THE CORPORATION

1
THE CORPORATION

• Legal entity created to sell goods and/or
  services.
• Owned by shareholders who purchase its stock.
• Possible returns to shareholders
• 1) dividends
• 2) stock price appreciation

2
FINANCE DECISIONS

• Investment
• Financing
• Dividend

3
Investment

• What assets does the company need to accomplish
  its mission?
• Buildings, machinery, equipment? (Ch 7 and Ch 8)
• Cash, accounts receivable, inventory? (Ch 9)

4
Financing

• How should firms assets be financed?
• Liabilities (debt) or Equity (selling new stock
  or reinvesting profits)?
• What is best mix of debt and equity?
• Valuation (Ch 5) Cost of Capital (Ch 6)

5
Dividend

• What to do with Earnings After Taxes (profit, net
  income)?
• Pay dividends to stockholders?
• Reinvest into company (retained earnings)?
• Some combination of both?

6
Goal of Financial Management

• Most people would say goal is to maximize profits
• Profits when? - this quarter, this year, next 5
  years
• Which measure of profit to use? - net income,
  income before extraordinary items, EPS

7
Better Goal

• Who owns firm?
• Stockholders.
• Why do they buy stock?
• To gain financially when stock price goes up (buy
  low, sell high)
• Goal MAXIMIZE STOCK PRICE

8
Advantages of Stock Price Maximization as a Goal

• Easy to measure
• Readily available
• Provides immediate feedback on how market values
  decisions of firms managers

9
Disadvantage of Stock Price Maximization as a Goal

• Majority of stocks owned by institutional
  investors
• Managers of institutional funds push for
  short-term returns
• When corporate managers focus on short-term stock
  price maximization, they may make decisions
  harmful to the corporation in the long-run.

10
Examples of Institutional Investors

• Mutual Funds
• Hedge Funds
• Private Equity Funds
• Sovereign Wealth Funds
• Pension Plans
• Insurance Companies
• Endowment Funds

11
Stakeholders in a corporation

• Shareholders (individuals institutions)
• Employees, including managers
• Customers
• Suppliers
• Community
• Creditors
• Government

12
Stakeholder Theory

• Says that managers should make decisions that
  maximize interests of all stakeholders
• Example UAW got BIG 3 Auto Makers to give big
  concessions in 1970s
• Look how that turned out in long-run for
  everyone!

13
Agency Theory

• Managers are agents of stockholders (principal)
• Managers sometimes act in own interest instead of
  stockholders
• Adelphia, Enron, Global Crossing, Qwest, Tyco,
  WorldCom, to name a few
• Agency costs making sure that managers are
  acting appropriately e.g. auditing

14
Long-term Decision Making

• All stakeholders, including employees, managers,
  and stockholders, have an interest in the
  continued operation of a corporation
• Managers should make decisions that maximize
  stock price in the long-run
• Taking the long view benefits all stakeholders

15
3 Steps to Follow in Making Financial Decisions

• Estimate impact of decision on future cash flows
• Adjust future cash flows for time value of money
  (Ch 3)
• Adjust future cash flows for risk (chance that
  actual cash flow will not be what is expected)
  (Ch 4)

16
Where We Are Headed

• Ch 2 Overview of Financial Markets
• Ch 3 Time Value of Money
• Ch 4 Risk
• Ch 5 and Ch 6 Financing Decision
• Ch 7, 8, 9 Investment Decision
• Ch 10 Financial Statement Analysis
• Ch 11 Financial Planning