Chapter 1
Introduction to Financial
Management
Forms of Business Organization
Stock Prices and Shareholder Value
Intrinsic Values, Stock Prices, and
Executive Compensation
Important Business Trends
Conflicts Between Managers,
Stockholders, and Bondholders
1-1
Finance Within the
Organization
1-2
Forms of Business
Organization
Proprietorship
Partnership
Corporation
1-3
Proprietorships and
Partnerships
Advantages
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages
Difficult to raise capital
Unlimited liability
Limited life
1-4
Corporation
Advantages
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages
Double taxation
Cost of set-up and report filing
1-5
Stock Prices and Shareholder
Value
The primary financial goal of management is shareholder wealth maximization, which translates to maximizing stock price.
Value of any asset is present value of cash flow stream to owners.
Most significant decisions are evaluated in terms of their financial consequences.
Stock prices change over time as conditions change and as investors obtain new information about a company’s prospects.
1-6
Stock Prices and Intrinsic Value
In equilibrium, a stock’s price should equal its “true” or intrinsic value.
Intrinsic value is a long-run concept.
To the extent that investor perceptions are incorrect, a stock’s price in the short run may deviate from its intrinsic value.
Ideally, managers should avoid actions that reduce intrinsic value, even if those decisions increase the stock price in the short run.
1-7
Determinants of Intrinsic Values and Stock Prices
Managerial Actions, the Economic
Environment, Taxes, and the Political
Climate
“True”
Risk
“Perceived”
Investor
Returns
Stock’s
Intrinsic
Value
“Perceived”
Risk
Stock’s
Market Price
Market Equilibrium:
Intrinsic Value = Stock
Price
