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Abu Dhabi University 1-1

Financial Management

FIN 512
Nadeem Aftab
Abu Dhabi University, Al Ain
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Introduction To Corporate Finance
Chapter One
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Chapter Outline
1. Corporate Finance and the Financial Manager
2. Forms of Business Organization
3. The Goal of Financial Management
4. The Agency Problem and Control of the Corporation
5. Financial Markets and Institutions
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Corporate Finance
Some important questions that are answered using finance

1. What long-term investments should the firm take on?
(lines of business, buildings, machinery, equipments, )

2. Where will we get the long-term financing to pay for the
investment? (equity or debt)

3. How will we manage the everyday financial activities of
the firm? (collecting from customers and paying suppliers)
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Financial Manager
Financial managers try to answer some or all of these questions

The top financial manager within a firm is usually the Chief
Financial Officer (CFO)
Treasurer oversees cash management, capital expenditures
and financial planning
Controller oversees taxes, cost accounting, financial
accounting and data processing
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Financial Management Decisions
Capital budgeting: the process of planning and managing
a firms long-term investments

What long-term investments or projects should the
business take on?

Evaluate the size, timing, and risk of future CFs

An example: extend the activity, open a new store,
develop a new software, acquire license,
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Financial Management Decisions (contd)
Capital structure: the mixture of debt and equity
maintained by a firm

How should we pay for our assets?

Should we use debt or equity?

The mixture chosen will affect both the risk and the
value of the firm

If you have to decide, what will be the chosen capital
structure? Why?

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Financial Management Decisions (contd)
Working capital management: A firms short-term assets and
liabilities (ex. Inventory, money owed to suppliers, )

How do we manage the day-to-day finances of the firm?

Answer the following questions:
Should we sell on credit (what term and to whom)?
Purchase on credit or borrow and pay cash?....

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Forms of Business Organization
Three major forms
Sole proprietorship
Partnership
Corporation
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Sole Proprietorship
Easiest to start
Least regulated
Single owner keeps all the
profits
Taxed once as personal
income
Unlimited liability
Limited to life of owner
Equity capital limited to
owners personal wealth
Difficult to sell ownership
interest
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Partnership
Two or more owners
More capital available
Relatively easy to start
Income taxed once as
personal income
Unlimited liability
Partnership dissolves when
one partner dies or wishes to
sell
Difficult to transfer ownership
1.8
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Corporation
Limited liability
Unlimited life
Separation of ownership and
management
Transfer of ownership is easy
Easier to raise capital
Separation of ownership and
management
Double taxation (income is
taxed at the corporate rate
and then dividends are taxed
at the personal rate)
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Goal Of Financial Management
What should be the goal of a corporation?
Maximize profit?
Minimize costs?
Maximize market share?
Maximize the current value of the companys stock?

Does this mean we should do anything and everything
to maximize owner wealth? (illegal or unethical actions)
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Possible Goals of Financial Management
1. Survival
2. Avoid financial distress and bankruptcy
3. Beat the competition
4. Maximize sales or market share
5. Minimize costs
6. Maximize profits
7. Maintain steady earnings growth
The most important or popular goal of financial
management is to maximize shareholders wealth.
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Agency Relationships
The agency relationship is the relationship between the
shareholders (owners) and the management of a firm.

The agency problem is the possibility of conflict of
interests between these two parties.

Agency costs refer to the direct and indirect costs arising
from this conflict of interest.

This can be explained in terms of risk appetite of the two
parties.
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Do Managers Act in Shareholders Interests?
The answer to this will depend on two factors:

How closely management goals are aligned with
shareholder goals

The ease with which management can be replaced if it
does not act in shareholders best interests.
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Alignment of Goals
The conflict of interests is limited due to:

1. Management compensation schemes

2. Monitoring of management

3. The threat of takeover

4. Other stakeholders.
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Financial Markets: The troika
Institutions
Com. Banks
Invest. banks
Stock Exchanges
Insurance cos.
Venture capitals
Mutual funds
Pension funds
Fund of funds
Markets
Debt
Capital
Money
Foreign Ex.
Commodities
Derivatives
Instruments

Cash
Bond
Stocks

Primary vs. secondary markets.

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Financial Markets and Corporations
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Example: Financial Markets
Financial markets bring together the buyers and sellers of
debt and equity securities.
Primary markets
involve the original sale of
securities.
Secondary markets
involve the continual buying
and selling of issued securities.
Money markets
involve trading of short-
term debt securities.
Capital markets
involve trading of long-
term debt securities.
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Structure of Financial Markets
Primary Market Secondary Market
Money Market
Primary Market Secondary Market
Capital Market
Financial Markets
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Summary
You should know:
Basic Definitions
Three basic questions in financial management
The advantages and disadvantages of sole
proprietorship, partnership and corporation
The primary goal of the firm
What an agency relationship and cost are
The role of financial markets