Unit 1

Goals of the Corporation Introduction

People venture into business with the hope of gaining profits and the fear of incurring losses. It is a fact that all forms of
business organizations whether sole proprietorship, partnership or corporation has the goal of maximizing earnings or
profit. More so, having big profit signals good financial and operating performance of the business. Thus, profit
maximization, as a measure of success of the business, may be the end goal of the sole proprietor and partners who
personally manage the business. However, for corporation form of business, this profit maximization is just a means to an
ultimate end goal of the corporation. Learning Objectives: 1. Explain the ultimate goal of a corporation 2. Differentiate
maximization of market value from maximization of Profit

Presentation of Contents

The shareholders of the corporation will earn income from their capital investments through dividends yield and capital
gains yield. The former is earned through dividend declaration approved by the Board of Directors (BOD) and the latter,
through selling of stocks or ownership to either prospective investors existing stockholders at a gain. This is when the
stock price is higher than the cost of investment.The ultimate goal of the corporation is shareholder’s wealth
maximization. This is sometimes referred to as stock price maximization- the increase in the value of stock price resulting
to capital gains that shareholders will yield on their investment. This is one of the reasons why shareholders want the
financial managers to maximize the market value of the firm and not just to maximize its profits.

Reasons of maximizing the market value: 1.) In maximizing the market value of the corporation, discount rate which
reflects the risks of capitalization and the time value of money is taken into consideration while profit maximization does
not considersuch.2.) In maximizing future profits, the company may opt to decrease and postpone its dividends
declaration and instead, it will reinvest and will not the freed up cash. If the reinvestment is too risky and will not be
successful, this will be detrimental to the shareholders. Thus, shareholder’s wealth is not maximize. 3.) The following are
the appropriate ways on how management maximizes the profits of the corporation. a. Management wants to accelerate
sales by materially increasing the selling prices of the goods offered to the consumer, or b. Management wants to reduce
expenses by cutting the wage rates of the laborers or buying cheaper materials forproduction.4.) Stock price or market
value per share considers both cash flow for the current and future years. Profits on the hand, may refer to either current
year’s profit or future year’s profit. 5.) The profit computation varies depending on the purpose. Thus, there are
differences in the computation of profit for tax purposes and profit for accounting purposes.

Summary : It is a fact that all forms of business organizations whether sole proprietorship, partnership or corporation has
the goal of maximizing earnings or profit. More so, having big profit signals good financial and operating performance of
the business. For corporation, the ultimate goal is shareholder’s wealth maximization. This is sometimes referred to as
stock price maximization- the increase in the value of stock price resulting to capital gains that shareholders will yield on
their investment. This is one of the reasons why shareholders want the financial managers to maximize the market value
of the firm and not just to maximize its profits.

Financial Managers of the Corporation Introduction

Financial managers ensures the financial health of an organization through investment activities andlong term financing
strategies. They are employees who are responsible for managing the monetary resources of the corporation in order to
maximize firm’s value. Financial managers can be a Board of Directors (BOD), Chief Financial Officer (CFO) , Treasurer
and Controller. Learning Objectives 1. Outline the various roles played by the financial managers

Presentation of Contents

Financial managers are employees who also responsible for dealing with the different financial markets such as stock
market or bonds market; and with financial institutions like banks. These managers, who are the agents of the
shareholders (owners), are given the authority to perform investment, financing and operating decisions that will benefit
the corporation. Generally the Financial managers are : 1.)Board of Directors (BOD)- They are direct owners and are
elected by the shareholders to manage the corporation. They are charge with ultimate governance of the corporation.
Thus, they have the ultimate responsibility for deciding on highly important financial matters of the corporation.
Moreover, the BOD decides on when to declare and how much dividends per share to distribute. 2.) Chief Financial
Officer(CFO)- also known as the Vice President for Finance(VP Finance) , who has responsibility overfinancial planning
and formulation of financial corporate strategies. Under his supervision are the Treasure and Controller. 3.) Treasurer –
one who focuses on the financial aspect of the corporation; wherein he has the responsibility on raising and managing
the capital of funds of the company. Moreover, he is responsible for transacting and maintaining good relationships with
various banks; and the formulation of the company’s credit policies and collection. 4.)Controller – one who focuses on the
accounting and budgeting aspect of the corporation; he is responsible for the custody of financial records, preparation of
the financial statements, and interpretation of financial data. Moreover, he is responsible for the management of the
budget for the efficient usage of the funds.

