Shareholder Value
The primary financial goal of management is shareholder
wealth maximization, which translates to maximizing stock
price.
Value of any asset is present value of cash flow stream to
owners.
Most significant decisions are evaluated in terms of their
financial consequences.
Stock prices change over time as conditions change and as
investors obtain new information about a companys
prospects.
Managers recognize that being socially responsible is not
inconsistent with maximizing shareholder value.

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Factors that affect stock prices

Projected cash
flows to
shareholders
Timing of the cash
flow stream
Riskiness of the
cash flows

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Stock Prices and Intrinsic Value

In equilibrium, a stocks price should equal its true or intrinsic
value.
Intrinsic value is a long-run concept.
Ideally, managers should avoid actions that reduce intrinsic
value, even if those decisions increase the stock price in the
short run.
To the extent that investor perceptions are incorrect, a stocks
price in the short run may deviate from its intrinsic value.
Its a BUY if the market stock price is below the investors
intrinsic value
Its a SELL if the market stock price is above the investors
intrinsic value
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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).

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Conflicts Between Managers and Stockholders
Managers are naturally inclined to act in their own best
interests (which are not always the same as the interest of
stockholders).
But the following factors affect managerial behavior:
Managerial compensation packages
Direct intervention by shareholders
The threat of firing
The threat of takeover

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Conflicts Between Stockholders and
Bondholders
Stockholders are more likely to prefer riskier projects,
because they receive more of the upside if the project
succeeds. By contrast, bondholders receiving fixed
payments are more interested in limiting risk.
Bondholders are particularly concerned about the use of
additional debt.
Bondholders attempt to protect themselves by including
covenants in bond agreements that limit the use of additional
debt and constrain managers actions.

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Ethical issues in Finance

Financial statements

Financial Markets
- Insider Trading

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Fraud in Financial Statements

Fictitious Revenues
Concealed Liabilities and Expenses
Fraudulent Asset Valuations
Improper or Fraudulent Disclosures or
Omissions
Creative accounting form of fraudulent
financial reporting so as to provide
misleading information.

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Insider Trading
Refers to trading on price sensitive information by
company employees or individuals closely connected
with the firm
This information has not been disclosed to other
market participants
Does not give a level playing field between insiders
and outsiders
It is ILLEGAL to trade based on inside information

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Ethics question
A manager A manager's compensation plan that offers financial
incentives for increases in quarterly profitability may create
agency problems in that
a) Short-term, not long-term profits become the focus. *
b) The managers are not motivated by personal gain.
c) The board of directors may claim the credit.
d) Investors desire stable profits.

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Ethics question
Corruption in business _________________.
a) creates inefficiencies in an economy.
b) inhibits growth in an economy.
c) slows the rate of economic growth in a country.
d) all of the above. *

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Learning objectives
What are the key differences between sole proprietorship, partnerships, LLC,
LLP and corporations?
What is the primary goal of a corporation? Shareholder wealth maximization
What is the difference between a stocks current market price and its intrinsic
value?
What are some mechanisms that encourage managers to act in the best interest
of stockholders? Executive compensation
Conflicts Between Managers and Stockholders (text p. 12-15)
Conflicts Between Managers and Bondholders (text p. 15-17)
Business ethics (text p. 19-21)
No calculations required for this chapter
Recommended practice questions: ST-1, 1-1, 2, 3, 4, 6, 8, 10, 11,

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