1. The Role & Objective of financial Managers Flashcards
what is the
What is Shareholder wealth:
CHAPTER GOAL
Shareholder wealth is defined as the present value of the expected future returns to the owners of the firm.
How is Shareholder wealth measured
CHAPTER GOAL
It is measured by the market value of the shareholders common stock holdings.
The primary normative goal of a firm
CHAPTER GOAL
is to make the most efficient use of the firm ’ s resources and thereby to maximize shareholder wealth.
how can the achievement of the shareholder wealth maximization goal be constrained
CHAPTER GOAL
by social responsibility concerns and problems arising out of agency relationships.
How is the market value of a firm ’ s stock is determined?
CHAPTER GOAL
the magnitude, timing, and risk of the cash flows the firm is expected to generate.
What Actions can managers can take to influence the magnitude, timing, and risk of the firm’s cash flows.
The actions are often classified as:
investment, financing, and dividend decisions.
what are the 3 most important forms of business organization?
CHAPTER GOAL
Sole proprietorship
Partnership — both limited and general
Corporation
What are the advantages of Corporations and what % in america do they comprise of
CHAPTER GOAL
limited liability for owners
potentially perpetual life
the ability to raise large amounts of capital.
they account for less than 18 percent of U.S. firms, and 81 percent of U.S. business revenues.
What is the Primary responsibility of a Financial Managers?
acquiring funds (cash) needed by a firm
and
directing those funds into projects that will maximize the value of the firm.
The primary goal/objective of the firm
CHAPTER OBJECTIVES
The most widely accepted objective of the firm is to make the most efficient use of the firm ’ s resources and thereby maximize the value of the firm for its owners; that is, to maximize shareholder wealth
- The determinants of the value of a firm
- The meaning and implications of agency problems in a corporation
- The importance of ethics in running a business organization
- The major types of business organizations and their distinguishing features
- The role and function of the financial manager The relationship between finance and other business disciplines
What is Shareholder wealth
Shareholder wealth is represented by the market price of a firm ’ s common stock.
how is Present value defined
Present Value is defined as the value today of some future payment or stream of payments, evaluated at an appropriate discount rate
what is discount rate
discount rate takes into account the returns that are available from alternative investment opportunities during a specific (future) time period.
what is reflected in the measure of a shareholders wealth
the magnitude , timing , and risk associated with future benefits expected to be received by stockholders.
How do you calculate total shareholder wealth
Total shareholder wealth equals:
the number of shares outstanding X the market price per share.
What do Stock Prices provide a direct Measure of?
the success of decisions made by a firm’s managers.
Who are considered Stakeholders?
customers,
employees,
suppliers,
and the communities in which firms operate
What is Economic Value Added ,
the difference between a firm ’ s annual after-tax operating profit and its total annual cost of capital.
Economic Value Added = After tax operating profit - annual cost of capital
What are the 2 most important Agency Relationships
stockholders and creditors
stockholders (owners) and managers
What are Agency Problems?
The divergent objectives between 2 parties ie
owners and managers
(Stock Holders and managers)
(Stock Holders and Creditors)
What is one of the Agency Problems between Creditors and Owners?
Creditors have a fixed financial claim on the company ’ s resources:
long-term debt, bank loans, commercial paper, leases, accounts payable, wages payable, taxes payable,
owners may attempt to increase the riskiness of the company ’ s investments in hopes of receiving greater returns.
When this occurs, bondholders suffer because they do not have an opportunity to share in these higher returns.
what are some of the protective covents creditors can insist on to protect their interests from agency problems?
- limitations on dividend payments,
- limitations on the type of investments (and divestitures) the company can undertake,
- poison puts,
- limitations on the issuance of new debt.
list some agency problems that can arrise
each party wanting to maximizing his or her own utility (welfare). ie management concerned more with long-run survival (job security) rather than shareholder wealth maximization
Another example is the consumption of on-the-job perquisites (such as the use of company airplanes, limousines, and luxurious offices)
Shirking by managers is also an agency-related problem.
list 4 agency costs
- Expenditures to structure the organization in such a way as to minimize the incentives for management to take actions contrary to shareholder interests
- Expenditures to monitor management ’ s actions, such as paying for audits of managerial performance and internal audits of the firm ’ s expenditures
- Bonding expenditures to protect the owners from managerial dishonesty
4. The opportunity cost of lost profits arising from complex organizational structures that prevent management from making timely responses to opportunities
List 3 different mechanisms to reduce Agency Conflicts
corporate governance,
managerial compensation,
and the threat of takeovers.
How does Corporate Govenance reduce Agency Conflicts
the board of directors of a corporation should have a majority of independent directors. Independent directors are individuals who are not current or former employees of the company and who have no significant business ties to the company.
the committee responsible for nominating members of the board of directors must be composed only of independent directors.
ensureing that everyone is independent will help reduce the chance of Agency conflics occuring
How can Managerial Compensation help reduce agency conflicts?
providing part of the compensation in the form of stock or options to purchase stock can reduce agency conflicts.
Typically, the options are set at an exercise price greater than the price of the stock at the time options are granted and can be exercised only after a certain period of time has elapsed.
How can the threat of takeover help to reduce Agency Conflicts
The argument goes as follows:
If managers act in their self-interest, then share values will be depressed, providing an incentive for someone to take over the company at a depressed level. The acquirer can then benefit from instituting policies that are consistent with shareholder wealth maximization, such as eliminating underperforming units and cutting overhead.