Fig. 1-2 To present the line of authority of these financial managers, the organizational structure of the
firm is shown below.

General Role of the Financial Manager:

It is noted previously that financial managers are responsible for managing the monetary resources of the corporation.
These means how much funds should be invested in the acquisition of real assets, how much fund shall be retained and
plowed back to the corporation or how much shall be paid out as dividends to the shareholders. Moreover, it is the
responsibility of these financial managers to raise additional capital or funds to support the investments and operations of
the corporation. Therefore, the financial managers shall perform these roles which are geared towards the attainment of
the ultimate goal of the corporation. 1. Investing decision –The investments made by these financial managers should
provide benefit to the corporation. This should be the main consideration of the managers when investing in tangible
assets such as machineries, land or building; investments in financial assets or investing in the intangible assets such
patent, trademarks or copyright. Investing decision is also known as Capital Budgeting , answering the question : “what
assets should the corporation acquire in order to provide better returns in the future”.2. Financing decision – One of the
main constraints of the financial managers is the scarcity of available capital. This normally results to forgone investment
opportunities. Hence, in order to finance these investments the financial managers should raise capital or money through
its financing activities through the following means:1.) performing long term financing through bank loans if the prevailing
interest in not high; or 2.) Issuance of financial assets such as share of stocks ( equity security) or bonds(debt
security).Hence, financing decision answers the question: “ how to raise funds in order to finance the investments and
operating activities of the firm. 3.) Operating Decision – Financial managers should decide on how much funds should be
allocated to each of its operating units. Funds raised through the financing decision are not only used for the acquisition
of real assets or long term investments but also for operating expenses of the corporation. Hence, operating decision
answer the question: “ how much funds will be allocated to support the day to day transactions of the firm.

Summary Financial managers perform data analysis and advise senior management on profit maximizing ideas. Financial
managers are responsible for the financial health of an organization. They produce financial reports, direct investment
activities and develop strategies and plans for the long term financial goals of their organization. Financial managers can
be a Board of Directors (BOD), Chief Financial Officer (CFO) , Treasurer and Controller.

Resolution of Agency Problem Introduction

Imagine receiving a windfall of money and hiring a financial advisor to invest it for you. In this relationship, you are the principal , and
the advisor is the agent. The advisor have fiduciary responsibility to act in your best interest. Unfortunately, incentives may exist for
the advisor to undermine your interest and put his needs first. Then, conflict of interest arise and agency problem occurs. Also, conflict
between stockholders and bondholders may arise, so with the ethics and profit goals of the corporation.Learning Objectives 1. Define
an agency (problem )conflict and how such conflicts be resolved 2. Describe the conflict of interest between the company’s
stockholders and its bondholders. 3. Distinguish between ethics and profit goals.

Presentation of Contents

Agency conflicts are problems between the principal and agent of the company. The conflicts arise when the financial managers
(agents) prioritize their own personal interest rather the best interest of the shareholders of the company.Thus, the following solutions
to mitigate if not to eliminate conflicts between the managers and stockholders: 1.)Compensation Plans – The compensation plan may
differ among the companies depending on its capacity in terms of finances. As part of its compensation plan , the companies would
offer incentives to their managers such as additional bonuses, percentage interest in net income of the company or stock options.
These are on top of the annual basic salary of the manager.Example : Say for instance, in comparing the compensation plan of the
Chief Executive officer (CEO) of the two companies: X and Y. If the CEO of Company X is given an additional incentive of 5% of the net
income above the normal profitability of the corporation aside from his basic salary while the CEO of company Y is only provided with
annual salary of similar amount, we can assume that the former is more driven to improve his performance than that of the
latter.However, these compensation plans sometimes provide pressure to the managers wherein it results to the commission of fraud.
2.)Threats as to change in Board of Directors – These Board of Directors (BOD) who are responsible for the ultimate governance of the
corporation are elected by the shareholders. Having a position in the board is not permanent . The shareholders have the
power to elect new set of BOD if they are not satisfied with the performance of the board particularly on how they
manage the business. Threatening the members of the BOD may motivate them to become active in governing the
corporation.3.)Threats as to Management Takeover- The top level of managers who are responsible for the daily
governance of the corporation are merely appointees of the BOD These managers are employees of the corporation
wherein they can be terminated or replaced if they fail to deliver what is due to the corporation.. management takeover
indicates that the old management team is replaced by the new mmanagement.4.) Legal and Regulatory requirement –
These requirement imposed upon the corporation, especially those publicly listed companies, aim to provide security on
the part of the shareholders or investors. Example. The Security and Exchange Commission (SEC) requires upon the
publicly listed corporations to file an annual audited Financial Statements. The external auditors gathers substantial and
appropriate data to support the claims of the management as regards the presentation of the Financial Statement. This
will prevent the management from committing acts that are against the interest of the owners such as fraud. 5.)Specialist
Monitoring – It is assumed that employees will perform their function well if they are monitored by their superior.
However, monitoring of performance is not solely within the corporation because the external parties such as investors or
creditors may also examine the performance of the company.

