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THE CORPORATION

This comprehensive overview delves into the fundamentals of corporations, highlighting their role as legal entities created to sell goods and services. It explores ownership by shareholders, potential returns, and the essential finance decisions that shape corporate strategies, including investments, financing options, and the utilization of earnings. The text discusses the goal of maximizing stock prices, the implications for stakeholders, and the importance of risk and time value in financial decisions. A holistic understanding empowers effective management and long-term planning.

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THE CORPORATION

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Presentation Transcript

  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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