Fundamentals of Financial

Management -15 Ed

Eugene F. Brigham & J.

Houston

1.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Text co-author Eugene F. Brigham-
university of Florida Since 1971

1.2 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Textbook co-author, Joel F. Houston.
University of Florida since 1987

1.3 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Chapter 1
An
Anoverview
overviewof
ofFinancial
Financial
Management
Management

1.4 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 After studying Chapter 1,
be able to:
1. Define Finance & Explain why the role of the financial
manager today is so important.
2. Describing "financial management three major Decisions
Areas"
3. Identify the goal of creating value - shareholders' wealth
maximization is preferred over other goals.
4. Forms of business organization
5. Understand the potential problems arising when management
of the corporation and ownership are separated (i.e., agency
problems).
6. Demonstrate an understanding of corporate governance.

1.5 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Major Areas & Opportunities in Finance:
Managerial Finance

 Managerial finance is concerned with the

duties of the financial manager in the
business firm.
 The financial manager actively manages the
financial affairs of any type of business,
whether private or public, large or small,
profit-seeking or not-for-profit.
 They are also more involved in developing
corporate strategy and improving the firm’s
competitive position.

.
1.6 1-6
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Major Areas & Opportunities in
Finance: Managerial Finance
(cont.)
 Increasing globalization has
complicated the financial management
function by requiring them to be
proficient in managing cash flows in
different currencies and protecting
against the risks inherent in
international transactions.
 Changing economic and regulatory
conditions also complicate the
financial management function.
1.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Career Opportunities in Finance

 Money and capital markets

 Investments
 Financial management

1.8 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Responsibilities of the Financial Staff
 Forecasting and planning
 Investment and financing decisions
 Coordination and control

Transactions in the financial markets
 Managing risk

1.9 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Why should I care about
Financial Management ?
• Prepare for the workplace of tomorrow.
• Broadening expectations of financial
knowledge and skills.
• Use and understand financial terminology
and concepts in team communication.
• Developing cross-functional capabilities.
• Critical thinking.

1.10 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 What is Financial
Management?

Concerns the Acquisition,

Financing, and Management (Planning,
Organizing, leading, staffing and
controlling) of assets with some overall
goal in mind. Business finance- 3 A’s-
Anticipation, Acquisition, Allocation-

1.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Webster’s Dictionary Defined Finance

“The system that includes the circulation on

money, granting of credit , making of
investments and the provision of banking
facilities”

1.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Financial Activities

.
1.13 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 A.Investment Decisions
Most important of the three
decisions.
• What is the optimal firm size?
• What specific assets should be
acquired?
• What assets (if any) should be
reduced or eliminated?
1.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 B. Financing Decisions

Determine how the assets (LHS of

balance sheet) will be financed (RHS
of balance sheet).
• What is the best type of financing?
• What is the best financing mix?
• What is the best dividend policy (e.g.,
dividend-payout ratio)?
• How will the funds be physically
acquired?
1.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 C. Asset Management Decisions

• How do we manage existing assets

efficiently?
• Financial Manager has varying degrees
of operating responsibility over assets.
• Greater emphasis on current asset
management than fixed asset
management.
1.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 What is the Goal
of the Firm?

Maximization of
Shareholder Wealth!

Value creation occurs when

maximize the share price for
current shareholders.
1.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Goal of the Firm:
Maximize Shareholder Wealth!!! (cont.)
 The process of shareholder wealth maximization can
be described using the following flow chart:

Share Price Maximization

1.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Goal of the Firm: Maximize Profit???

Which Investment is Preferred?

Earnings per share (EPS)

Investment Year 1 Year 2 Year 3 Total (years 1-3)
Rotor $ 1.40 $ 1.00 $ 0.40 $ 2.80
Valve $ 0.60 $ 1.00 $ 1.40 $ 3.00
 Profit maximization fails to account for differences in
the level of cash flows (as opposed to profits), the
timing of these cash flows, and the risk of these cash
flows.

1.19
. Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Factors that Affect the Level and Riskiness of
Cash Flows

 Decisions made by financial managers:

 Investment decisions
 Financing decisions (the relative use
of debt financing)
 Dividend policy decisions
 The external environment

1.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Shortcomings of
Alternative Perspectives
Earnings per Share Maximization
• Maximizing earnings after taxes divided
by shares outstanding.
Problems
• Does not specify timing or duration of
expected returns.
• Ignores changes in the risk level of the firm.
• Calls for a zero payout dividend policy.
1.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Goal of the Firm:
Maximize Shareholder Wealth!!!
 Why?
 Because it properly considers cash flows, the timing
of these cash flows, and the risk of these cash flows.
 This can be illustrated using the following simple
stock valuation equation:

level & timing

of cash flows
Share Price = Future Dividends
Required Return risk of cash
flows

1.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Does profit maximization equal stock
price maximization?