Conflicts between Stockholders and Bondholders

Conflicts between the two(2) sources of funds, the stockholders and the bondholders are investors of the firm’s equity
and debt securities respectively. As regards their conflicts, the stockholders, as owners of the firm, want the financial
managers to invest in risky investment while he bondholders, as lenders of the firm, oppose to risky investments. Bond
holders have fixed income from interest payments of the firm while stockholder’s income depends on the dividend yield
and capital gain yield. For example :If the financial managers of the firm have the option to invest its P100 million in the
following Unit Investment Trust Funds (UITF) :a. 100% equity fund (High Risk) b. 50% equity or 50% debt (Balanced
Fund) c. 100% debt fund (Low Risk) Normally, the stockholders, as risk takers, would want the P100 Million to be
invested in 100% equity fund because the said fund has the highest risk which will provide the highest return. Hence if
the result of the investment is Positive, the firm will gain high returns which shows that the expected dividends to be
distributed is also high.

On the other hand, the bondholders want managers to invest the P100 million in a lower risk investment such as 100%
debt fund or the balanced fund which provide lower return. For bond holders, they are already assured of the fixed
interest income as long as the firm is solvent.In determining the optimal capital structure, we will learn that the firm may
be classified as unlevered (without debt) and levered (with debt).

Ethical Considerations:

It is true that the ultimate goal of the corporation is maximizing the firm’s market value or maximization of the shareholder’s wealth.
This goal should be achieve not through fraudulent acts but in an ethical manner of doing business. Moreover, the company should
maintain its Corporate Social responsibility (CSR) at all times such as avoiding things that has adverse effects in the society and to the
people. Ethics and the goal of maximizing shareholder’s wealth generally lean towards similar ends because ethical behavior builds
good reputation that will benefit the organization in the long run.

Summary The agency problems arises in business when one party , known as the agent, faces the expectation of acting in the best
interest of another party, known as the principal. Conflict of interest can arise if the agent personally gains by not acting in the
principal’s best interest. You can overcome the agency problem by requiring full transparency placing restrictions on the agent’s
capabilities, and tying your compensation structure to the well being of the principal. Conflict may also arises between shareholders
and bondholders. The shareholders are individuals or institutions that legally own shares of stock in the corporation, while the
bondholders are the firm’s creditors. The two parties have different relationships to the company, accompanied by different rights and
financial returns. Conflict between ethics and profits goals should be considered too.

NOTE : After reading this material proceed answering the topic-related questions.

UNIT 2 FINANCIAL ENVIRONMENT

Introduction

In unit 1, we have learned that the ultimate goal of the corporation is maximization of its market value or shareholder’s
wealth maximization. One of the means to achieve this primary goal is to maximize profits through proper allocation of
funds to its operating and investing activities. However, thereare times when firm’s capital is not sufficient to support its
investment and operational activities wherein there is a need to raise additional funds through the utilization of financial
markets, financial institutions or stockholders infusing additional capital. Learning Objectives 1. Identify the different
kinds of markets 2 Compare the different financial intermediaries

Presentation of Contents

Financial Environment are factors and situations that primarily affect the financial aspects of the corporation. The principal
factors are the sources of financing through a) Financial Markets and b) Financial Intermediaries.The main source of
funds used for investments and operations comes from the savings of the investor. The financial managers acquire these
funds through equity financing and debt financing. These financing transactions take place in the so called financial
markets and with the intervening of the different financial intermediaries and institutions. On the other hand, there are
other markets not classified as financial markets but can affect the operating and investing activities of the firm. I.
Different Types of Markets

