Chapter 1
The Financial Manager and the Firm

Learning Objectives

1. Identify the key financial decisions facing the financial manager of any business firm.
2. Identify the basic forms of business organization used in the United States, and review their respective strengths and weaknesses.
3. Describe the typical organization of the financial function in a large corporation.
4. Explain why maximizing the current value of the firm’s stock price is the appropriate goal for management.
5. Discuss how agency conflicts affect the goal of maximizing stockholder wealth.
6. Explain why ethics is an appropriate topic in the study of corporate finance.

I. Chapter Outline
1.1 The Role of the Financial Manager
A. It’s All about Cash Flows
The financial manager is responsible for making decisions that are in the best interest of the firm’s owners.
A firm generates cash flows by selling the goods and services produced by its productive assets and human capital. After meeting its obligations, the firm can pay the remaining cash, called residual cash flows, to the owners as a cash dividend, or it can keep the money and reinvest the cash in the business.
A firm is unprofitable when it fails to generate sufficient cash flows to pay operating expenses, creditors, and taxes. Firms that are unprofitable over time will be forced into bankruptcy by their creditors. In bankruptcy, the company will be reorganized, or the company’s assets will be liquidated, whichever is more valuable. If anything is left after all creditor and tax claims have been satisfied, which usually does not happen, the remaining cash, or residual, is distributed to the owners.

B. Three Fundamental Decisions in Financial Management
The capital budgeting decision: Which productive assets should the firm buy? This the most important decision because they drive the firm’s success or failure.
The financing decision: How should the firm finance or pay for assets?
Working capital management decisions: How should day-to-day financial matters be managed so that the firm can pay its bills, and how should surplus cash be invested?

1.2 Forms of Business Organization
A. A sole proprietorship is a business owned by one person.
There is also no legal distinction between personal and business income for a sole proprietor.
All business income is taxed as personal income.
A sole proprietor is responsible for paying all the firm’s bills and has unlimited liability for all business debts and other obligations of the firm.

B. A partnership consists of two or more owners joined together legally to manage a business.
A general partnership has the same basic advantages and disadvantages as a sole proprietorship.
When a transfer of ownership takes place, such as when a partner wants to sell out, the partnership is terminated, and a new partnership is formed.
The problem of unlimited liability can be avoided in a limited partnership where there must still be a general partner with unlimited liability.

C. Corporations are legal entities authorized under a state charter.
In a legal sense, it is a “person” distinct from its owners.
The owners of a corporation are its stockholders, or shareholders.
A major advantage of the corporate form of business is that stockholders have limited liability for debts and other obligations of the corporation.
A major disadvantage of corporate organization is taxes.
The owners of corporations are subject to double taxation—first at the corporate level and then at the personal level when dividends are paid to them.
Some operate as a public corporation, which can sell their debt or equity in the public securities markets.
Others operate as a private corporation, where the common stock is often held by a small number of investors, typically the management and wealthy private backers.

D. Hybrid Forms of Business Organization
Limited liability partnerships (LLPs) combine the limited liability of a corporation with the tax advantage of a partnership—there is no