FIN 305 Fall 24 FTU - Financial Management - Chapter 1 PDF

FIN 305 Fall 24 FTU...

FIN 305 Fall 24 FTU 12/11/2024 Chapter 1 Learning Objectives An Overview of The Role of Finance Financial Management Career Opportunities in Finance Chapter 1 Forms of Business Organization Creating Value for Investors Stockholder-Manager Conflicts Stockholder-Debtholder Conflicts Balancing Interests of Shareholders and Society 2 © 2020 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. © 2020 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1 2 What is Finance? Some Recent Job Offers to CSU Finance Grads…  Relationship to Other Disciplines Connection to other business fields: – Economics – Accounting  Focus on cash flows – magnitude, timing, risk  Primary Goal of Financial Manager – Maximize shareholder wealth  Main Areas of Finance – Financial Management – Capital Markets – Investments 3 4 © 2020 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 3 4 Simplified Balance Sheet Simplified Balance Sheet Assets Liabilities Assets Liabilities Equity Equity  Assets represent uses of funds.  Liabilities represent a debt claim.  Liabilities and equity represent sources of  Equity represents an ownership claim. funds. 5 6 5 6 1 FIN 305 Fall 24 FTU 12/11/2024 Forms of Business Organization Proprietorship  Proprietorship – Single Owner  A proprietorship is an unincorporated  Partnership business owned by one individual – Multiple Owners  The owner has unlimited liability for business  Corporation debts – “C” Corporation – “S” Corporation  Other – Limited Liability Company (LLC) – Limited Liability Partnership (LLP) 7 8 7 8 Partnership Proprietorships and Partnerships  Advantages:  Similar to a proprietorship, except two or – Ease of formation more owners – Subject to few government regulations  Owner/partners have unlimited liability for – No corporate income taxes business debts  Disadvantages:  Each partner is equally liable for the – Unlimited personal liability business debts of the firm – Limited life – Difficult to raise capital 9 10 9 10 Corporation Corporation (i.e., “C” corp.)  A legal entity created by a state; separate  Advantages: and distinct from its owners and managers – Unlimited life – Easy transfer of ownership  Shareholder losses are limited to funds invested in the company – Limited personal liability – Ease of raising capital  Larger corporations are known as “C” corporations  Disadvantages: – Double taxation – Cost of set-up and report filing 11 12 11 12 2 FIN 305 Fall 24 FTU 12/11/2024 “S” Corporation Other Forms of Organization  Special type of corporation based on subchapter S of the IRS tax code  Limited Liability Company (LLC) – Hybrid between a partnership and a corporation  Created by Congress as an aid to small businesses  Limited Liability Partnership (LLP) – qualifying companies are limited to a maximum of – Similar to an LLC but used in professional fields 100 shareholders such as accounting, law, and architecture  S Corporations are exempt from corporate  both types have limited liability but are taxed income tax like a partnership – taxed like a proprietorship or a partnership – while retaining the benefit of limited liability 13 14 13 14 Colorado Secretary of State Website Click on “Start a new business” to see the following choices: go to https://www.sos.state.co.us/ 15 16 Note: In the text, ‘Limited’ Partnerships are described Benefit Corporation: in a footnote (text page 7, footnote 2): 17 18 3 FIN 305 Fall 24 FTU 12/11/2024 From the text (section 1-7; page 20) on “Benefit Maximizing Present Value of Cash Flow Corporations” (called B-Corporations):  Value of a cash flow stream depends on: – Magnitude of CFs – Timing of CFs – Riskiness of CFs 0 1 2 3 CF1 CF2 CF3 Value0 = ? 20 19 20 Stock Prices and Intrinsic Value Financial Goals of the Corporation  In equilibrium, a stock’s price should equal its  The primary financial goal is shareholder “true” or intrinsic value. wealth maximization, which translates to  Intrinsic value is a long-run concept. maximizing the stock’s long-run intrinsic  In the short run, stock price can deviate from value. intrinsic value – Do firms have any responsibilities to society at  Stock price depends on investor perceptions large? and available information – Is stock price maximization good or bad for society?  Ideally, managers should avoid actions that reduce intrinsic value, even if those decisions – Should firms behave ethically? benefit the stock price in the short run. 21 22 21 22 Manager Must Consider All Stakeholder Groups Business Ethics Revenue Customers  Ethics Definition: “A standard of conduct - Operating expenses Suppliers, Employees and moral behavior.” - Depreciation Operating earnings  Business Ethics: A company’s attitude - Interest payments Bondholders and conduct toward its employees, Taxable income customers, community, and stockholders - Taxes Government Earnings after taxes Preferred dividends Preferred stockholders Earnings available to common stockholders Common stockholders 23 24 23 24 4 FIN 305 Fall 24 FTU 12/11/2024 Conflicts Between Conflicts Between Managers and Stockholders Stockholders and Bondholders  Managers are naturally inclined to act in their  Stockholders are more likely to prefer riskier own best interests (which are not always the projects, because they receive more of the upside if same as the interest of shareholders). the project succeeds. By contrast, bondholders receiving fixed payments are more interested in – This is referred to as an ‘agency problem’ limiting risk. – Stems from separation of ownership and control  Bondholders are particularly concerned about the  Ways to help alleviate agency problems: use of additional debt. – Managerial compensation plans  Bondholders attempt to protect themselves by – Direct intervention by shareholders including covenants in bond agreements that limit – The threat of firing the use of additional debt and constrain managers’ – The threat of takeover actions. 25 26 25 26 Balancing Shareholder Interests Main Decision Areas in Financial Management and Society Interests  The primary financial goal of management is shareholder  Capital Structure Decisions wealth maximization, which translates to maximizing – How to Finance Assets? intrinsic value or long run stock price.  Capital Budgeting Decisions  The value of any asset is equal to the present value of the expected cash flow stream from the asset. – Which Long Term Projects to Undertake?  Most significant business decisions are evaluated in terms  Dividend Policy Decisions of their financial consequences. – How & When to Distribute Earnings?  Stock prices change over time as conditions change and as investors obtain new information about a company’s  Working Capital Management prospects. – How to Manage Short Term Cash Flows?  Managers recognize that being socially responsible is not inconsistent with maximizing shareholder value. 27 28 27 28 End of Chapter 1 © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. Cover image attribution: “Finance District” by Joan Campderrós-i-Canas (adapted) https://flic.kr/p/6iVMd5 29 5