BUS 106

INTRODUCTION TO FINANCIAL MANAGEMENT

Spring 2016
Y. Peter Chung

University of California,
Riverside

INTRODUCTION
Professor Peter Chung

The goal of the firm:

maximization of shareholders' wealth
Financial managers task:
Raising

and

Financing decision
Cost of capital
Equity vs. bond
financing
Capital structure
decision
Dividend policy

Allocatin
financial capital
g
Capital budgeting
decision
Valuation
(asset&project)
Working capital
mgmt

Profit vs. Value maximization rules

1. Uncertainty of companys
return
State of economy
Better
Same
Worse
Expected outcome

Project A
$ 10,000.00
$ 10,000.00
$ 10,000.00
$ 10,000.00

Project B
$ 20,000.00
$ 10,000.00
$0
$ 10,000.00

2. Time Value of Money

Year 1

Project X
Project Y
$ 10,000.00 $ 0

.
.
.

Year 5
$ 2,000.00 $ 10,000.00
Average annual profit
$ 2,000.00 $ 2,000.00

If 1 and 2 are ignored, as in the case with profit

maximization, the firm would make incorrect investment
(capital budgeting) decisions.
Then, the financial managers would be:
Financial manager should try to maximize
.

Maximization of Shareholder Wealth (maximization of

the total market value of the firm's common stock)
The historic stock price that the current shareholders
paid for or the book value of the stock does not properly
represent
The existence of the well-functioning market guarantees
that the market price fully aggregates relevant
information, including information conveyed by all
financial decisions (called 'efficient market hypothesis'),
and hence

Agency Problem
The agency problem is result of the separation between

As a result, managers may make decisions

Agency
relationship

An agency relationship arises whenever one or more

individuals, called principals, hire one or more
individuals, called agents, to perform some service and
then
.
Agency
conflicts

A potential conflict arises whenever the manager of a

firm owns

Agency

costs
Expenditures to
Expenditures to
undesirable managerial behavior
Opportunity costs of
Agency cost
reduction
Performance-based
Direct intervention by
The threat of
The threat of

Do top managers in the U.S. have any incentives to

maximize stock price?
Managers often
.
Stock option plans are
Changes in salary and bonus are related to
Poorly performing firms
Poorly performing firms attract attention of