Laguna State Polytechnic University- Los Baños Laguna (LSPU-LBC)

SPECIAL TOPICS IN FINANCIAL MANAGEMENT

BSBA 3A

Material no. 1 Nicole S.A Parducho,CTT,MRITax,MBA

AN OVERVIEW OF FINANCIAL MANAGEMENT

Expected Learning Outcomes:

After studying the chapter, you should be able understand:

• What is finance: cash flows between capital markets and firm’s operations
• The goal of a firm
• Forms of business organization
• Intrinsic value and market price of a stock
• Important business trends
• Business ethics
• Agency problem

What is finance: cash flows between capital markets and firm’s operations

(2) (1)
Firm’s Capital
O peration Financial ( 4 a) M arkets
( Real Assets ) M anagers ( Financial
(3) (4 b) A ssets)

(1) Cash raised by selling financial assets in financial markets

(2) Cash invested in firm’s operations and used to purchase real assets
(3) Cash generated from firm’s operations
(4a) Cash reinvested in firms’ operations
(4b) Cash returned to investors

Financing decisions vs. investment decisions: raising money vs. allocating money
o Activity (1) is a financing decision
o Activity (2) is an investment decision
o Activities (4a) and (4b) are financing decisions

The role of a financial manager

o Forecasting and planning of firms’ financial needs
o Making financing and investment decisions
o Coordinating with other departments/divisions
o Dealing with financial markets
o Managing risks
 Laguna State Polytechnic University- Los Baños Laguna (LSPU-LBC)
SPECIAL TOPICS IN FINANCIAL MANAGEMENT
BSBA 3A

Material no. 1 Nicole S.A Parducho,CTT,MRITax,MBA

AN OVERVIEW OF FINANCIAL MANAGEMENT

Finance within an organization

Finance includes three areas

(1) Financial management: corporate finance, which deals with decisions related to how much
and what types of assets a firm needs to acquire, how a firm should raise capital to
purchase assets, and how a firm should do to maximize its shareholders wealth - the
focus of this class

(2) Capital markets: study of financial markets and institutions, which deals with interest rates,
stocks, bonds, government securities, and other marketable securities. It also covers
Federal Reserve System and its policies.

(3) Investments: study of security analysis, portfolio theory, market analysis, and
behavioral finance

The goal of a firm

To maximize shareholder’s wealth (or firm’s long-run value)
Question: Why not profit or EPS maximization?
 Laguna State Polytechnic University- Los Baños Laguna (LSPU-LBC)
SPECIAL TOPICS IN FINANCIAL MANAGEMENT
BSBA 3A

Material no. 1 Nicole S.A Parducho,CTT,MRITax,MBA

AN OVERVIEW OF FINANCIAL MANAGEMENT

Answer: Profit maximization usually ignores timing and risk of cash flows
EPS sometimes can be manipulated or misleading

Forms of business organization

➢ Proprietorship: an unincorporated business owned by one individual
Advantages:
Easy and inexpensive to form
Subject to less government regulations
Lower income taxes

Disadvantages:
Unlimited personal liability
Limited lifetime of business
Difficult to raise capital

➢ Partnership: an unincorporated business owned by two or more people

Advantages vs. disadvantages: similar to those of proprietorship, in general

➢ Corporation: legal entity created by a state

Advantages:
Limited liability
Easy to transfer the ownership
Unlimited lifetime of business
Easy to raise capital

Disadvantages:
Double taxation (at both corporate and individual levels)
Cost of reporting

Corporation: allows small business to be taxed as proprietorship or partnership

Restrictions: no more than 100 shareholders; for small and privately owned firms

➢ Limited Liability Company (LLC) and Limited Liability Partnership (LLP):

Hybrid between a partnership and a corporation - limited liability but taxed
as partnership

o LLPs are used in professional fields of accounting, law, and architecture while
o LLCs are used by other businesses
 Laguna State Polytechnic University- Los Baños Laguna (LSPU-LBC)
SPECIAL TOPICS IN FINANCIAL MANAGEMENT
BSBA 3A

Material no. 1 Nicole S.A Parducho,CTT,MRITax,MBA

AN OVERVIEW OF FINANCIAL MANAGEMENT

Intrinsic value and market price of a stock

o Intrinsic value is an estimate of a stock’s “fair” value (how much a stock should be
worth)

o Market price is the actual price of a stock, which is determined by the demand and
supply of the stock in the market

Determinants of intrinsic value and stock price

o Intrinsic value is supposed to be estimated using the “true” or accurate risk and
return data. However, since sometimes the “true” or accurate data is not directly
observable, the intrinsic value cannot be measured precisely.

o Market value is based on perceived risk and return data. Since the perceived risk
and return may not be equal to the “true” risk and return, the market value can be
mispriced as well.
 Laguna State Polytechnic University- Los Baños Laguna (LSPU-LBC)
SPECIAL TOPICS IN FINANCIAL MANAGEMENT
BSBA 3A

Material no. 1 Nicole S.A Parducho,CTT,MRITax,MBA

AN OVERVIEW OF FINANCIAL MANAGEMENT

o Stock in equilibrium: when a stock’s market price is equal to its intrinsic value the
stock is in equilibrium

o Stock market in equilibrium: when all the stocks in the market are in equilibrium
(i.e. for each stock in the market, the market price is equal to its intrinsic value)
then the market is in equilibrium

Actual prices vs. intrinsic values

o When the intrinsic value of a stock is higher than the market price of the stock, we
say that the stock in the market is under-valued (under-priced)
For example, if the intrinsic value for a stock is $26 and the market price is $25, then the
stock is under-valued.

o When the intrinsic value of a stock is lower than the market price of the stock, we
say that the stock in the market is over-valued (over-priced)
For example, if the intrinsic value for a stock is $30 and the market price is $32, then the
stock is over-valued.
 Laguna State Polytechnic University- Los Baños Laguna (LSPU-LBC)
SPECIAL TOPICS IN FINANCIAL MANAGEMENT
BSBA 3A

Material no. 1 Nicole S.A Parducho,CTT,MRITax,MBA

AN OVERVIEW OF FINANCIAL MANAGEMENT

o When the intrinsic value of a stock is equal to the market price of the stock, we say
that the stock in the market is fairly priced (the stock is in equilibrium)

Important business trends

o Globalization
o Improving information technology
o Corporate governance

Business ethics
Standards of conduct or moral behavior toward its employees, customers, community, and
stockholders - all its stakeholders

Measurements: tendency of its employees, adhere to laws and regulations, moral

standards to product safety and quality, fair employment practice, fair marketing and selling
practice, proper use of confidential information, community involvement, and no illegal payments
or practice to obtain business

Agency problem
A potential conflict of interest between two groups of people

Stockholders vs. managers

o Instead of shareholders’ wealth maximization, managers may be interested in their own
wealth maximization

o Incentives:
Performance shares, executive stock options (positive)
Threat of firing, hostile takeover (negative)

o Stockholders vs. bondholders

Stockholders prefer high-risk projects for higher returns
Bondholders receive fixed payment and therefore prefer lower risk projects