Chapter 1 Notes

Chapter 1 Notes
The Role of the Financial Manager

- Maximize Shareholder Wealth
o Maximizing the price of a firm’s stock will maximize the value of
a firm and the wealth of its shareholders/owner
- Stakeholders
o Manager, employees, suppliers, creditors, and the government
o Positive residual cash flow may be paid to firm owners as
dividends or invest in the firm. (The Larger the positive residual
cash flow, the greater the value of a firm)
o Negative residual cash flow, over the long run, leads to
bankruptcy or closing a business
- 3 Fundamental Decisions in Financial Manager
o Capital Budgeting: Identify which long-term assets to acquire to
maximize net benefits for the firm
o Financing: determine how to pay for a short-term and long-term
assets by finding the best combination of short-term debt, long-
term debt, and equity
o Working capital: decide how to manager short-term resources
and obligations by adjusting current assets and current liabilities
to promote growth in cash flow
o
- Forms of Business Organization
o Sole Proprietorships
 Owned by a single person who is financially responsible for
the actions and obligations of the business
 Advantages are ; easiest to create and control, easiest to
dissolve, & right to all profits
 Disadvantage’s; owner’s personal assets at risk due to
unlimited liability for firm obligations, equity only from
owner or business profits, business income taxes as
personal income, & difficult to transfer ownership
o Partnerships
 A business owned by more than one person; one or more
of them is financially responsible for the actions and
obligations of the business
 Advantages; limited protection of owner’s personal assets,
owner’s limited liability for firm obligations, more sources
of equity and expertise
 Disadvantages; shared control & shared profit harder to
dissolve
o Corporations
 A business owner by more than on person; none of them
are financially responsible for the actions and obligations of
the business.
 Advantages; protect personal assets, no shareholder
liability for business, easiest to change ownership, & great
access to source of funds
 Disadvantages; most difficult and expensive to establish,
dilutes individual control over the firm, & overall higher
taxes on income for shareholders
Managing the Financial Function
- Organizational Structure
- Chief Financial Officer ( CFO ) , responsible for the quality of the
financial reports received by the Chief Executive Officer ( CEO )
- Positions Reporting to the CFO
o Treasurer
o Risk Manager
o Controller
o Internal Auditor
- External Auditor
- Audit Committee
- Compliance and Ethics Director
Agency Relationship is created when the owner ( a principal ) of a

business hires an employee ( an agent )
o The owner surrenders some control over the enterprise and it's
resource to the employee
o Separating ownership from control creates the potential for
agency conflicts
Agency Conflicts
- An agency relationship exists between stockholders ( principals ) and
the firm’s hired management ( agents )
Agency Costs
- Agency costs are costs that arise from incurring and preventing
conflicts of interest between a firm’s owners and it's managers
- The cost may reduce positive residual cash flow, stock price, and
shareholder wealth
- Agency costs can be reduced by
o Increased oversight
o Aligning incentives
Aligning the interests of managers and stockholders
- Board of Directors has oversight over the CEO and major capital
decisions
The importance of ethics in business
- Ethics are society’s standards for judging whether an action is right or
wrong. Business Ethics are society’s standards for acceptable behavior
applied to business and financial markets
Examples of Ethical Conflict In Business
- Agency Cost
o Employee’s Unacceptable use of em
Golden rule = ethical norm
Goal of the firm is to maximing the market price of the share
Which of the following would generally NOT increase shareholders' wealth? –
government regulation
Which of the following business organizational forms create(s) a tax liability
on income at the personal income tax rate? Sole propiertionsip &
partnership
Which form(s) of business organization generate(s) the majority of business
revenues and profits in the United States?- Corporations
In a public corporation, which of the following reports directly to the owners
of a firm? – Directors
Information asymmetry _occur(s) when one party in a business
transaction has information that is unavailable to the other parties in the
transaction.
Which of the following is NOT one of the goals of the Sarbanes-Oxley Act of
2002? Is compensation levels
An example of an agency cost is: a manager expensing a lavish dinner on
the company expense report.
Which organizational form best enables the owners of a firm to monitor the
professional conduct of each other owners of the firm? Partnership
Who among the following is the "agent" in the agency relationship of a
corporation? CEO
Stakeholder is someone who has claim on cash of the firm
Which of the following is responsible for performing an independent audit of
a firm's financial statements? External auditor
A good capital budgeting decision is: one in which the perceived benefits
of the project are more than the cost of the asset.
If a firm has had an agency conflict which is reflected by a poor
performing stock for a long period of time, then the firm may
become a target of: A corporate raider

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The Role of the Financial Manager

Agency Relationship is created when the owner ( a principal ) of a

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