Fundaments of Financial Management

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Lesson 1

Chapter 1 : Outline

1.1 What is Corporate Finance ?

Some important questions that are answered using finance
• What long-term investments should the firm take on?
• Where will we get the long-term financing to pay for the investment? • How will we manage the everyday financial activities of the firm?

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

Financial Management Decisions

Capital budgeting
• Should you take a particular project?
• What is this project worth?
Capital structure
• To undertake project investments, should you borrow money (debt) or sell a share to partners (equity) or finance it yourself (if you can)? • How can/should a manager finance projects and disperse funds? Working capital management

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

1.2 Forms of Business Administration

Three major forms in Canada
• Sole proprietorship
• Partnership
• General
• Limited
• Corporation
• In other countries, corporations are also called joint stock companies, public limited companies and limited liability companies

SOLE PROPRIETORSHIP A business owned by a single individual | Advantages • Easiest to start • Least regulated • Single owner keeps all the profits • Taxed once as personal income | Disadvantages • Unlimited liability • Limited to life of owner • Equity capital limited to owner’s personal wealth • Difficult to sell ownership interest |

PARTNERSHIP A business formed by two or more co-owners |
Advantages • Two or more owners • More human and financial capital available • Relatively easy to start • Income taxed once as personal income | Disadvantages • Unlimited liability• General partnership • Limited partnership • Partnership dissolves when one partner dies or wishes to sell • Difficult to transfer ownership • Possible disagreements between partners |

CORPORATION A business created as a distinct legal entity owned by one or more individuals or entities. | Advantages • Limited liability • Unlimited life • Separation of ownership and management • Transfer of ownership is easy • Easier to raise capital | Disadvantages • Separation of ownership and management • Double taxation (income is taxed at the corporate rate and then dividends are taxed at the personal rate) |

Income Trust

• Holds the debt and equity of an underlying business.
• Distributes the income generated to the unit-holders.
• Until 2011, income was not taxed at corporate level.
• Not a corporation, but unit-holders do have limited liability protection. • Many income trusts are now converting to corporations.
1.3 Goal of Financial Management

What should be the enterprise’s goal when making financial decision? It should maximize: customer satisfaction, environmental quality, sales revenue, the value of its shares, market share?

• Maximize profit?
• Minimize costs?
• Maximize market share?
• Maximize the current value of the company’s stock?

Does this mean we should do anything and everything to maximize owner wealth? Maximizing the company’s value.

Primary Goal of Financial Management
Three equivalent goals of financial management:
• Maximize shareholder wealth
• Maximize share price
• Maximize firm value

1.4 Agency Problems
-related to problems in the relationship between stake holders. Conflicts because the goals are not aligned. The person taking the decision is not the one who suffers the consequences.

Agency relationship
• Principal hires an agent to represent their interests
• Stockholders (principals) hire...
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