Financial Management Chpt 1

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Chapter 1

An Overview of Financial Management

Learning Objectives

After reading this chapter, students should be able to:

◆ Explain the role of finance, and the different types of jobs in finance.

◆ Identify the advantages and disadvantages of different forms of business organization.

◆ Explain the links between stock price, intrinsic value, and executive compensation.

◆ Discuss the importance of business ethics and the consequences of unethical behavior.

◆ Identify the potential conflicts that arise within the firm between stockholders and managers and between stockholders and bondholders and discuss the techniques that firms can use to mitigate these potential conflicts.

Lecture Suggestions

Chapter 1 covers some important concepts, and discussing them in class can be interesting. However, students can read the chapter on their own, so it can be assigned but not covered in class. We spend the first day going over the syllabus and discussing grading and other mechanics relating to the course. To the extent that time permits, we talk about the topics that will be covered in the course and the structure of the book. We also discuss briefly the fact that it is assumed that managers try to maximize stock prices, but that they may have other goals, hence that it is useful to tie executive compensation to stockholder-oriented performance measures. If time permits, we think it’s worthwhile to spend at least a full day on the chapter. If not, we ask students to read it on their own, and to keep them honest, we ask one or two questions about the material on the first mid-term exam. One point we emphasize in the first class is that students should print a copy of the PowerPoint slides for each chapter covered and purchase a financial calculator immediately, and bring both to class regularly. We also put copies of the various versions of our “Brief Calculator Manual,” which in about 12 pages explains how to use the most popular calculators, in the copy center. Students will need to learn how to use their calculators before time value of money concepts are covered in Chapter 5. It is important for students to grasp these concepts early as many of the remaining chapters build on the TVM concepts. We are often asked what calculator students should buy. If they already have a financial calculator that can find IRRs, we tell them that it will do, but if they do not have one, we recommend either the HP-10BII or 17BII. Please see the “Lecture Suggestions” for Chapter 5 for more on calculators.

DAYS ON CHAPTER: 1 OF 58 DAYS (50-minute periods)

Answers to End-of-Chapter Questions

1-1When you purchase a stock, you expect to receive dividends plus capital gains. Not all stocks pay dividends immediately, but those corporations that do, typically pay dividends quarterly. Capital gains (losses) are received when the stock is sold. Stocks are risky, so you would not be certain that your expectations would be met—as you would if you had purchased a U.S. Treasury security, which offers a guaranteed payment every 6 months plus repayment of the purchase price when the security matures.

1-2If investors are more confident that Company A’s cash flows will be closer to their expected value than Company B’s cash flows, then investors will drive the stock price up for Company A. Consequently, Company A will have a higher stock price than Company B.

1-3A firm’s intrinsic value is an estimate of a stock’s “true” value based on accurate risk and return data. It can be estimated but not measured precisely. A stock’s current price is its market price—the value based on perceived but possibly incorrect information as seen by the marginal investor. From these definitions, you can see that a stock’s “true long-run value” is more closely related to its intrinsic value rather than its current price.

1-4Equilibrium is the situation where the actual...
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