Ch.

1 - An Introduction to
Financial Management

 2002, Prentice Hall, Inc.

What is Finance

• Maintenance & creation of economic value

or wealth.
Thus we will focuses on decision making with
an eye towards creating wealth.
• Financial decisions- when to introduce a
new product, invest in new assets, replace
the existing assets, when to borrow from
bank , when to issue stocks or bonds.
• Decision making techniques & the logic
behind those techniques.
 Goal of the Firm

1) Profit Maximization?
Efficient use of capital resources
R&D Expenditures
Cutting down the routine maintenance
Effect in short run = Profit Max
Long run = not in the interest of the firm
 this goal ignores:
The firm must deal every day with 2 major factors
a) TIMING of Returns
(Time Value of Money - Ch. 5)
b) UNCERTAINTY of Returns
(Risk - Ch. 6)
 Goal of the Firm

2) Shareholder Wealth
Maximization?
this is the same as:
a) Maximizing Firm Value
b) Maximizing Stock Price
 Legal Forms of Business
1) Sole Proprietorship
• A business owned by a single individual.
• Owner maintains title to the firm’s assets.
• Owner has unlimited liability.

2) Partnership
• Similar to a sole proprietorship, except
that there are two or more owners.
 Legal Forms of Business
2a) General Partnership
• All partners have unlimited liability.

2b) Limited Partnership

• Consists of one or more general partners,
who have unlimited liability, and
• One or more limited partners (investors)
whose liability is limited to the amount of
their investment in the business.
 Legal Forms of Business
3) Corporation
• A business entity that legally functions
separate and apart from its owners.
• Owners’ liability is limited to the amount
of their investment in the firm.
• Owners hold common stock certificates,
and ownership can be transferred by
selling the certificates.
The Corporation and Financial
Markets
 The Corporation and Financial
Markets

Corporation
 The Corporation and Financial
Markets

Corporation Investors
 The Corporation and Financial
Markets

Corporation Investors

Government
 The Corporation and Financial
Markets

Corporation cash Investors

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Secondary
markets

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Secondary
markets

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Secondary
markets

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Secondary
markets
Cash flow

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities

Secondary
markets
Cash flow

tax

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities
reinvest
Secondary
markets
Cash flow

tax

Government
 The Corporation and Financial
Markets

Corporation cash Investors

securities
reinvest
Secondary
markets
dividends,
Cash flow
etc.

tax

Government
 The Corporation and Financial
Markets
• Primary Market
 The Corporation and Financial
Markets
• Primary Market
– Market in which new issues of a
security are sold to initial buyers.
 The Corporation and Financial
Markets
• Primary Market
– Market in which new issues of a
security are sold to initial buyers.
• Secondary Market
 The Corporation and Financial
Markets
• Primary Market
– Market in which new issues of a
security are sold to initial buyers.
• Secondary Market
– Market in which previously issued
securities are traded.
 The Corporation and Financial
Markets
• Initial Public Offering (IPO)
 The Corporation and Financial
Markets
• Initial Public Offering (IPO)
– The first time the firm’s stock is
sold to the general public.
 The Corporation and Financial
Markets
• Initial Public Offering (IPO)
– The first time the firm’s stock is
sold to the general public.
• Seasoned New Issue
 The Corporation and Financial
Markets
• Initial Public Offering (IPO)
– The first time the firm’s stock is
sold to the general public.
• Seasoned New Issue
– A new stock offering by a firm that
already has stock that is traded in
the secondary market.
 Financial Management Axioms
• 1) Risk - return trade-off
• 2) Time value of money
• 3) Cash - not profits - is king
• 4) Incremental cash flows count
• 5) The curse of competitive markets
• 6) Efficient capital markets
• 7) The agency problem
• 8) Taxes bias business decisions
• 9) All risk is not equal
• 10) Ethical dilemmas are everywhere in finance