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An Overview of Financial Management: Learning Objectives
An Overview of Financial Management: Learning Objectives
Identify some of the forces that will affect financial management in the
new millennium.
State the primary goal in a publicly traded firm, and explain how social
responsibility and business ethics fit in with that goal.
and
disadvantages
of
alternative
forms
of
Learning Objectives: 1 - 1
LECTURE SUGGESTIONS
Chapter 1 covers some important concepts, and discussing them in class can be
interesting. However, students can read the chapter on their own, so it can be
assigned but not covered in class.
We generally spend much of the first day going over the syllabus and
discussing grading and other mechanics relating to the course. To the extent
that time permits, we talk about the topics that will be covered in the course
and the structure of the book. We also discuss briefly the fact that it is
assumed that managers try to maximize stock prices, but that they may have
other goals, hence that it is useful to tie executive compensation to
stockholder-oriented performance measures.
If time permits, we think its
worthwhile to spend at least a full day on the chapter.
If not, we ask
students to read it on their own, and to keep them honest, we ask one or two
questions about the material on the first mid-term exam.
One point we emphasize in the first class is that students should get a
copy of Blueprints and a financial calculator immediately, and bring both to
class regularly.
We also put copies of the various versions of our Brief
Calculator Manual, which in about 12 pages explains how to use the most
popular calculators, in the copy center. We want students to start learning to
use their calculators early, because in the past we have found that many
students wait to learn to use their calculators at the same time they are
trying to understand time value of money concepts. If students learn how to
use the calculator early, they are less likely to get confused by time value
concepts.
We are often asked what calculator students should buy. If they already
have a financial calculator that can find IRRs, we tell them that it will do,
but if they do not have one, we recommend either the HP-10B or 17B. Please see
the Lecture Suggestions for Chapter 7 for more on calculators.
DAYS ON CHAPTER:
Lecture Suggestions: 1 - 2
1-1
The
three
principal
forms
of
business
organization
are
sole
proprietorship, partnership, and corporation.
The advantages of the
first two include the ease and low cost of formation. The advantages of
the corporation include limited liability, indefinite life, ease of
ownership transfer, and access to capital markets.
The disadvantages of a sole proprietorship are (1) difficulty in
obtaining large sums of capital; (2) unlimited personal liability for
business debts; and (3) limited life. The disadvantages of a partnership
are (1) unlimited liability, (2) limited life, (3) difficulty of
transferring ownership, and (4) difficulty of raising large amounts of
capital. The disadvantages of a corporation are (1) double taxation of
earnings and (2) setting up a corporation and filing required state and
federal reports, which are complex and time-consuming.
1-2
No. The normal rate of return on investment would vary among industries,
principally due to varying risk.
The normal rate of return would be
expected to change over time due to (1) underlying changes in the
industry and (2) business cycles.
1-3
An increase in the inflation rate would most likely increase the relative
importance of the financial manager.
Virtually all of the managers
functions, from obtaining funds for the firm to internal cost accounting,
become more demanding in periods of high inflation. Usually, uncertainty
is also increased by inflation, and hence, the effects of a poor decision
are magnified.
1-4
1-5
1-6
1-7
Profit maximization abstracts from (1) the timing of profits and (2) the
riskiness of different operating plans. However, both of these factors
are reflected in stock price maximization.
Thus, profit maximization
would not necessarily lead to stock price maximization.
1-8
1-9
adversely affected unless its costs are much lower, hence its profits
are much higher.
e. The company will be retaining more earnings, so its growth rate should
rise, which should increase its stock price. The decline in dividends,
however, will pull the stock price down. It is unclear whether the net
effect on its stock will be an increase or a decrease in its price,
but the change will depend on whether stockholders prefer dividends or
increased growth. This topic will be discussed in greater detail in
the chapter titled, Distributions to Shareholders:
Dividends and
Share Repurchases.
1-10
1-11
As the stock market becomes more volatile, the link between the stock
price and the management ability of senior executives is weakened.