No, Generally a high correlation

between EPS, cash flow, and stock
price, but today’s stock price relies not
only on current earnings, but future
earnings and cash flows.
Some actions may increase earnings,
yet cause stock price to decrease (and
vice versa).
1.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Strengths of Shareholder
Wealth Maximization
• Takes account of: current and future
profits and EPS; the timing, duration,
and risk of profits and EPS; dividend
policy; and all other relevant factors.
• Thus, share price serves as a
barometer for business performance.

1.24 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Factors that Affect Stock Price

 Projected cash flows to

shareholders
 Timing of the cash flow stream
 Riskiness of the cash flows

1.25 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Alternative Forms of Business Organization

 Sole proprietorship
 Partnership
 Corporation

1.26 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Strengths and Weaknesses of the Common
Legal Forms of Business Organization

1.27 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 The Managerial Finance Function:
Relationship to Accounting (cont.)
 One major difference in perspective
and emphasis between finance and
accounting is that accountants
generally use the accrual method
while in finance, the focus is on
cash flows.
 The significance of this difference
can be illustrated using the
following simple example.
.
1.28 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 The Managerial Finance Function:
Relationship to Accounting (cont.)
 The Nassau Corporation experienced the
following activity last year:
Sales $100,000 (1 yacht sold, 100% still uncollected)
Costs $ 80,000 (all paid in full under supplier terms)

 Now contrast the differences in

performance under the accounting method
versus the cash method.

.
1.29 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Corporate Social
Responsibility Discussion

Class Discussion:
Discussion What role should
CSR and/or sustainability have on
living the “goal of the firm”?
Corporate Social Responsibility (CSR): A business
outlook that acknowledges a firm’s responsibilities to
its stakeholders and the natural environment.
Sustainability: Meeting the needs of the present without
compromising the ability of future generations to meet
their own needs.
1.30 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Shortcomings of
Alternative Perspectives
Profit Maximization
• Maximizing a firm’s earnings after taxes.
Problems
• Could increase current profits while
harming firm (e.g., defer maintenance,
issue common stock to buy T-bills, etc.).
• Ignores changes in the risk level of the
firm.
1.31 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 The Modern Corporation

Modern Corporation

Shareholders Management

There exists a SEPARATION

between owners and managers.
1.32 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Role of Management
Management acts as an agent
for the owners (shareholders)
of the firm.
• An agent is an individual
authorized by another person,
called the principal, to act in
the latter’s behalf.
1.33 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Agency Theory

• Jensen and Meckling developed

a theory of the firm based on
agency theory.
theory
• Agency Theory is a branch of
economics relating to the
behavior of principals and their
agents.
1.34 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Agency Theory

• Principals must provide incentives

so that management acts in the
principals’ best interests and then
monitor results.
• Incentives include, stock options,
perquisites, and bonuses.
bonuses

1.35 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Corporate
Social Responsibility
• Wealth maximization does not
preclude the firm from being socially
responsible at the corporate level.
• Assume we view the firm as producing
both private and social goods.
• Then shareholder wealth maximization
remains the appropriate goal in
governing the firm.
1.36 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Corporate Governance
• Corporate governance: represents the
system by which corporations are
managed and controlled.
• Includes shareholders, board of
directors, and senior management.
• Then shareholder wealth maximization
remains the appropriate goal in
governing the firm.
1.37 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Board of Directors
• Typical responsibilities:
• Set company-wide policy;
• Advise the CEO and other senior executives;
• Hire, fire, and set the compensation of the CEO;
• Review and approve strategy, significant
investments, and acquisitions; and
• Oversee operating plans, capital budgets, and
financial reports to common shareholders.
• CEO/Chairman roles commonly same person
in US, but separate in Britain (US moving in
this direction).
1.38 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Board of Directors
• Typical responsibilities:
• Set company-wide policy;
• Advise the CEO and other senior executives;
• Hire, fire, and set the compensation of the CEO;
• Review and approve strategy, significant
investments, and acquisitions; and
• Oversee operating plans, capital budgets, and
financial reports to common shareholders.
• CEO/Chairman roles commonly same person
in US, but separate in Britain (US moving in
this direction).
1.39 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Organization of the Financial
Management Function

Board of Directors

President
(Chief Executive Officer)

Executive Vice Executive Vice Executive Vice

President President President
(Operations) (Finance - CFO) (Marketing)

1.40 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1.41 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1.42 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1.43 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1.44 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1.45 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1.46 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.