1-The Role of Managerial Finance(Modified 4) 2-Time value of money(modified 1) 3-Capital Budgeting(Modified 1) [Repaired] 4-Stock Valuation(modified 1) MBA Assignments

1. The Role of
Managerial
Finance

2. What is Finance?
 Finance can be defined as the science and art of
managing money.
 In a business context, finance involves:
• how firms raise money from investors
• how firms invest money in an attempt to earn a profit
• how firms decide whether to reinvest profits in the business
or distribute them back to investors.

3. Career Opportunities in Finance:
Managerial Finance
 Managerial finance is concerned with the duties of the
financial manager working in a business.
 Financial managers administer the financial affairs of all
types of businesses—private and public, large and small,
profit-seeking and not-for-profit. Tasks include:
• developing a financial plan or budget
• extending credit to customers
• evaluating proposed large expenditures
• raising money to fund the firm’s operations.

4. Goal of the Firm:
Maximize Shareholder Wealth
 Decision rule for managers: only take actions that are
expected to increase the share price.

5. Goal of the Firm:
Maximize Profit?
 Profit maximization may not lead to the highest possible share price
for at least three reasons:
1. Timing is important—the receipt of funds sooner rather than later is
preferred
2. Profits do not necessarily result in cash flows available to stockholders
3. Profit maximization fails to account for risk
Which Investment is Preferred?

6. Managerial Finance Function:
Relationship to Economics
 The field of finance is closely related to economics.
 Financial managers must understand the economic
framework and be alert to the consequences of varying
levels of economic activity and changes in economic
policy.
 They must also be able to use economic theories as
guidelines for efficient business operation.

7. Managerial Finance Function:
Relationship to Accounting
 The firm’s finance and accounting activities are closely-
related and generally overlap.
 In small firms accountants often carry out the finance
function, and in large firms financial analysts often help
compile accounting information.
 One major difference in perspective and emphasis
between finance and accounting is that accountants
generally use the accrual method while in finance, the
focus is on cash flows.
 Whether a firm earns a profit or experiences a loss, it
must have a sufficient flow of cash to meet its obligations
as they come due.

8. Managerial Finance Function:
Relationship to Accounting (cont.)
The Nassau Corporation experienced the following activity
last year:
Sales: $100,000 (1 yacht sold, 100% still uncollected)
Costs: $80,000 (all paid in full under supplier terms)

9. Managerial Finance Function:
Relationship to Accounting (cont.)
Now contrast the differences in performance under the
accounting method (accrual basis) versus the financial view
(cash basis):

10. Managerial Finance Function:
Relationship to Accounting (cont.)
Finance and accounting also differ with respect to decision-
making:
 Accountants devote most of their attention to the collection
and presentation of financial data.
 Financial managers evaluate the accounting statements,
develop additional data, and make decisions on the basis of
their assessment of the associated returns and risks.

11. Governance and Agency:
Corporate Governance
 Corporate governance refers to the rules, processes, and
laws by which companies are operated, controlled, and
regulated.
 It defines the rights and responsibilities of the corporate
participants such as the shareholders, board of directors,
officers and managers, and other stakeholders, as well as
the rules and procedures for making corporate decisions.

12. Governance and Agency:
Government Regulation
 Government regulation generally shapes the corporate
governance of all firms.
 During the recent decade, corporate governance has
received increased attention due to several high-profile
corporate scandals involving abuse of corporate power
and, in some cases, alleged criminal activity by corporate
officers.

13. Governance and Agency:
Government Regulation
The Sarbanes-Oxley Act of 2002:
 established an oversight board to monitor the accounting
industry;
 tightened audit regulations and controls;
 toughened penalties against executives who commit
corporate fraud;
 strengthened accounting disclosure requirements and ethical
guidelines for corporate officers;
 established corporate board structure and membership
guidelines;
 established guidelines with regard to analyst conflicts of
interest;
 mandated instant disclosure of stock sales by corporate
executives;
 increased securities regulation authority and budgets for
auditors and investigators.

14. Governance and Agency:
The Agency Issue
 A principal-agent relationship is an arrangement in
which an agent acts on the behalf of a principal. For
example, shareholders of a company (principals) elect
management (agents) to act on their behalf.
 Agency problems arise when managers place personal
goals ahead of the goals of shareholders.
 Agency costs arise from agency problems that are borne
by shareholders and represent a loss of shareholder
wealth.

