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THE CORPORATION

THE CORPORATION. Legal entity created to sell goods and/or services. Owned by shareholders who purchase its stock. Possible returns to shareholders: 1) dividends 2) stock price appreciation. FINANCE DECISIONS. Investment Financing Dividend. Investment.

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THE CORPORATION

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  1. THE CORPORATION • Legal entity created to sell goods and/or services. • Owned by shareholders who purchase its stock. • Possible returns to shareholders: • 1) dividends • 2) stock price appreciation

  2. FINANCE DECISIONS • Investment • Financing • Dividend

  3. Investment • What assets does the company need to accomplish its mission? • Buildings, machinery, equipment? (Ch 7 and Ch 8) • Cash, accounts receivable, inventory? (Ch 9)

  4. Financing • How should firm’s assets be financed? • Liabilities (debt) or Equity (selling new stock or reinvesting profits)? • What is best mix of debt and equity? • Valuation (Ch 5); Cost of Capital (Ch 6)

  5. Dividend • What to do with Earnings After Taxes (profit, net income)? • Pay dividends to stockholders? • Reinvest into company (retained earnings)? • Some combination of both?

  6. Goal of Financial Management • Most people would say goal is to maximize profits • Profits when? - this quarter, this year, next 5 years… • Which measure of profit to use? - net income, income before extraordinary items, EPS…

  7. Better Goal • Who owns firm? • Stockholders. • Why do they buy stock? • To gain financially when stock price goes up (buy low, sell high) • Goal: MAXIMIZE STOCK PRICE

  8. Advantages of Stock Price Maximization as a Goal • Easy to measure • Readily available • Provides immediate feedback on how market values decisions of firm’s managers

  9. Disadvantage of Stock Price Maximization as a Goal • Majority of stocks owned by institutional investors • Managers of institutional funds push for short-term returns • When corporate managers focus on short-term stock price maximization, they may make decisions harmful to the corporation in the long-run.

  10. Examples of Institutional Investors • Mutual Funds • Hedge Funds • Private Equity Funds • Sovereign Wealth Funds • Pension Plans • Insurance Companies • Endowment Funds

  11. Stakeholders in a corporation • Shareholders (individuals + institutions) • Employees, including managers • Customers • Suppliers • Community • Creditors • Government

  12. Stakeholder Theory • Says that managers should make decisions that maximize interests of all stakeholders • Example: UAW got BIG 3 Auto Makers to give big concessions in 1970s • Look how that turned out in long-run for everyone!

  13. Agency Theory • Managers are agents of stockholders (principal) • Managers sometimes act in own interest instead of stockholders’ • Adelphia, Enron, Global Crossing, Qwest, Tyco, WorldCom, to name a few • Agency costs – making sure that managers are acting appropriately; e.g. auditing

  14. Long-term Decision Making • All stakeholders, including employees, managers, and stockholders, have an interest in the continued operation of a corporation • Managers should make decisions that maximize stock price in the long-run • Taking the long view benefits all stakeholders

  15. 3 Steps to Follow in Making Financial Decisions • Estimate impact of decision on future cash flows • Adjust future cash flows for time value of money (Ch 3) • Adjust future cash flows for risk (chance that actual cash flow will not be what is expected) (Ch 4)

  16. Where We Are Headed • Ch 2: Overview of Financial Markets • Ch 3: Time Value of Money • Ch 4: Risk • Ch 5 and Ch 6 – Financing Decision • Ch 7, 8, 9 – Investment Decision • Ch 10 – Financial Statement Analysis • Ch 11 – Financial Planning

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