A. Financial Markets are the place where financial assets such as Equity Securities (Shares of Stocks ) and Debt Securities
(Bond Certificates) are issued and traded. 1. Stock Market – This is a market where equity securities are being issued
and traded. In market, the stockholders may sell their stock investments or the firm may issue additional stocks if the
stock price is overvalued or may purchase stocks if undervalued.For example: If the firm has to raise funds but want to
avoid high interest rate, the firm may issue equity securities in his market. 2. Bond Market- This is a market where debt
securities are being issued and traded. This is also referred as the fixed income market because the investors or so
called bondholders received fixed interest payment from their investments assuming they will hold the bond until
maturity or on a longer period of time. For example: If the firm has to raised funds but the stock is undervalued, the firm
may issue debt securities rather equity securities in this market.3. Money Market – This is a market where short-term
debts with maturities of one year or less are used as a source of financing.An example of this short-term debt is a
Treasury bill which is issued by the government with maturity of one year or less.4. Capital Market – This is a market
where long-term debt and equity securities are involved for financing.The examples of the long-term debt security are
Treasury note and Treasury bond wherein the former is a debt security issued by the government usually with maturity
of more than one year but not more than 10 years while the latter is a debt security issued by the government with
maturity of more than 10 years.

B. Other markets:1. Physical Market is also known as real asset or tangible markets because the products involved are
real estate, property plant and equipment, inventories, etc. Hence, those assets not qualified as financial assets are sold
in this market. For example, the acquisition of raw materials to be used for the manufacture of products takes place in
this market. In addition, if the firm has to expand its operations and increase its production, the firm has to purchase
machineries in this market.2. Spot Market – This a market where assets or goods are sold for and delivered on the spot
or today. Thus, the determination of price and delivery of goods is on the same date.

For example, when a rice dealer went to the farm during harvest to purchase all the harvest at an agreed price and to
be delivered on the same day; this takes place in spot market.3. Future Market- This a market where future contracts are
sold. A future contract is a contract that gives the purchaser an obligation to buy an asset ( and the seller an obligation
to trade an asset) at a predetermined price at a future date. Thus, the price is agreed today but delivery of good is in
the future. For example, when a rice dealer went to the farm a month before harvest to purchase all the future harvest
at an agreed price today and to be delivered o the day of harvest; this takes place in future market.4. Private Market –
This is a market where negotiation and agreement takes place personally between two parties. Hence, making the
contract unique or tailor made.For example, investing in a life insurance is personal between the insured and insurer. The
policy holder being the insured while the insurance company being the insurer.5. Public Market – This is a market where a
security or contracts with standardized features are being traded and held by individuals. For example, in stock markets
and bonds market , the securities ( stock certificates and bond certificates ) issued by the corporation have standard
features. Hence, making them available for trading and exchange unlike the life insurance policy discussed above.

FINANCIAL INTERMEDIARIES

Financial Intermediaries are the organization that provide financing to the individuals, corporation or other organizations
by raising funds or money from investors.

Types of Financial Intermediaries1. Mutual Funds (MF)- The investment company pools money from the investors then
invest these accumulated amount in a portfolio securities whether equity (shares of stock), debt (bond or money market
(short term securities). In an Mutual Fund, the investors purchased shares of the investment company thereby giving the
former the right to receive dividends. The body that regulates this fund is the Security and Exchange Commission. Ex.
Sun Life Balanced fund, Philequity Peso Bond Fund or ALFM Growth Fund.2. Unit Investment Trust Fund (UITF) – The
investment company sells units of investment to the investors to accumulate a trust fund. The trust fund may be
invested also in equity, debt or balance of equity and debt. Hence, the investors own units of investments not shares of
stock. The regulatory body which supervises these unit investment trust funds is the Banko Sentral ng Pilipinas. Ex. BPI
Equity Index Fund 3. Pension Fund – These are pooled contribution from the employee or from the employers that
serves as the investment plans for the retirement benefits of the employees. The accumulated funds may be invested in
shares of stocks or in a mutual fund in order to

increase the amount of pension received by the retirees.4. Financial Institution - This is a kind of financial intermediary
that provide additional financial services other than pooling an investing of funds. Ex. Banks or Insurance Company.