15. The Financial Market
Environment

16. Financial Institutions & Markets
Firms that require funds from external sources can obtain
them in three ways:
1. through a financial institution
2. through financial markets
3. through private placements

17. Financial Institutions & Markets:
Financial Institutions
 Financial institutions are intermediaries that channel the
savings of individuals, businesses, and governments into
loans or investments.
 The key suppliers and demanders of funds are individuals,
businesses, and governments.
 In general, individuals are net suppliers of funds, while
businesses and governments are net demanders of funds.

18. Commercial Banks, Investment
Banks, and the Shadow Banking
System
 Commercial banks are institutions that:
 provide savers with a secure place to invest their funds
 offer loans to individual and business borrowers
 Investment banks are institutions that:
 assist companies in raising capital
 advise firms on major transactions such as mergers or
financial restructurings
 engage in trading and market making activities

19. Financial Institutions & Markets:
Financial Markets
 Financial markets are forums in which suppliers of funds
and demanders of funds can transact business directly.
 Transactions in short term marketable securities take
place in the money market while transactions in long-
term securities take place in the capital market.
 A private placement involves the sale of a new security
directly to an investor or group of investors.
 Most firms, however, raise money through a public
offering of securities, which is the sale of either bonds or
stocks to the general public.

20. Financial Institutions & Markets:
Financial Markets (cont.)
 The primary market is the financial market in which
securities are initially issued; the only market in which the
issuer is directly involved in the transaction.
 Secondary markets are financial markets in which
preowned securities (those that are not new issues) are
traded.

21. The Money Market
 The money market is created by a financial relationship
between suppliers and demanders of short-term funds.
 Most money market transactions are made in
marketable securities which are short-term debt
instruments, such as:
• Treasury bills issued by the government
• commercial paper issued by businesses
 Investors generally consider marketable securities to be
among the least risky investments available.

22. The Capital Market
 The capital market is a market that enables suppliers
and demanders of long-term funds to make transactions.
 The key capital market securities are bonds (long-term
debt) and both common and preferred stock (equity, or
ownership).
 Bonds are long-term debt instruments used by businesses
and government to raise large sums of money, generally
from a diverse group of lenders.
 Common stock are units of ownership interest or equity in a
corporation.
 Preferred stock is a special form of ownership that has
features of both a bond and common stock.

23. The Role of Capital Markets
 From a firm’s perspective, the role of capital markets is to
be a liquid market where firms can interact with investors
in order to obtain valuable external financing resources.
 From investors’ perspectives, the role of capital markets
is to be an efficient market that allocates funds to their
most productive uses.
 An efficient market allocates funds to their most
productive uses as a result of competition among wealth-
maximizing investors and determines and publicizes
prices that are believed to be close to their true value.

24. Integrative Case: Merit Enterprise
Corp.
Merit Enterprise Corporation ’ s CEO would like to
dramatically expand the company’s production capacity.
This would require the company to raise up to $4 billion in
addition to the $2 billion of excess cash that they have
accumulated. Merit is currently a private company and is
considering two options for raising the much needed capital.

25. Integrative Case: Merit Enterprise
Corp.
Option 1 – Merit could approach JPMorgan Chase, a bank
that had served Merit well for many years with seasonal
credit lines as well as medium-term loans. Lehn believed
that JPMorgan was unlikely to make a $4 billion loan to
Merit on its own, but it could probably gather a group of
banks together to make a loan of this magnitude.
However, the banks would undoubtedly demand that
Merit limit further borrowing and provide JPMorgan with
periodic financial disclosures so that they could monitor
Merit’s financial condition as it expanded its operations.

26. Integrative Case: Merit Enterprise
Corp.
Option 2 – Merit could convert to public ownership, issuing
stock to the public in the primary market. With Merit’s
excellent financial performance in recent years, Sara
thought that its stock could command a high price in the
market and that many investors would want to participate
in any stock offering that Merit conducted.

27. Integrative Case: Merit Enterprise
Corp.
a. Discuss the pros and cons of option 1, and prioritize your thoughts. What
are the most positive aspects of this option, and what are the biggest
drawbacks?
b. Do the same for option 2.
c. Which option do you think Sara should recommend to the board and why?