Introduction to the Foundations of Financial Management

The goal of a firm is to create value for the firm’s owners, which refers to its shareholders.
Specifically, the objective is to “maximize shareholder wealth” by maximizing the price of the existing common stock.
Financial decisions are judged by their impact on stock price: good decisions will increase the price, while poor decisions will lead to a decline.

Accounting profits are not equal to cash flows. A firm can generate significant accounting profits and yet have no cash or fail to generate actual cash flows.
Business value is determined by cash flow rather than accounting profits.
Financial decisions must be based on incremental or marginal cash flows.
Incremental cash flow is defined verbatim as the difference between the projected cash flows if the project is selected versus what they will be if the project is not selected.

A dollar received today is worth more than a dollar received in the future.
This is because money received today can earn interest, making it better to receive money sooner rather than later.
Opportunity Cost is defined as the cost of making a choice in terms of the next best alternative that must be forgone.
Example: By lending money to a friend at $0\,\%$ interest, there is an opportunity cost of $1\,\%$ that could potentially be earned by depositing that money into a bank savings account.

Investors will not take on additional risk unless they expect to be compensated with additional reward or return.
Investors expect to be compensated for two specific things: “delaying consumption” and “taking on risk.”
Consequently, investors expect a return when they deposit savings in a bank (compensating for delayed consumption) and expect a relatively higher rate of return on stocks compared to a bank savings account (compensating for taking on risk).
Figure 1.1 The Risk-Return Trade-off: Expected return is composed of the expected return for delaying consumption plus the additional expected return for taking on added risk.

In an efficient market, the market prices of all traded assets (such as stocks and bonds) fully reflect all available information at any moment in time.
Stock prices serve as a useful indicator of the company's value; price changes reflect changes in expected future cash flows.
Inefficiencies may exist that distort market prices from the actual value of assets. These are often caused by behavioral biases.

The separation of management and ownership creates an agency problem, where managers may make decisions inconsistent with maximizing shareholder wealth.
Agency conflict is reduced through: - Monitoring (e.g., annual reports). - Compensation schemes (e.g., stock options). - Market mechanisms (e.g., takeovers).

Ethical behavior is defined as doing the right thing.
Ethical dilemma: Each person possesses a unique set of values, forming a basis for personal judgments about what the right thing is.
Sound ethical standards are vital for both business and personal success. Unethical decisions, such as those in the Enron scandal, can destroy shareholder wealth.

Finance addresses three basic issues: 1. Capital budgeting decision: What long-term investments should the firm undertake? 2. Capital structure decision: How should the firm raise money to fund these investments? 3. Working capital decision: How should cash flows arising from day-to-day operations be managed?
Financial tools are relevant for decision-making in all areas of business (including marketing and production) and for managing personal finances.
Financial tools help adjust for time and risk and help determine the financial viability of business decisions.

Sole Proprietorship: - Business owned by a single individual. - Owner maintains title to all assets and profits. - Owner has unlimited liability. - Termination occurs upon the owner’s death or choice.
Partnership: - Two or more persons as co-owners. - General Partnership: All partners are fully responsible for liabilities incurred. - Limited Partnership: One or more partners have limited liability restricted to their invested capital. There must be at least one general partner with unlimited liability. Limited partners cannot manage the business or have their names in the firm's name.
Corporation: - Functions legally as a separate entity from its owners. - Can sue/be sued, purchase, sell, and own property. - Shareholders dictate direction via an elected Board of Directors. - Liability restricted to the amount of investment. - Lifetime is independent of owners; run by managers after ownership transfer. - Benefits: Limited liability, easy ownership transfer, easier capital raising, unlimited life (excluding mergers or bankruptcies). - Drawbacks: No secrecy of information, potential decision-making delays, greater regulation, double taxation.

S-Type Corporations: - Benefits: Limited liability and taxed as a partnership (no double taxation). - Limitations: Cannot be used for a joint venture between two corporations. Maximum of $100$ owners.
Limited Liability Companies (LLC): - Benefits: Limited liability and taxed like a partnership. - Limitations: Qualifications vary by state; must not appear too much like a corporation to avoid being taxed as one.
Double Taxation Example: - Assume Earnings Before Tax = $\text{\$1,000}$ - Federal Tax at $25\,\%$ = $\text{\$250}$ - After-tax income available for distribution = $\text{\$750}$ - Dividend Tax calculation (at $15\,\%$ ) = $\text{\$750} \times 0.15 = \text{\$112.50}$

Sole Proprietorship: One owner; owner is liable; ownership change dissolves the firm; Personal/Pass-Through taxation.
General Partnership: No limit on owners; each partner liable for the entire amount; ownership change dissolves the firm; Personal/Pass-Through taxation.
Limited Partnership: At least one general partner (GP) and no limit on limited partners (LP); GP is liable, LP is not; GP change dissolves the firm, LP change does not; Personal/Pass-Through taxation.
Corporation: No limit on owners; owners not liable; ownership change does not dissolve the firm; both corporate and personal taxes.
S-corporation: Maximum of $100$ owners; owners not liable; ownership change does not dissolve the firm; Personal/Pass-Through taxation.
Limited Liability Company: No limit on owners; owners not liable; ownership change does not dissolve the firm; Personal/Pass-Through taxation.

Companies like Coca-Cola receive significant profits from overseas sales.
U.S. firms look for international expansion to discover profits.
Foreign firms also mark the U.S. market, specifically the auto industry dominated by Toyota, Honda, Nissan, and BMW.

Finance is a necessary skill for any career choice.
Skills developed in this course include: - Critical thinking skills. - Excel skills. - Data analysis skills. - Collaboration and communication skills.