Summary

Financial Environment plays a vital role in the maximization of its goals of a corporation. There are times when firm’s
capital is not sufficient to support its investment and operational activities wherein there is a need to raise additional
funds. Sources of funds can be through Financial Markets and Financial Intermediaries. And the types of markets are a)
Financial Markets such Stock, Bond, Money and Capital Market and b) Other Markets such as Physical, Spot, Future,
Private and Public Market. Financing transactions take place with the intervention of financial intermediaries and
institutions. Financial Intermediaries are the organization that provide financing to the individuals, corporation or other
organizations by raising funds or money from investors.

Transfer of Securities Introduction

Companies under financial distress may engage in the issuance of its financial assets (debts and equity securities) in the
financial markets or borrow money from financial institutions.Learning Objectives 1. Determine the process of transferring
financial assets: Direct or Indirect2. Identify stock market transactions3. Evaluate stock market efficiency

Presentation of Contents

Direct transfer of financial securities, the equity securities evidenced by stock certificates and debt securities evidenced by
bond certificates are issued directly to the investors. In turn, these investors pay directly to the issuing company. Thus,
the securities do not pass through the profession of any financial intermediaries.Indirect transfer of securities, the issuing
company seeks the aid of the financial institution to easily issue their securities to the investors. Thus, there is mediation
between the issuer and the investor.

Classification of Indirect Transfer:1. Indirect transfer through Investment Bank- The securities of the company are bought
by the investment bank or the so called underwriter with the intention of reselling them to a prospective
investor.2.Indirect transfer through Financial Intermediary- The securities of the company are bought by these financial
intermediaries without the intention of reselling the said securities; rather than they will sell their own securities to the
new investors.

Stock Market Transaction

Stock Markets are markets where shares of stocks of corporation are sold to new investors and or existing
stockholders.The Philippine had 2 stock markets namely. 1.Manila Stock Exchange (MSE) –was established on August 8,
1927 2.Makati Stock Exchange (MkSE)- was established on May 27, 1963.These 2 markets were unified forming the
Philippine Stock Exchange on December 23, 1992 with eight(8) constituent indices such as :1)PSE Composite Index (PSEi)
2) PSE All Share Index (ALL) 3) PSE Holding Firms (HDG) 4)PSE Industrial Index (IND) 5)PSE Financial Index (FIN) 6)
PSE Mining and Oil Index (M-O) 7) PSE property Index (PRO) 8) PSE Services Index (SVC)

Figure 2-1: The Stock Market Index and Stock position of Investments

The figure shows that the investor has invested in the stock s of the following company as shown in the CODE column:1
Bank of the PHILIPPINE Island 2 East West bank (EW) 3 Petron Corporation (PCOR) 4Philippine National Bank (PNB) 5
San Miguel Corporation (SMC) 6 Philippine Long distance and Telephone Company (TEL) The LAST column shows the
current stock price while the DIFF column is the peso value increase or decrease in the said price of these stocks. The
BID VOLUME column displays the number of outstanding stocks that the willing buyers want to buy while the ASK
VOLUME column is the number of outstanding stocks that willing sellers want to sell. The BID PRICE column illustrates
the stock prices that sellers are willing to accept. For example, in BPI stock, the BID price is 83.70 while the ASK PRICEis
P85.75. There will be a bargain between the willing buyer and seller until they meet at an agreed price. Now, if the BID
equals to ASK price, with an agreed price of 84.50, this will be the new current market price of the stock to be shown in
the LAST column.

