Upload
tasha-vang
View
37
Download
3
Embed Size (px)
DESCRIPTION
Chapter 1 An Overview of Managerial Finance. Learning Objectives. 1.Understand the general framework for financial decision making. 2.Describe the role of financial decision making in maximizing the value of the firm. - PowerPoint PPT Presentation
Citation preview
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 1 of 23
Chapter 1Chapter 1
An Overview
of Managerial
Finance
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 2 of 23
Learning Objectives1. Understand the general framework for financial decision making.
2. Describe the role of financial decision making in maximizing the value of
the firm.
3. Identify how to determine whether an investment should be made and how
to finance acceptable investments.
4. Explain what is meant by the risk/return trade-off and how risk and return
can affect management decisions.
5. Understand the role of financial institutions and markets and its effect on
financial decisions made by the firm.
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 3 of 23
Importance of Managerial Finance
Assets: Liabilities & Equity:
Current Assets Current Liabilities
Cash & M.S. Accounts payable
Accounts receivable Notes Payable
Inventory Total Current Liabilities
Total Current Assets Long-Term Liabilities
Fixed Assets: Total Liabilities
Gross f ixed assets Equity:
Less: Accumulated dep. Common Stock
Goodw ill Paid-in-capital
Other long-term assets Retained Earnings
Total Fixed Assets Total Equity
Total Assets Total Liabilities & Equity
CompanyBalance Sheet
As of December 31, 2004
Maximize wealth
notprofit!
Debts are paid
by cashflownot income!
InvestmentDecisions
utilizefunds
FinancingDecisions
require funds
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 4 of 23
The operation of a firm
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 5 of 23
Forms of Business Organization
• Advantages
– Easy formation with low organizational costs
– Affected by few government regulations
– Income included and taxed only on proprietor’s
personal tax return (i.e. only one)
Proprietorship
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 6 of 23
Forms of Business Organization
• Drawbacks
– Owner has unlimited liability (i.e. total wealth can be
taken to satisfy debts)
– Lacks continuity when proprietor dies
– Transferring of ownership is difficult
– Limited fund-raising power tends to inhibit growth
Proprietorship
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 7 of 23
Forms of Business Organization
• Advantages
– Fairly easy and inexpensive formation
– Affected by few government regulations
– Income included and taxed only on partner’s tax
return
Partnership
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 8 of 23
Forms of Business Organization
• Drawbacks
– Owners have unlimited liability and may have to
cover debts of other partners
– Partnership is dissolved when a partner dies
– Difficulty to liquidate or transfer partnership
– Difficulty of raising large amounts of capital
Partnership
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 9 of 23
Forms of Business Organization
• Advantages
– Long life of firm even if owners do not have a
relationship with the business
– Ownership (stock) is readily transferable
– Owners have limited liability which guarantees that
they cannot lose more than they invested
– Better access to financing
Corporation
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 10 of 23
Forms of Business Organization
• Drawbacks
– More expensive to organize than other business
forms and subject to greater government regulation
– Taxes are higher because of double taxation:
corporate income is taxed and also dividends paid
to owners are taxed
Corporation
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 11 of 23
Value maximized for corporations
• Limited Liability reduces the risk borne by investors
• A firm’s current value is related to its future growth
opportunities
•Corporate ownership can be transferred easier than the
ownership of either a proprietorship or a partnership
Why?