Therefore, in this environment companies may choose to de-emphasize the
awarding of stock and stock options and rely more on bonuses and
performance shares that are tied to other performance measures besides
the companys stock price.
Moreover, in this environment it may be
harder to attract or retain top talent if the compensation is tied too
much to the companys stock price.
1-12
1-13
CINTEGRATED CASE
themselves
a. Increasing corporate tax rates and reducing individual tax rates will
cause the firm to remain as an unincorporated partnership.
In
addition to higher corporate tax rates, corporations are exposed to
double taxation.
b. By increasing environmental and labor regulations to include firms
with 50+ employees, this firm will choose to remain an unincorporated
partnership due to the additional costs it would have to bear if it
operated as a corporation.
1-15
Earnings per share in the current year will decline due to the cost of
the investment made in the current year and no significant performance
impact in the short run.
However, the companys stock price should
increase due to the significant cost savings expected in the future.
Take a Dive
Financial Management Overview
1-1
KATO SUMMERS OPENED TAKE A DIVE 17 YEARS AGO; THE STORE IS LOCATED IN
MALIBU, CALIFORNIA, AND SELLS SURFING-RELATED EQUIPMENT.
TODAY, TAKE
A DIVE HAS 50 EMPLOYEES INCLUDING KATO AND HIS DAUGHTER AMBER, WHO
WORKS PART TIME IN THE STORE TO HELP PAY FOR HER COLLEGE EDUCATION.
KATOS BUSINESS HAS BOOMED IN RECENT YEARS, AND HE IS LOOKING FOR
NEW WAYS TO TAKE ADVANTAGE OF HIS INCREASING BUSINESS OPPORTUNITIES.
ALTHOUGH KATOS FORMAL BUSINESS TRAINING IS LIMITED, AMBER WILL SOON
GRADUATE
WITH
DEGREE
IN
FINANCE.
KATO
HAS
OFFERED
HER
THE
AMBER IS
NOW,
AMBER
IS
LEANING
TOWARD
STAYING
WITH
THE
FAMILY
KATO IS
INTRIGUED BY HER IDEAS, BUT HE IS ALSO CONCERNED THAT HER PLANS MIGHT
CHANGE THE WAY IN WHICH HE DOES BUSINESS.
ANSWER:
DEALS
WITH
SECURITIES
MARKETS
AND
FINANCIAL
INSTITUTIONS;
AS A SECURITY ANALYST.
MANAGERS
ALSO
HAVE
THE
RESPONSIBILITY
FOR
DECIDING
THE
CREDIT TERMS UNDER WHICH CUSTOMERS MAY BUY, HOW MUCH INVENTORY THE
FIRM SHOULD CARRY, HOW MUCH CASH TO KEEP ON HAND, WHETHER TO ACQUIRE
OTHER FIRMS, AND HOW MUCH OF THE FIRMS EARNINGS TO PLOW BACK INTO THE
BUSINESS VERSUS TO PAY OUT AS DIVIDENDS.
B.
ANSWER:
SPECIFIC ACTIVITIES
INCLUDE: (1) FORECASTING AND PLANNING, (2) MAKING MAJOR INVESTMENT AND
FINANCING DECISIONS, (3) COORDINATING AND CONTROLLING, (4) DEALING
WITH THE FINANCIAL MARKETS, AND (5) MANAGING RISK.
C.
ANSWER:
D.
ANSWER:
D.
ANSWER:
PROPRIETORSHIPS:
ORGANIZATION,
(3)
DIFFICULTY
OF
TRANSFERRING
OWNERSHIP,
AND
(4)
CORPORATE
FORM
OF
BUSINESS
HAS
THREE
MAJOR
ADVANTAGES:
(3)
LIMITED
LIABILITY.
WHILE
THE
CORPORATE
FORM
OFFERS
E.
ANSWER:
E.
ANSWER:
FIRMS
HAVE
AN
ETHICAL
RESPONSIBILITY
TO
PROVIDE
SAFE
WORKING
E.