To maximize profits, we learned in microeconomics that a firm should :
expand output to the point where the marginal (additional) cost ( MC ) of the last unit produced and sold just equals the marginal revenue ( MR ) received.
https://www.youtube.com/watch?v=qaQRM6WIxpA
why is the profit maximization model (MC = MR rule) not
useful as the central decision-making model for a firm
- Major decisions made by financial managers must reflect the time dimension. Financial managers must make trade-offs between short-run and long-run returns in conjunction with capital investment decisions.
- The second limitation of the profit maximization objective has to do with the definition of profit (or earnings or income) . Generally accepted accounting principles (as discussed in Chapter 3) result in literally hundreds of definitions of profit for a firm because of the latitude permitted in recognizing and accounting for costs and revenues.
What are the limitations of “Book Value” of a share as opposed to “Market Value” of a share
book value
reflects the historic cost of assets, not the earning capacity of those assets. Also, the book value does not consider the risk associated with the assets.
market value of a company ’ s shares of stock:
the 3 major factors determining this are:
- The amount of the cash flows expected to be generated for the benefit of stockholders ;
- The timing of these cash flows ;
- The risk of the cash flows.
explain the 3 major factors in determining the market value of a companies shares of stock
- Cash Flow
relates to the actual cash generated or Only cash can be used to acquire assets, and only cash can be used to make valuable distributions to investors. In contrast, the accounting system focuses primarily on a matching over time of the historic, cost-based revenues and expenses of a company, resulting in a bottom-line earnings figure. But accounting earnings are often misleading because they do not reflect the actual cash inflows and outflows of the firm. For example, an accountant records depreciation expense on an asset each period over the depreciable life of that asset. Depreciation is designed to reflect the decline in value of that asset over time. However, depreciation itself results in no cash outflow. The entire cash outflow occurred when the asset was originally purchased.
Timing of Cash
If faced with the alternatives of receiving $100 today or $100 three years from today, you would surely choose the $100 today because you could invest that $100 for three years and accumulate the interest. Thus, financial managers must consider both the magnitude of the cash flows they expect to generate and the timing of these cash flows, because investors will reflect these dimensions of return in their valuation of the enterprise.
Risk
Finally, the market value of a share of stock is influenced by the perceived risk of the cash flows it is expected to generate.
list some:
Economic Enviornmental Factors.
Policiy Decisions Under Managment Control
Conditions in financial Markets
that affect stock price
Economic Environment Factors
- Level of economic activity
- Tax rates and regulations
- Competition, including the threat of new competitors and substitute products
- Laws and government regulations
- Unionization of employees
- International business conditions and currency exchange rates
- Bargaining power of buyers
Major Policy Decisions Under Management Control
- Products and services offered for sale
- Production technology
- Marketing and distribution network
- Investment strategies
- Employment policies and compensation packages for managers and other employees
- Ownership form— proprietorship, partnership, or corporation
- Capital structure— use of debt and equity to finance the firm
- Working capital management policies
- Dividend policies
Conditions in Financial Markets
- Interest rate levels
- Investor optimism
- Anticipated inflation
What are the 5 Competitive forces that can affect the market price of stocks
- The threat of new entrants
- The threat of substitute products
- The bargaining power of buyers
- The bargaining power of suppliers
- The rivalry among current competitors
What are the 3 most common buissness structures
with advandages/ disadvantages
1. sole propriotorship
Advantages: Inexpensive to establish
Disadvantage: unlimited personal liability, dificulty raising funds for growth,
72% of USD biss, but only 4.1% total revenue
2. Partnership
General Partnership
each partner has unlimited liability, = same disadvantages as a sole propriotor
Limited Partnership
one or more General Partner, and one or mor Limited liability partner. (the limit is set out in contract and varies). common in real-estate
10% of usa buissnesses are Partnerships that account for less than 15% revenue
Corporation
Advantages:
Limited liability: Stock holders are not liable for obligations or debts
Permanancy :the corporation will exist independent of weather stockholders sell their shares
Flexibility: a change in ownership can be as simple as selling shares.
Ability to raise capital: limited liability, and easy marketabliity of shares it is much easier to raise capital for growth.
Disadvantage
ownership is seperated from managment ( possible agancy costs)
what are the 2 types of Corporate Securities
Debt Securities:
lending of money (the investor wants periodic interest payments and the return of the principal after a set time period)
Equity Securities
2 types: Common Stock,__Prefered Stock
Common Stock: residule form of ownership. considered to be true holders of the company. Claims are considered last. after; government, debt holders & prefered stock holders. possess dividend, rights asset, rights voting rights.
Perfered stock holders: their rights come before common stock holders. paid dividends before, and if the company liquidates are in front of common stock holders for payouts.
if bankrupcy occurs the order of priority is
- creditors
- prefered stock holders
common stock holders
what does a CFO do
- strategic planning,
-monitoring and trading foreign currencies,
-managing the risk from volatile interest rates,
- monitoring production and inventory levels.
- communicate effectively with the investment community concerning the financial performance of the company.
The chief financial officer often distributes the financial management responsibilities between:
1. the controller
2. the treasurer.
The controller normally has responsibility for all accounting-related activities.
Financial accounting, Cost accounting, Taxes, Data Processing
The treasurer is normally concerned with the acquisition, custody, and expenditure of funds.