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 12 of 23
Role of Finance in a Business Organization
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 13 of 23
The Goals of the CorporationStockholder wealth maximization
• This should be the primary goal of a financial manager Incentives against are
to keep stockholder returns “at reasonable level” and work for other goals such
as:
– pursue goals of public service activities
– target employee benefits
– pursue higher executive salaries
• But…
– Competitive forces require financial managers to opt for stockholder wealth
maximization, to avoid losing their jobs
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 14 of 23
The Goals of the CorporationSocial Responsibility
• Firms should provide a safe environment, avoid air pollution and produce safe
products. Incentives against for firms to act in a socially responsible manner
are:
– Disadvantage in attracting funds due to extra costs incurred
– Inability to compete due to higher prices of products
– Constraints by capital market factors
• Therefore…
– Social Responsibility actions should be enforced on a mandatory rather than a
voluntary basis
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 15 of 23
The Goals of the CorporationStock Price Maximization and Social Welfare
• Shareholder Wealth Maximization is beneficial for the society:
– Stock price maximization requires efficient, low cost plants that produce
high-quality goods and services at a low cost
– Stock price maximization requires the development of products that
customers want and need, leading to new technology, new products
and new jobs
– Stock price maximization necessitates efficient service, adequate
stocks and well located business establishments
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 16 of 23
The Goals of the Corporation
Therefore primary goal is to Maximize Shareholder Wealth
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 17 of 23
Decisions affecting the firm’s value
nn
22
11
)k1(CF
)k1(CF
)k1(
CFvalueAsset
Value = Current (present) value of expected cash flows (CFs) based on the return
demanded by investors (k)
• How to finance (capital structure decision)
•What assets to purchase (capital budgeting decision)
•Pay dividends or re-invest earnings? (dividend policy
decision)
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 18 of 23
Present Value… explained• The value of any financial contract (i.e., stock) answers
the following questions:– 1. How much do I expect receipts to be (expected cash flow to
the investor (i.e., dividends))?– 2. When do I receive the payments (timing/opportunity cost)?– 3. What is the chance I do not receive what I expected (risk)?
• The Present Value (discounted) of cash flows received by an investor is used as the estimate of the value of a contract (i.e., shareholder wealth)
• The Present Value (discounted) of a single share is the shares market price
• Shareholders Wealth=Market Value of Equity=Number of shares * share price
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 19 of 23
Should Earnings Per Share Be Maximized?
Beware: Wealth is NOT profit!
Investment Year 1 Year 2 Year 3 Total
A 2,90 0,00 0,00 2,90
B 0,00 0,00 3,00 3,00
EPS (€)
Which Investment is Preferred?
Profit maximization fails to account for differences in the level of cash flows (as
opposed to profits), the timing of these cash flows, and the risk of these cash flows.
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 20 of 23
Make decisions about the cash flow Beware: Accounting is NOT an economic profit!
Sales Revenue (in €) 100.000 Cash Inflow s (in €) 100.000
Less: Costs (in €) 80.000 Less: Cash Outflow s(in €) 80.000
Net Profit (in €) 20.000 Net Cash Flow (in €) 20.000
Finance ViewCash Flow Statement
for the year ended 2004
Accounting ViewIncome Statement
for the year ended 2004
Cash flow is the actual cash generated by the firm. CF = Net Income + Depreciation or (CF = NI + DEP )
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 21 of 23
Agency Relationships
• Whenever a manager owns less than 100% of the
firm’s equity, a potential agency problem exists.
• In theory, managers would agree with shareholder
wealth maximization.
• However, managers are also concerned with their
personal wealth, job security, fringe benefits, and
lifestyle.
• This would cause managers to act in ways that do not
always benefit the firm’s shareholders.
Stockholders versus Managers – The problem
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 22 of 23
Agency Relationships
• Managerial compensation (in the form of performance
shares, executive stock options or restricted stock grants)
– But…. Recent studies have failed to find a strong relationship
between CEO compensation and share price.
• The threat of firing
•Shareholder intervention
•The threat of takeover
Stockholders versus Managers - Solutions
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 23 of 23
Agency Relationships
• Creditors consider the riskiness of the firm
• Stockholders should not act against creditors because
– Creditors protect themselves through restrictions in credit
agreements
– Creditors may request an interest rate much higher than
normal to compensate for the stockholder’s actions
•Result: Stockholders may find it difficult to borrow funds in
the future
Stockholders versus Creditors