Chap 1BB(Aug 13)

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FINANCIAL

MANAGEMENTChapter 1 The Corporation

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Financial Management2

How people in corporations make financial

decisions?

Financial decisions?

Where, when, what, how much, howetc.

Mostly concern with three decisions:

_______decisions, _________ decisions and_________decisions.

With one goal

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The Role of the Financial

Manager3

Capital budgeting: decide which L-T assets to

acquire;

Financing: decide how to pay for S-T and L-T

assets,

Working Capital: decide how to manage S-T

resources and obligations or

Dividend decision: decide on the payout ofdividend.

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Cash Flows Between the Firm and

Its Stakeholders and Owners

(Parrino et al., 2012)

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How the Financial Managers

Decisions Affect the Balance Sheet

(Parrino et al., 2012)

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Learning Objectives

1. Identify the key financial decisions faced

by the financial managers;

2. Identify the basic forms of business

organisation;3. Understand the rationale of firms goal of

maximisation of shareholders wealth;

4. Understand the nature of the StockMarket.

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The Four Types of Firms

Sole Proprietorship

Partnership

Limited Liability Company

Corporation

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Sole proprietorshipA business owned by a single individual, unlimited

liability, limited access to capital, lack of continuity,constraints of various skills.

Advantages

Easy to create

Disadvantages

Unlimited personal liability

Limited life

Difficult to transfer ownership

Legal forms of business organisation

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PartnershipAn association of two or more individuals joining

together as co-owners to operate a business forprofit, joint responsibility, involves partnership

agreement, better access of capital/skills, continuityof business?

All partners are personally liable for all of the firms

debts. A lender can require any partner to repay all

of the firms outstanding debts.

The partnership ends with the death or withdrawal

of any single partner.

Legal forms of business organisation

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(cont'd)

PartnershipAdvantages: limited protection of owners personal

assets; more sources of equity & expertise.

Disadvantages: hard to dissolve, shared control &profit.

Limited Partnership has two types of owners.

General Partners Have the same rights and liability as partners in a

regular partnership (personally liable for firms debt

obligations.) Typically run the firm on a day-to-day basis

Limited Partners Have liability limited to their investment Have no management authority and cannot legally be involved

in the managerial decision making for the business The limited partners interest is transferable

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(cont'd) Limited Liability Company (LLC)

All owners have limited liability (not personally

liable) but they can also run the business.

Can be private orpublic companies.

Known as PLC in UK.

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(cont'd) Corporation

A legal entity separate from its owners

Has many of the legal powers as individuals have, such as

the ability to enter into contracts, own assets, and borrowmoney

The corporation is solely responsible for its ownobligations. Its owners are not liable for any obligation the

corporation enters into.An entity that legally functions separately and apart from

its owners, limited liability, good access of capital/skills,separation of management and ownership, ownership isdictated by the shareholdings and is transferable.

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Advantages: protects personal assets, no

shareholder liability for business, greater access

to sources of funds.

Disadvantages?

Formation

Corporations must be legally formed.A legaldocument is created on formation of the corporation.

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Ownership

Represented by shares of stock

Owner of stock is called Shareholder Stockhoder Equity Holder

Sum of all ownership value is called equity.

There is no limit to the number ofshareholders, andthus the amount of funds a company can raise byselling stock.

Owner is entitled to dividend payments.

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Legal forms of business

organisation

Comparison of organisational forms

Consider:

Organisation requirements and costs

Liability of owners Continuity of business

Transferability of ownership

Management control

Ease of capital raising Income taxes

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Ownership versus Control

of Corporations

Corporate Management Team

In a corporation, ownership and direct control are

typically separate.

Board of Directors

Elected by shareholders

Have ultimate decision-making authority

Chief Executive Officer (CEO) Board typically delegates day-to-day decision making

to CEO.

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Figure 1.2 Organizational Chart of

a Typical Corporation

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Ownership versus Control of

Corporations (cont'd)

Financial Manager

Responsible for:

Investment Decisions Financing Decisions

Cash (Treasury) Management or Dividend Decisions

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Goal of the Firm

Shareholders will agree that they are better off if

management makes decisions that maximizes the

value of their shares.

Maximisation ofshareholders wealth; orfirms

value.

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Goal of the firm

Problems:

Timing of returns, eg.

Uncertainty of returns, (risk vs return,

opportunity cost of capital) eg.

Profit maximisation?

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The Goal of the Firm

Do not Maximize Profit

Accounting profit differs from cash flows

Profit earned may not equal cash received

Cash not received cant be used to pay bills

The strategy ignores the timing of future cash

flows

The strategy ignores the risks associated with

having to wait for cash flows

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Maximize Shareholders Wealth!

Future cash flows are considered

The timing of future cash flows is considered

The risks associated with having to wait to forcash flows are considered

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Its All About Cash flow!

Positive residual cash flow may be paid to firm

owners as dividends or invested in the firm

The larger the positive residual cash flow, thegreater the value of a firm

Negative residual cash flow over the long run -

leads to bankruptcy or closing a business

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Goal of the firm

How do we measure it?

Maximisation of shareholder

wealth?

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Goal of the firm

refers to The maximisation of theprice/market value of the existingordinary shares which owned by

the ultimate owners - who affectsthe movement of share prices.

Maximisation of shareholderwealth?

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Goal of the firm

This goal is consistent with: Maximising firm value

Maximising share value

BUTits not without its difficulties!

Maximisation of shareholder

wealth?

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Ethics and Incentives within Corporations

Agency Problems

Managers may act in their own interest rather than inthe best interest of the shareholders.

One potential solution is to tie managements

compensation to firm performance. (may encourage

risk-taking)

How should performance be measured?


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CEO PerformanceIf a CEO is performing poorly:

shareholders can express their dissatisfaction byselling their shares. This selling pressure will drive thestock price down.

or

shareholders could pressure the board to reappoint a

new CEO. Hostile Takeover

Low stock prices may entice a Corporate Raider to buyenough stock so they have enough control to replace currentmanagement. The stock price will rise after the new

management team fixes the company.

Ownership versus Control ofCorporations (cont'd)

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Corporate Bankruptcy

Debt holders vs equity holders

Reorganization

Liquidation

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The Stock Market

The stock market provides liquidity

to shareholders.

Liquidity

The ability to easily sell an asset for close to the price

you can currently buy it for

Why is it important?

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The Stock Market (cont'd)

Public Company

Stock is traded by the public on a stock exchange.

Private Company

Stock may be traded privately.

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The Stock Market (cont'd)

Primary Markets

When a corporation itself issues new shares of

stock and sells them to investors, they do so on

the primary market.

Secondary Markets

After the initial transaction in the primary market,the shares continue to trade in a secondary

market between investors.

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The Stock Market (cont'd) Largest Stock Markets

New York Stock Exchange (NYSE)

Market Makers/Specialists Each stock has only one market maker

NASDAQ Does not meet in a physical location

May have many market makers for a single stock

Bid Price versus Ask Price Bid-Ask Spread

Transaction cost

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Getting A Stock Price

The stock price is the market price of a stock. Using the

Bursa Malaysia website you can view the price for any

listed stock.

Getting a Price:

There are many places you can find market news, eg:

The financial section of the daily newspapers

Bursa Malaysia Website. (www.bursamalaysia.com) Your broker website may have an up-to-date list of stock

prices

Your telephone company may be able to send you

market updates via your mobile phone

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The Essence of Share Prices35

What is the importance of share prices?

Why are the news focused heavily on the

movement of the share prices?

What are the factors that driving the changesin the share prices?

Chap 1BB(Aug 13)

Documents

Transcript of Chap 1BB(Aug 13)