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Chap ter 1
The Role of FinancialManagement
Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Created by: Gregory A. Kuhlemeyer, Ph.D.
Carroll College, Waukesha, WI
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After s tudying Chapter 1,
you shou ld be able to:
1. Explain why the role of the financial manager today is soimportant.
2. Describe "financial management" in terms of the three majordecision areas that confront the financial manager.
3. Identify the goal of the firm and understand whyshareholders' wealth maximization is preferred over othergoals.
4. Understand the potential problems arising whenmanagement of the corporation and ownership are
separated (i.e., agency problems).5. Demonstrate an understanding of corporate governance.
6. Discuss the issues underlying social responsibility of thefirm.
7. Understand the basic responsibilities of financial managersand the differences between a "treasurer" and a "controller."
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The Role o f
Financ ial Management
What is Financial Management?
The Goal of the Firm
Corporate Governance
Organization of the FinancialManagement Function
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What is Financ ial
Management?
Concerns the acquisition,
financing, andmanagementof assets
with some overall goal inmind.
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Investment Decis ions
What is the optimal firm size?
What specific assets should be
acquired?
What assets (if any) should be
reduced or eliminated?
Most
important of the three
decisions.
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Financing Decis ions
What is the best type of financing?
What is the best financing mix?
What is the best dividend policy (e.g.,dividend-payout ratio)?
How will the funds be physically
acquired?
Determine how the assets (LHS of
balance sheet) will be financed (RHS
of balance sheet).
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Asset Management
Decis ions
How do we manage existing assets
eff icient ly?
Financial Manager has varying degrees
of operating responsibility over assets.
Greater emphasis on current assetmanagementthan fixed asset
management.
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What is the Goal
o f the Firm?
Maxim izat ion o f
Shareho lder Wealth!
Value creat ion occurs whenwe maxim ize the share pr ice
for cu rrent shareho lders.
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Sho r tcom ings of
A lternat ive Perspec t ives
Could increase current profits while
harming firm (e.g., defer maintenance,issue common stock to buy T-bills, etc.).
Ignores changes in the risk level of the
firm.
Profit Maximization
Maximizing a firms earnings after taxes.
Problems
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Sho r tcom ings of
A lternat ive Perspec t ives
Does not specify timing or duration of
expected returns.
Ignores changes in the risk level of the firm.
Calls for a zero payout dividend policy.
Earnings per Share Maximization
Maximizing earnings after taxes divided
by shares outstanding.Problems
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Streng ths o f Shareho lder
Wealth Max im izat ion
Takes account of: current and future
profits and EPS; the timing,
duration, and risk of profits and EPS;dividend policy; and all other
relevant factors.
Thus, share price serves as a
barometer for business performance.
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What companies say about
their co rporate goal*
Cadbury Schweppes: governing objective isgrowth in shareowner value
Credit Suisse Group: achieve high customersatisfaction, maximize shareholder value andbe an employer of choice
Dow Chemical Company: maximize long-term
shareholder value ExxonMobil: long-term, sustainable
shareholder value*Refer to text for add it ion al detai ls
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The Modern Corporat ion
There exists a SEPARATION
between owners and managers.
Modern Corporation
Shareholders Management
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Role o f Management
An agentis an individual
authorized by another person,called the principal, to act in
the latters behalf.
Management acts as an agent
for the owners (shareholders)
of the firm.
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Agency Theory
Agency Theory is a branch of
economics relating to thebehavior of principals and their
agents.
Jensen and Meckling developed
a theory of the firm based onagency theory.
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Agency Theory
Incentives include,stock options,perquisites,andbonuses.
Principals must provide incent ives
so that management acts in the
principals best interests and then
moni torresults.
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Social Responsib i li ty
Wealth maximization does no t
preclude the firm from being socially
responsible.
Assume we view the firm as producing
bothprivate and social goods.
Thenshareholder wealth maximization
remains the appropriate goal in
governing the firm.
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Corporate Governance
Corpo rate governance: represents the
sys tem by wh ich co rporat ions are
managed and con tro l led.
Includes shareholders, board of
directors, and senior management.
Thenshareholder wealth maximization
remains the appropriate goal in
governing the firm.
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Board o f Directo rs
Typical responsibilities:
Set company-wide policy;
Advise the CEO and other senior executives;Hire, fire, and set the compensation of the CEO;
Review and approve strategy, significant investments, and
acquisitions; and
Oversee operating plans, capital budgets, and financial
reports to common shareholders.
CEO/Chairman roles commonly same person in US,
but separate in Britain (US moving this direction).
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Sarbanes-Ox ley Act o f 2002
Sarbanes-Oxley Act of 2002(SOX): addressescorporate governance, auditing and accounting, executivecompensation, and enhanced and timely disclosure of
corporate informationImposes new penalties for violations of securities
laws
Established the Public Company Accounting
Oversight Board (PCAOB) to adopt auditing, qualitycontrol, ethics, disclosure standards for publiccompanies and their auditors, and policing authority
Generally increasing the standards for corporategovernance
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Organ izat ion o f the Financ ial
Management Funct ion
Board of Directors
President
(Chief Executive Officer)
Vice President
Operations
Vice President
Marketing
VP of
Finance
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TreasurerCapital Budgeting
Cash Management
Credit Management
Dividend DisbursementFin Analysis/Planning
Pension Management
Insurance/Risk Mngmt
Tax Analysis/Planning
Organ izat ion o f the Financ ial
Management Funct ion
VP of Finance
ControllerCost Accounting
Cost Management
Data Processing
General LedgerGovernment Reporting
Internal Control
Preparing Fin Stmts
Preparing Budgets
Preparing Forecasts
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Texas Instruments BA II+
Integratedthroughout the
ChaptersA Useful
Financial Tool
Does NOT replacefinancialunderstanding
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Change Disp lay Sett ing
Change the decimal
places displayed from
2 to FloatingPress:
2nd Format
9 ENTER2nd QUIT
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