ANSWER:
THE SAME ACTIONS THAT MAXIMIZE STOCK PRICES ALSO BENEFIT SOCIETY.
STOCK PRICE MAXIMIZATION REQUIRES EFFICIENT, LOW-COST OPERATIONS THAT
PRODUCE HIGH-QUALITY GOODS AND SERVICES AT THE LOWEST POSSIBLE COST.
STOCK PRICE MAXIMIZATION REQUIRES THE DEVELOPMENT OF PRODUCTS AND
SERVICES THAT CONSUMERS WANT AND NEED, SO THE PROFIT MOTIVE LEADS TO
NEW TECHNOLOGY, TO NEW PRODUCTS, AND TO NEW JOBS.
OF
MERCHANDISE,
AND
WELL-LOCATED
BUSINESS
ESTABLISHMENTS--
FACTORS THAT ARE ALL NECESSARY TO MAKE SALES, WHICH ARE NECESSARY FOR
PROFITS.
E.
ANSWER:
YES.
POSITIVE
CORRELATION
BETWEEN
ETHICS
AND
LONG-RUN
PROFITABILITY.
F.
ANSWER:
[SHOW
S1-12
HERE.]
AN
AGENCY
RELATIONSHIP
EXISTS
WHENEVER
PRINCIPAL ENGAGES AN AGENT AND GRANTS THE AGENT SOME DECISIONMAKING POWER.
F.
ANSWER:
WITHIN
THE
FINANCIAL
MANAGEMENT
CONTEXT,
THE
PRIMARY
AGENCY
RELATIONSHIPS ARE THOSE (1) BETWEEN STOCKHOLDERS AND MANAGERS AND (2)
BETWEEN DEBTHOLDERS AND STOCKHOLDERS (THROUGH MANAGERS).
F.
ANSWER:
SPECIFIC
MECHANISMS
THAT
ENCOURAGE
MANAGERS
TO
ACT
IN
F.
3. SHOULD
SHAREHOLDERS
(THROUGH
MANAGERS)
TAKE
ACTIONS
THAT
ARE
DETRIMENTAL TO BONDHOLDERS?
ANSWER:
ARE
STOCKHOLDERS
AGREEMENTS.
MADE,
BY
CREDITORS
PLACING
WILL
RESTRICTIVE
PROTECT
SECOND, IF SUCH
THEMSELVES
COVENANTS
IN
AGAINST
FUTURE
DEBT
WITH
THE
FIRM
OR
ELSE
WILL
CHARGE
HIGHER
THAN
NORMAL
DEBT
MARKETS
OR
ARE
SADDLED
WITH
HIGH
INTEREST
RATES
AND
G.
ANSWER:
NO.
AND STOCK PRICE, AND ALL OF THEM GENERALLY RISE IF A FIRMS SALES
RISE.
AND CASH FLOWS--FUTURE CASH FLOWS AND THE RISKINESS OF THE FUTURE
EARNINGS AND YET REDUCE STOCK PRICES WHILE OTHER ACTIONS MAY BOOST
STOCK PRICE BUT REDUCE EARNINGS.
LARGE
ARE
EXPENDITURES
PERFORMANCE.
TODAY
THESE
THAT
EXPENDITURES
WILL
DESIGNED
LIKELY
TO
IMPROVE
REDUCE
FUTURE
EARNINGS
PER
SHARE, YET THE STOCK MARKET MAY RESPOND POSITIVELY IF IT BELIEVES THAT
THESE EXPENDITURES WILL SIGNIFICANTLY ENHANCE FUTURE EARNINGS.
BY
THESE
ACTIONS
COMPROMISE
FUTURE
EARNINGS
AND/OR
DRAMATICALLY
H.
ANSWER:
POLICY
DECISIONS,
AND
EXTERNAL
FACTORS,
INCLUDING
LEGAL
VALUE (AND ITS STOCK PRICE) BY INCREASING THEIR FIRMS EXPECTED CASH
FLOWS, SPEEDING UP CASH FLOWS, AND REDUCING THEIR RISKINESS.
I.
ANSWER: