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moals and movernance of the
Sixth Edition Firm
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V unvestment and Financing Decisions
All successful companies must make good
investment & financing decisions.
V What is a Corporation?
Advantages Vs Disadvantages
V Who us The Financial Manager?
CFO: Treasurer & Controller
V moals of the Corporation
Maximize firm value
V Careers in Finance
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V Making good investment and financing

decisions is the chief task of the financial
manager.
unvestment decision
(Capital budgeting decision)
Financing decision
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V Capital Budgeting Decision uv



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Decision to invest in tangible (new plant,
equipment) or intangible (patents,
trademark, investment in R&D) assets.
V «also called the unvestment Decision
V unvestment Decision steps:
udentify investment opportunities
Analyze & value opportunities
Decide whether and how much to invest.
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‰Capital Budgeting´

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‰Capital Budgeting´

Financial manager«
-helps firm to invest in projects that are worth more than cost.
- needs to value capital investment projects by considering amounts,
timing, & risk of the future cash flows generated by the projects.
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V Financial manager takes responsibility to
raise money that firm needs for investments
& operations, this is financing decision.
V Financing Decision
The form and amount of financing of a
firm¶s investments.
V Capital Structure: choices of raising funds
The mix of long term debt and
equity financing.
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V When firm needs to raise money:

ut can invite investors to put up cash in
exchange for a share of future profits
(equity investors contribute
equity financing), or
ut can promise to pay back investors¶
cash plus a fixed rate of interest
(debt investors, one day must be repaid).
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V Financing & investment decisions

(both S/T & L/T) are interconnected.

V The amount of investment (how to invest cash

for projects) determines amount of financing
(how to raise cash to meet the needs) that has
to be raised.
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Flow of cash between investors & firm¶s operations:
How money flows from investors to firms & back to investors again.
ÿ  ÿ
Firm's
Financial
operations ÿ unvestors
Manager

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(1) Cash raised from investors by selling financial assets
(2) Cash invested in firm¶s operations (pay for real assets ± investment projects)
(3) Cash generated by operations if firm does well 4a or 4b: depends on promises
(4a) Cash reinvested (retained earnings) made when raise funds.
(4b) Cash returned to investors who furnished money in first place
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V £


Assets used to produce goods and services.
unclude tangible assets such as machinery &
factories and intangible assets such as technical
knowledge, trademarks, & patents.
V  


Financial claims to the income generated by firm¶s
real assets such as a share of stock & a bank loan.
Firm finances its investments in real assets by
issuing financial assets to investors.
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V Corporation: distinct & permanent legal entity
A business organized as a separate legal entity
owned by stockholders.
Limited liability (owners have no personally
responsibility for corporation¶s debts).
V Types of Corporations
Public Companies
Private Corporations
Limited Liability Corporations (LLC)
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§   

V Types of Business Organizations
Sole Proprietorships
Partnerships: agreement
Corporations: live forever
Limited Liability Options
‡ Limited Liability Partnerships: tax
advantage of partnership plus limited
liability advantage of corporation
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§   

- A separa on of ownersh p & managemen s one d s nc ve
fea ure of corpora ons & shareho ders e ec BOD, who
appo n he op manager & mon or performance;
- Con ras a so e propr e orsh p, who s bo h owner & manager.
So e
Propr e orsh p Par nersh p Corpora on

Who owns he
The manager Par ners S ockho ders
bus ness?

Are managers and

No No Usua y
owners separa e?

Wha s he owner's
Un m ed Un m ed L m ed
ab y?

Are he owner and

bus ness axed No No Yes
separa e y?
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Disadvantages of corporation: cost in time & money of managing

corporation¶s legal entity and tax on profits & also dividends.

Sole Proprietorships
Unlimited Liability
Personal tax on profits
Partnerships

Limited Liability
Corporations Corporate tax on profits +
Personal tax on dividends
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CFO: Overseas FM: Refers to
treasurer & anyone responsible
controller and sets Chief Financial Officer for a significant
overall financial corporate
strategy, financial investment or
policy, & corporate
financing decision.
planning.

Treasurer Controller

‰Obtain & manage firm¶s capital´ ‰Ensure that money is used efficiently´
Cash management, raising capital, Preparation of financial statements,
banking relationships, other accounting & internal budget
investors relationships. managing, taxes.
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V Chief Financial Officer (CFO)
Oversees the treasurer and controller and sets
overall financial strategy.
V Treasurer
Responsible for financing, cash management, and
relationships with banks and other financial
institutions.
V Controller
Responsible for budgeting, accounting, and taxes.
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V Shareholders want managers to maximize
market value not only profit maximization.
V Profit maximization is not well-defined
corporate objective because «
uncrease only S/T profits but L/T are damaged.
uncrease future profits by cutting down
dividend & R&D investment, this is not the
stockholders¶ best interest.
A decision can improve profit by using one set
of accounting rules, can manipulate profits.
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V Shareholders desire wealth maximization:
maximize value of firm
V Do managers maximize shareholder wealth?:
large corporation, managers are not owners.
V Mangers have many constituencies
‰stakeholders´: stockholders, creditors, employees
V ‰Agency Problems´ represent the
conflict of interest between
management and owners
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V Maximize shareholder¶s wealth =
V Maximize current market value =
V Maximize today¶s stock price

‰ Market value is the total amount that

investors are willing to pay for all of its
shares. ´
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Ethics & Management Objectives
V Does value maximization justify unethical behavior?
V Enron example (energy trading & investment firm)
Accounting fraud, not report huge amount of liabilities.
V WorldCom example (telecom giant)
Failed to report operating expenses but report in
investments instead so go bankruptcy.
‰ ut is not always easy to know what is ethical behavior
and there can be many gray areas.´
‰ Written rules and laws can help but there are also
unwritten rules of behavior.´
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Conflicts of interest that arise in large corporations
Ownership vs. Management
Difference in unformation Different Objectives
V Stock prices and returns V Managers vs.
V ussues of shares and stockholders
other securities V Top mgmt vs.
V Dividends operating mgmt
V Financing V Stockholders vs. banks
and lenders
Managers may be tempted to act in ways that are not in the best
interests of shareholders. But good Cm protects investors.
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V 

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Managers, acting as agents for stockholders, may act
in their own interests rather than maximizing value.
Creates mechanics that mitigate agency costs ensure
effective Cm.
Firms align managers¶ & shareholders interests by
granting stock options, profit sharing, compensation
scheme to top management.
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Anyone with a financial interest in the firm.
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Agency Problem Solutions:
1 - Compensation plans tie fortunes/interests of
managers to fortunes/interests of firms
2 - Board of Directors: more independent directors
3 - Takeovers: poor performance firms to be taken over
4 - Specialist Monitoring: by lenders, stock market
analysts, investors, banks if asking for loans.
5 - Legal and Regulatory Requirements/Standards:
Sarbanes-Oxley Act (SOX)
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