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FM-Lecture 1

1) Financial management concerns acquiring, financing, and managing assets to achieve overall goals. It involves investment, financing, and asset management decisions. 2) The goal of the firm is to maximize shareholder wealth by increasing the share price for current shareholders. 3) There are three main forms of business organization: sole proprietorships, partnerships, and corporations. Corporations provide advantages like limited liability but also double taxation.

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46 views

FM-Lecture 1

1) Financial management concerns acquiring, financing, and managing assets to achieve overall goals. It involves investment, financing, and asset management decisions. 2) The goal of the firm is to maximize shareholder wealth by increasing the share price for current shareholders. 3) There are three main forms of business organization: sole proprietorships, partnerships, and corporations. Corporations provide advantages like limited liability but also double taxation.

Uploaded by

Awan Nadia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Lecture 1

Goals and Functions


of Finance
From the desk of Adeel Durvesh
What is Financial
Management?

Concerns the acquisition,


financing, and
management of assets
with some overall goal in
mind.
TYPES OF DECISIONS

Investment Decisions
Financing Decisions
Asset Management Decisions
Investment Decisions
Most important of the three
decisions.
 What is the optimal firm size?
 What specific assets should be
acquired?
 What assets (if any) should be
reduced or eliminated?
Financing Decisions
Determine how the assets (LHS of
balance sheet) will be financed (RHS
of balance sheet).

What is the best type of financing?


What is the best financing mix?
What is the best dividend policy?
Asset Management
Decisions
 How do we manage existing assets
efficiently?
 FinancialManager has varying degrees
of operating responsibility over assets.
 Greater
emphasis on current asset
management than fixed asset
management.
What is the Goal
of the Firm?

Maximization of
Shareholder Wealth!

Value creation occurs when


we maximize the share price
for current shareholders.
Shortcomings of
Alternative Perspectives
Profit Maximization
Maximizing a firm’s earnings after taxes.
Problems
 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.
Shortcomings of
Alternative Perspectives
Earnings per Share Maximization
Maximizing earnings after taxes divided
by shares outstanding.
Problems
 Doesnot specify timing or duration of
expected returns.
 Ignores changes in the risk level of the firm.
Strengths of Shareholder
Wealth Maximization
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.
FORMS OF
ORGANIZATIONS
Three basic forms of business
organizations:

 Sole Proprietorships
 Partnerships (general and limited)
 Corporations
SOLE PROPRIETORSHIP

A business form for which there is


one owner. This single owner has
unlimited liability for all debts of
the firm.
 Oldest form of business organization.
 Business income is accounted for on
the owner’s personal income tax form.
Summary for
Sole Proprietorship
Advantages Disadvantages
 Simplicity  Unlimited liability
 Low setup cost  Hard to raise
 Quick setup additional capital

 Singletax filing  Transfer of


on individual form ownership
difficulties
PARTNERSHIP

A business form in which two or


more individuals act as owners.

Business income is accounted


for on each partner’s personal
income tax form.
Types of Partnerships
General Partnership -- All partners have
unlimited liability and are liable for all
obligations of the partnership.
Limited Partnership -- Limited partners
have liability limited to their capital
contribution (investors only). At least
one general partner is required and all
general partners have unlimited liability.
Summary for Partnership
Advantages Disadvantages
 Can be simple  Unlimited liability for
 Low setup cost, higher the general partner
than sole  Difficultto raise
proprietorship additional capital, but
 Relatively quick setup easier than sole
proprietorship
 Limited liability for
 Transfer of ownership
limited partners
difficulties
CORPORATIONS

A business form legally separate


from its owners.
An artificial entity that can own
assets and incur liabilities.
Business income is accounted
for on the income tax form of the
corporation.
Summary for Corporation
Advantages Disadvantages
 Limited liability  Double taxation
 Easy
transfer of  Moredifficult to
ownership establish
 Unlimited life  More expensive
 Easierto raise large to set up and
quantities of capital maintain
The Modern Corporation

Modern Corporation

Shareholders Management

There exists a SEPARATION


between owners and managers.
Role of Management
Management acts as an agent
for the owners (shareholders)
of the firm.
 An agent is an individual
authorized by another person,
called the principal, to act in
the latter’s behalf.
Agency Theory

Jensen and Meckling developed


a theory of the firm based on
agency theory.
Agency Theory is a branch of
economics relating to the
behavior of principals and their
agents.
Agency Theory

Principals must provide incentives


so that management acts in the
principals’ best interests and then
monitor results.
Incentives include stock options,
perquisites, and bonuses.
Social Responsibility
 Wealthmaximization does not
preclude the firm from being socially
responsible.
 Assume we view the firm as producing
both private and social goods.
 Thenshareholder wealth maximization
remains the appropriate goal in
governing the firm.

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