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CHAPTER 1
Overview of Financial Management
and the Financial Environment

Financial management

Forms of business organization

Objective of the firm: Maximize wealth

Determinants of stock pricing

The financial environment

Financial instruments, markets and
institutions

Interest rates and yield curves
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Why is corporate finance important to
all managers?

Corporate finance provides the skills
managers need to:

Identify and select the corporate
strategies and individual projects
that add value to their firm.

Forecast the funding requirements

Difficult to raise capital to support
growth
Starting as a Sole Proprietorship
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
A partnership has roughly the same
advantages and disadvantages as a
sole proprietorship.
Starting as or Growing into a
Partnership
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Becoming a Corporation

A corporation is a legal entity
separate from its owners and
managers.

File papers of incorporation with
state.

Charter

Bylaws
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
Advantages:

Unlimited life

Easy transfer of ownership

The primary objective should be
shareholder wealth maximization,
which translates to maximizing stock
price.

Should firms behave ethically? YES!

Do firms have any responsibilities to
society at large? YES! Shareholders
are also members of society.
What should management’s primary
objective be?
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Is maximizing stock price good for
society, employees, and customers?

Employment growth is higher in firms
that try to maximize stock price. On
average, employment goes up in:

firms that make managers into
owners (such as LBO firms)

firms that were owned by the
government but that have been sold
to private investors
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
Consumer welfare is higher in
capitalist free market economies

To all investors (stockholders and
creditors)

After paying current expenses,
taxes, and making the investments
necessary for growth.
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Determinants of Free Cash Flows

Sales revenues

Current level

Short-term growth rate in sales

Long-term sustainable growth rate in
sales

Operating costs (raw materials, labor,
etc.) and taxes

Required investments in operations
(buildings, machines, inventory, etc.)
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What is the weighted average cost of
capital (WACC)?

The weighted average cost of capital
(WACC) is the average rate of return
required by all of the company’s

FCF

)WACC1(
FCF
)WACC1(
FCF
Value
2
2
1
1
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What are financial assets?

A financial asset is a contract that
entitles the owner to some type of
payoff.

Debt

Equity

Derivatives

In general, each financial asset
involves two parties, a provider of
cash (i.e., capital) and a user of cash.
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What are some financial instruments?
Instrument Rate (April 2003)

breakeven
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
Direct transfer (e.g., corporation issues
commercial paper to insurance company)

Through an investment banking house
(e.g., IPO, seasoned equity offering, or
debt placement)

Through a financial intermediary (e.g.,
individual deposits money in bank, bank
makes commercial loan to a company)
What are three ways that capital is
transferred between savers and
borrowers?
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
Commercial banks

Savings & Loans, mutual savings
banks, and credit unions

Life insurance companies

Mutual funds

Pension funds
What are some financial intermediaries?
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