The document is a chapter from a textbook on financial management. It discusses the role and goals of financial management, which include making investment, financing, and asset management decisions with the goal of maximizing shareholder wealth by increasing share price. It also covers the financial environment and markets through which funds flow from the savings sector to the investment sector.

1. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 1
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-1
Chapter 1
The Role of Financial
Management
The Role of Financial
Management
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Created by: Gregory A. Kuhlemeyer, Ph.D.
Carroll College, Waukesha, WI
1-2
What is Financial
Management?
Concerns the acquisition,
financing, and
management of assets
with some overall goal in
mind.

2. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 2
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-3
Investment Decisions
What is the optimal firm size?
What specific assets should be
acquired?
What assets (if any) should be
reduced or eliminated?
Most important of the three
decisions.
1-4
Financing Decisions
What is the best type of financing?
What is the best financing mix?
What is the best dividend policy (e.g.,
dividend-payout ratio)?
How will the funds be physically
acquired?
Determine how the assets (LHS of
balance sheet) will be financed (RHS
of balance sheet).

3. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 3
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-5
Asset Management
Decisions
How do we manage existing assets
efficiently?
Financial Manager has varying degrees
of operating responsibility over assets.
Greater emphasis on current asset
management than fixed asset
management.
1-6
What is the Goal
of the Firm?
Maximization of
Shareholder Wealth!
Value creation occurs when
we maximize the share price
for current shareholders.

4. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 4
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-7
Shortcomings of
Alternative Perspectives
Could increase current profits while
harming firm (e.g., defer maintenance,
issue common stock to buy T-bills, etc.).
Ignores changes in the risk level of the
firm.
Profit Maximization
Maximizing a firm’s earnings after taxes.
Problems
1-8
Shortcomings of
Alternative Perspectives
Does not specify timing or duration of
expected returns.
Ignores changes in the risk level of the firm.
Calls for a zero payout dividend policy.
Earnings per Share Maximization
Maximizing earnings after taxes divided
by shares outstanding.
Problems

5. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 5
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-9
Strengths of Shareholder
Wealth Maximization
Takes account of: current and future
profits and EPS; the timing,
duration, and risk of profits and EPS;
dividend policy; and all other
relevant factors.
Thus, share price serves as a
barometer for business performance.
1-10
What companies say about
their corporate goal*
Cadbury Schweppes: “governing objective is
growth in shareowner value”
Credit Suisse Group: “achieve high customer
satisfaction, maximize shareholder value and
be an employer of choice”
Dow Chemical Company: “maximize long-term
shareholder value”
ExxonMobil: “long-term, sustainable
shareholder value”
*Refer to text for additional details

6. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 6
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-11
Chapter 2
The Business, Tax,
and Financial
Environments
The Business, Tax,
and Financial
Environments
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Created by: Gregory A. Kuhlemeyer, Ph.D.
Carroll College, Waukesha, WI
1-12
Financial Environment
Businesses interact continually with
the financial markets.
Financial Markets are composed of all
institutions and procedures for
bringing buyers and sellers of financial
instruments together.
The purpose of financial markets is to
efficiently allocate savings to ultimate
users.

7. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 7
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-13
Flow of Funds
in the Economy
INVESTMENT SECTOR
FINANCIAL
INTERMEDIARIES
SAVINGS SECTOR
FINANCIAL BROKERS
SECONDARY MARKET
1-14
Flow of Funds
in the Economy
FINANCIAL
INTERMEDIARIES
SAVINGS SECTOR
FINANCIAL BROKERS
SECONDARY MARKET
INVESTMENT
SECTOR
Businesses
Government
Households
INVESTMENT SECTOR

8. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 8
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-15
Flow of Funds
in the Economy
FINANCIAL
INTERMEDIARIES
SAVINGS SECTOR
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS
SECTOR
Households
Businesses
Government
INVESTMENT SECTOR
1-16
Flow of Funds
in the Economy
FINANCIAL
INTERMEDIARIES
SAVINGS SECTOR
FINANCIAL BROKERS
SECONDARY MARKET
FINANCIAL
BROKERS
Investment
Bankers
Mortgage
Bankers
INVESTMENT SECTOR

9. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 9
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-17
Flow of Funds
in the Economy
FINANCIAL
INTERMEDIARIES
SAVINGS SECTOR
FINANCIAL BROKERS
SECONDARY MARKET
FINANCIAL
INTERMEDIARIES
Commercial Banks
Savings Institutions
Insurance Cos.
Pension Funds
Finance Companies
Mutual Funds
INVESTMENT SECTOR
1-18
Flow of Funds
in the Economy
FINANCIAL
INTERMEDIARIES
SAVINGS SECTOR
FINANCIAL BROKERS
SECONDARY MARKET
SECONDARY
MARKET
Security
Exchanges
OTC
Market
INVESTMENT SECTOR

10. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 10
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-19
Allocation of Funds
In a rational world, the highest expected
returns will be offered only by those
economic units with the most promising
investment opportunities.
Result: Savings tend to be allocated to the
most efficient uses.
Funds will flow to economic units that are
willing to provide the greatest expected
return (holding risk constant).
1-20
Risk-Expected
Return Profile
RISK
EXPECTEDRETURN(%)
U.S. Treasury Bills (risk-free securities)
Prime-grade Commercial Paper
Long-term Government Bonds
Investment-grade Corporate Bonds
Medium-grade Corporate Bonds
Preferred Stocks
Conservative Common Stocks
Speculative Common Stocks

11. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 11
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-21
What Influences Security
Expected Returns?
Marketability is the ability to sell
a significant volume of securities
in a short period of time in the
secondary market without
significant price concession.
Default Risk is the failure to meet
the terms of a contract.
1-22
Ratings by Investment
Agencies on Default Risk
MOODY’S INV SERVICE STANDARD & POOR’S
Aaa Best Quality AAA Highest Grade
Aa High Quality AA High Grade
A Upper Med Grade A Higher Med Grade
Baa Medium Grade BBB Medium Grade
Ba Possess Speculative
Elements
BB Speculative
C Lowest Grade D In Default
Investment grade represents the top four categories.
Below investment grade represents all other categories.

12. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 12
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-23
What Influences Expected
Security Returns?
Taxability considers the expected
tax consequences of the security.
Maturity is concerned with the life
of the security; the amount of
time before the principal amount
of a security becomes due.
1-24
Term Structure of
Interest Rates
A yield curve is a graph of the relationship between
yields and term to maturity for particular securities.
Upward Sloping Yield Curve
Downward Sloping Yield Curve
0246810
YIELD(%)
0 5 10 15 20 25 30
(Usual)
(Unusual)
YEARS TO MATURITY

13. Van Horne & Wachowicz,
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Chapter 1: The Role of Financial Management
I - 13
by Gregory A. Kuhlemeyer, Ph.D.,
Carroll College, Waukesha, WI
1-25
What Influences Expected
Security Returns?
Inflation is a rise in the average
level of prices of goods and
services. The greater inflation
expectations, then the greater the
expected return.
Embedded Options provide the
opportunity to change specific
attributes of the security.