CHAPTER 1

Introduction to Financial
Management
 Forms of Businesses
 Goals of the Corporation
 Stock Prices and Intrinsic Value
 Some Recent Trends
 Conflicts Between Managers and
Shareholders 1-1
 Finance Within the
Organization
Board of Directors

Chief Executive Officer (CEO)

Chief Operating Officer (COO) Chief Financial Officer (CFO)

Marketing, Production, Human Accounting, Treasury, Credit,

Resources, and Other Operating Legal, Capital Budgeting, and
Departments Investor Relations

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Alternative Forms of Business
Organization
 Primary forms
 Proprietorship
 Partnership
 Corporation
 Hybrid forms
 S Corporation
 Limited liability company (LLC)
 Limited partnership (LP)
 Limited liability partnership (LLP)
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Proprietorships & Partnerships
 Advantages
 Ease of formation
 Subject to few regulations
 No corporate income taxes
 Disadvantages
 Difficult to raise capital
 Unlimited liability
 Limited life
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Corporation
 Advantages
 Unlimited life
 Easy transfer of ownership
 Limited liability
 Ease of raising capital
 Disadvantages
 Double taxation
 Cost of set-up and report filing

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Hybrid Business Forms
 S Corporations
 No more than 100 shareholders
 No corporate income taxes

 Limited liability companies (LLCs)

 Similar to S corporations
 More flexible ownership rules

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Hybrid Business Forms
 Limited partnerships (LPs)
 At least one general partner
 Any number of limited partners

 Limited liability partnerships (LLPs)

 Often used by legal, accounting, medical
professionals
 Liable for own malpractice, but not for
actions of other partners
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Financial Goals of the Corporation
 The primary financial goal is
shareholder wealth maximization,
which translates to maximizing stock
price.
 Do firms have any responsibilities to
society at large?
 Is stock price maximization good or bad
for society?
 Should firms behave ethically?
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Factors that affect stock price
 Projected cash
flows to
shareholders
 Timing of the
cash flow stream
 Riskiness of the
cash flows

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 Stock Prices and Intrinsic Value
 In equilibrium, a stock’s price should equal its
“true” or intrinsic value.
 To the extent that investor perceptions are
incorrect, a stock’s price in the short run may
deviate from its intrinsic value.
 Managers should avoid actions that reduce
intrinsic value, even if those decisions
increase the stock price in the short run.

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Determinants of Intrinsic Value
and Stock Prices (Figure 1-1)

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Conflicts Between Managers and
Stockholders
 Managers are naturally inclined to act in their
own best interests (which are not always the
same as the interest of stockholders).
 But the following factors affect managerial
behavior:
 Managerial compensation plans
 Direct intervention by shareholders
 The threat of firing
 The threat of takeover
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 Conflicts Between Stockholders
and Bondholders
 Stockholders are more likely to prefer risky projects,
because they receive more of the upside if the project
succeeds. By contrast, bondholders receiving fixed
payments are more interested in limiting risk.
 Bondholders are particularly concerned about the use
of additional debt.
 Bondholders attempt to protect themselves by
including covenants in bond agreements that limit the
use of additional debt and constrain managers’
actions.
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