The following are the stock market transaction:1. Initial Public Offering (IPO) Markets – are markets where the stocks of
a closely held corporation, going public, are offered to the public for the first time. The closely held corporations undergo
IPO in order to raise additional capital to finance their operating and investing activities. 2. Seasoned Offering – is the
issuance of additional shares of stocks of the company after its first time of offering in order to finance the capital budget
or to improve its capital structure. This kind offering may be done by the family corporations or publicly listed
corporation.3. Primary Markets are involved with this issuance or selling of new shares of stocks to the investors through
the aid of the investment bankers. The cash proceed from the primary market transaction goes to the corporation. Thus,
the transactions in this market change the size of the capital structure of the company.4. Secondary Market are involved
with the sale of the outstanding shares of stocks to the existing shareholders or to new investors. The cash proceed from
the secondary market transaction goes to the selling shareholders, not the corporation. Thus , the capital structure of the
company is not affected by the secondary market transactions.To illustrate the stock market transactions:In January 2,
2018 Double A construction, a family corporation engaged in construction business, wants to raise additional fund in
order to finance their additional capital expenditure. To address their financial needs, the board of directors decided to
have their corporation listed in the Philippine Stock Exchange (PSE) so that they can sell new stocks to the public. On
February1, 2018 Double A Construction sold its shares to the public for the first time. The outstanding and authorized
capital stocks of the corporation are 500,000 and 1,000,000 shares respectively.In June 30, 2018 the DOUBLE A
CONSTRUCTION, now a publicly listed company , sold additional 250,000 shares to fund their expansion projects. Hence,
the outstanding shares as of this date are 750,000.One of the stockholders, named Ramon, owned 200,000 shares. He
sold half of his ownership to his brother Jerry on October 30,2018. On the other hand , DOUBLE A CONSTRUCTION
repurchased the remaining 100,000 shares of Ramon on November 30, 2018.

Analysis of the transactions:1 The initial Public Offering (IPO) was performed on February 1, 2018.2 The Seasoned
Offering (SO) was after the IPO, in this illustration, it was done on June 30, 2018 when additional 250,000 shares were
sold.3 The IPO and SO are considered as sale of shares under primary market transaction.4 The sale of outstanding
shares by Ramon to Jerry on October 30,2018 is a secondary market transaction since the capital structure of the firm is
not affected.5 The stock repurchased by DOUBLE A CONSTRUCTION FROM Ramon on November 30, 2018 is considered
primary market transaction because such purchase affected the capital structure of the firm.

Stock Market Efficiency

Stock market may be considered efficient or inefficient market. If the stocks market shows that the market prices of the
stocks are about equal or close to intrinsic values, there is a market efficiency. In this situation, the stock price reflects all
publicly available information hence, are fairly priced. Thus,Investors returns or losses under efficient market are relative
low.On the other hand, if stock market is inefficient, the stock prices are considered to be highly overvalued or
undervalued. Hence, the investors are not confident to invest unless they knew some information over the others. 3
Levels of efficiency in Efficient Market Hypothesis (EMH) namely 1. Weak form- This level shows that the information
regarding past or historical prices of a particular stock is not conclusive in predicting stock prices. Hence, an investor can’t
beat the market by simply analyzing the past performance.2. Semi-strong form – This level shows that all the available
public information I already incorporated in the stock prices. Hence, the investor cannot beat the market solely by
analysing the published financial reports of the company unless they have information from company insiders.Stock prices
can be classified as a. Market value also known as perceived value, is the price of the stock which is currently traded in
the market. In the Phil, the market price of the stocks of publicly listed companies are readily available in the Philippine
Stock Exchange (PSEP). b. Intrinsic value- This is the true value of the stock. This is the price that the willing buyer will
bid and willing seller will ask provided that all are necessary information about the stock is available. The intrinsic value
can be estimated using either the a) Dividend Discount Model or b) Corporate Valuation Model.

1 If the so called market value (perceived value ) is equal to the intrinsic value (true value), the stock price is at
equilibrium. Hence, the investor is neutral as to selling or buying stocks. 2 If the market value of a stock is higher than
the intrinsic value, the stock price is deemed as overvalued. Thus, the stockholders are expected to sell than to buy
shares.3 If the market value is lower than the intrinsic value, the stock price is undervalued . hence, the investors are
expected to purchase more shares to take advantage of lower price.

Summary
Companies encountering financial problem or distress may engage in the issuance of its financial assets (debts and equity
securities) in the financial markets or borrow money from financial institutions. It may resort from direct or indirect
issuance or transfer of securities, the equity securities evidenced by stock certificates and debt securities evidenced by
bond certificates to the investors. While stock markets are markets where shares of stocks of corporation are sold to new
investors and or existing stockholders. If the stocks market shows that the market prices of the stocks are about equal or
close to intrinsic values, there is a market efficiency. In this situation, the stock price reflects all publicly available
information hence, are fairly priced. Thus, Investors returns or losses under efficient market are relative low.