VYE Keown PPCh01A upd

VYE Keown PPCh01A upd - Learning Objectives A 1. 2. An...

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Unformatted text preview: Learning Objectives A 1. 2. An Introduction to Financial Management By Keown, Martin, Petty & Scott • Maintenance & creation of economic value or wealth Ex. 2 firms: Merck & GM in end 2003 – Merck, a large pharmaceutical company Total market value $103 B Investments over the life of the business $ 30 B Value creation $ 73 B – General Motors GM, car company 4. Explain the 10 principles that form the basics of financial management. • We will designate maximization of shareholder wealth i.e. maximization of the total market value of the firm's common stock (price of the existing common stock) to be the goal of the firm. • Scarce resources are directed to the most productive use by businesses competing to create wealth $ 30B $ 85B $ 55B Goal of the firm • We will designate maximization of shareholder wealth To understand this goal and its inclusive nature it is first necessary to understand the difficulties involved with the frequently suggested goal of profit maximization. Why not profit maximization? Compare the various legal forms of business and explain why the corporate form of business is the most logical choice for a firm that is large or growing. Goal of the firm What is Finance? Total market value Investments over the years Loss in value Explain the goal of the firm. 3. Chapter 1 Describe what the subject of financial management is about. Profit Maximization • Stresses the efficient use of capital resources. It assumes away many of the complexities of the real world. - It assumes away uncertainty of returns, i.e. projects are compared by examining their expected values or weighted average profit. - It assumes away timing differences of returns (not specific about the time frame) - It tends to focus on short term increase in profits • Is unacceptable and a more realistic goal is needed. Profit Maximization • Weaknesses – Ignores uncertainty and risk Projects & investment alternatives compared i.t.o. expected values or weighted average profits Calculations do not reflect whether one project riskier than another – Ignores timing of the project’s returns Given equivalent cash flows from profits, we want those cash flows sooner rather than later. Profit Maximization • Weaknesses – Accounting profits ignores cost of funds provided by the firm’s shareholders. i.e. it only considers interest expense as a cost of borrowing money ex. New investment will earn 8% But could earn 12% on another investment of similar risk Maximization of Shareholder Wealth Maximization of Shareholder Wealth • We have chosen the goal of shareholder wealth maximization i.e. Maximize the market value of the existing shareholders’ common stock Modifying the goal of profit maximization Considers complexities of the operating environment Includes effects of all financial decisions • To employ this goal we need not consider every price change to be a market interpretation of the worth of our decisions. Maximization of Shareholder Wealth Maximize Shareholder Wealth!!! – Investors react to the firm’s investment or dividend decisions Poor decisions total value of the firm’s stock falls Good decisions pushes up the price of the stock Good decisions create wealth for the shareholder Over the long run, price = value Note that shareholders are the legal owners of the firm What we do focus on is the effect that our decision should have on the stock price if everything were held constant. Why? Because maximizing shareholder wealth properly considers: – cash flows, – the timing of these cash flows, timing risk – and the risk of these cash flows. illustrated using the ff simple valuation equation: level & timing of cash flows Share Price = Future Dividends Required Return risk of cash flows Maximization of Shareholder Wealth Year 1 2 3 Sum Asset 1 $42,000 30,000 15,000 $87,000 Asset 2 $15,000 30,000 42,000 $87,000 Asset 3 $16,000 38,000 42,000 $96,000 Maximization of Shareholder Wealth Year 1 2 3 Sum Asset 1 $42,000 30,000 15,000 $87,000 Asset 2 $15,000 30,000 42,000 $87,000 Asset 3 $16,000 38,000 42,000 $96,000 As a financial manager, what asset would you choose? Based on profit maximization goal Based on shareholder wealth maximization goal Maximization of Shareholder Wealth • The agency problem It is a result of the separation between the decision makers and the owners of the firm. As a result managers may make decisions that are not in line with the goal of maximization of shareholder wealth. Sole proprietorship Sole proprietorship is a business owned by a single person who operates it for his/her own profit and has a minimum amount of legal structure. About 75% of all business firms Examples: market vendors, s-s stores sMajority found in the wholesale, retail, and construction industries Legal Forms of Business Organization • Three most common categories: – Sole proprietorship – Partnership – Corporation Sole proprietorship Typically, the proprietor with a few employees operates the business, raises capital from personal resources or from borrowings, and is responsible for all all business decisions. Has unlimited liability, his/her wealth and not merely the amount of original investment can be taken to satisfy creditors Termination occurs on the owner’s death, or by choice Sole proprietorship Partnership Advantages a. Easily established with few complications b. Minimal organizational costs c. Does not have to share profits or control with others Disadvantages a. Unlimited liability for the owner b. Owner must absorb all losses c. Equity capital limited to the owner's personal investment d. Business terminates immediately upon death of owner Partnership Relationship among partners dictated by the partnership agreement- whether oral commitment agreementor formal document In a general (or regular) partnership, all partners general have unlimited liability, and each partner is legally all of liable for all of the debts of the partnership. Partnership is an association of two or more individuals coming together as co-owners to operate a cobusiness for profit. Account for about 10% of all business firms Typically larger than sole proprietorship Most common: finance, insurance and real estate firms; public accounting, stock brokerage and law partnerships often have large number of partners Partnership Two types of partnerships a. General partnership- Relationship between partnershippartners is dictated by the partnership agreement. b. Limited partnership In a general (or regular) partnership, all partners general have unlimited liability, and each partner is legally all of liable for all of the debts of the partnership. Partnership a. General partnership. Advantages a. Minimal organizational requirements b. Negligible government regulations Disadvantages a. All partners have unlimited liability b. Difficult to raise large amounts of capital c. Partnership dissolved by the death or withdrawal of general partner Partnership b. Limited partnership Advantages a. For the limited partners, liability limited to the amount of capital invested in the company b. Withdrawal or death of a limited partner does not affect continuity of the business c. Stronger inducement in raising capital Partnership b. Limited partnership Disadvantages a. There must be at least one general partner who has unlimited liability in the partnership b. Names of limited partners may not appear in the name of the firm c. Limited partners may not participate in the management of the business d. More expensive to organize than general partnership, as a written agreement is mandatory Corporation Corporation An artificial, “impersonal” being created by law often called a “legal entity” Has the power of an individual in that it can purchase, sell, and own assets/ property in its own name, incur liabilities, sue and be sued and make and be party to contracts while existing separately Partnership c. There is also a Limited Liability Company (LLC) form of business. A cross between a partnership and a corporation. It retains limited liability for its owners, but is run and taxed like a partnership. Corporation In general only about 15% of all businesses, but is the dominant form in terms of receipts and profits, i.e. 90% of business receipts and 80% of net profits Manufacturing corporations account for largest portion of corporate business receipts and net profits. and apart from its owners Ownership is evidenced by shares of stock Corporation Advantages a. Limited liability of owners b. Ease of transferability of ownership, i.e., by the sale of one's shares of stock c. The death of an owner does not result in the discontinuity of the firm's life d. Ability to raise large amounts of capital is increased Disadvantages a. Most difficult and expensive form of business to establish b. Control of corporation not guaranteed by partial ownership of stock Legal Forms of Business Organization Corporation The owners of a corporation are its stockholders, stockholders equity whose ownership is equity, is evidenced by either common common stock or preferred stock. Common preferred stock is the purest and most basic form of corporate ownership. ownership. Corporation Stockholders expect to earn a return • By receiving dividends- periodic distribution of earnings dividends • By realizing gains through increases in share price Control of the corporation is structured as a democracy. The stockholders (owners) vote periodically to elect members of the board of directors, and to decide other issues • Corporation The board of directors is typically responsible for: board is Ex. Amendments to corporate charter Corporation The board of directors typically include: board typically • Developing strategic goals and plans • Inside directors, such as key corporate executives • Setting general policy • Outside directors, such as executives from other • Guiding corporate affairs • Approving major expenditures • Hiring/ firing • Compensating • Monitoring key officers and executives Corporate Organization companies, major shareholders, and national or community leaders The president or chief executive officer (CEO) president is responsible for managing day-to-day operations, day-tocarrying out the policies established by the board, and reporting periodically to the firm’s board. Other Other Limited Liability Organizations Organizations Corporation • Owners elect a board of directors • Board members in turn select/ hire individuals to serve as company officers – Including the president, vice president, secretary and treasurer • Ownership is reflected in common stock certificateswith no. of hares owned by its holder • Shares are transferable, so ownership changes by simply remitting the shares to a new shareholder. Corporation • Life of the corporation is not dependent on the status of the investors. • Death or withdrawal of an investor does not affect the continuity of the corporation. • Management continues to run the corporation when the stock is sold or passed on through inheritance. Treasurer – Handles the firm’s financial activities Cash and credit management Making capital expenditure decisions Raising funds Financial planning Managing foreign currency received by the firm Corporation • Investor’s liability is confined to the amount of investment in the company • This prevents creditors from confiscating stockholders’ personal assets to settle unresolved claims. The Role of the Financial Manager in a Corporation • Vice President for Finance/ Chief Financial Officer (CFO) – Serves under the Chief Executive Officer (CEO) – Responsible for overseeing the Financial planning Corporate strategic planning Controlling the firm’s cash flow – Treasurer and Controller serve under the CFO Controller – Manages the firm’s accounting duties Producing accounting statements Cost accounting Paying taxes Gathering and monitoring data necessary to oversee the firm’s financial well-being • We focus on the duties of the Treasurer and on how investment decisions are made. Flow Flow Of Capital Through The Financial Markets Financial Intermediaries SAVERS Flow Of Capital Through The Financial Markets Financial Intermediaries BORROWERS Flow Of Capital Through The Financial Markets • The popularity of the corporation stems from the ease in raising capital that it provides. Among the corporation, individuals and the government Initially, the corporation raises funds in the financial markets by selling securities- stocks and debt. Receives cash in turn. The corporation then invests this cash in assets that generate returns Flow Of Capital Through The Financial Markets Cash flow from those assets is: Either reinvested in the corporation Or given back to the investors in the form of dividends or interest payments Or used to repurchase stock- which should cause the stock price to rise Or given to the government as tax payments Primary and Secondary Markets • Securities market is a place where you can buy or sell securities – Wall Street, an actual building in New York City – Electronic hookup among security dealers all over the world Primary Market • A market where new (as opposed to previously issued) securities are traded. • This is the only time that the issuing firm actually receives money for its stock. Initial public offering (IPO)- first time the company’s stock is sold to the general public Seasoned new issue- stock offerings from companies that already have common stock traded in the secondary market. REFERENCES: Titman, S., Keown, A.j, Martin, J.D., (2011). Financial Management: Principles and Applications. (11th Ed.). Pearson Education, Pearson/Prentice Hall Keown, A.J., Martin, J.D., Petty, J.W., Scott Jr, D.F., Financial Management: Principles and Applications, 10th Edition, Pearson Prentice Hall 2005 Gitman, L. J. Principles of Managerial Finance, (11th ed.) Massachusetts: Addison Wesley Longman. Secondary Market • The market where securities that have previously been issued and bought are traded. Ex. You bought 100 shares of stock in an IPO, and wanted to resell them. You resell them in the secondary market. Ex. The proceeds from the sale of a share of IBM stock in the secondary market go to the previous owner of the stock, not to IBM. The only time IBM ever receives money from the sale of one of its securities is in the primary markets. ...
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This note was uploaded on 09/22/2011 for the course ECON 101 taught by Professor Mr.tull during the Spring '11 term at De La Salle University.

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