Financial Management Principles, Corporate Governance, and Intrinsic Value

Primary Goal of Financial Management

• Shareholder Wealth Maximization: The primary goal of a firm is to maximize shareholder wealth, which is equivalent to maximizing the stock price and the overall market value of the firm.

• Factors Affecting Stock Price:

  • Generating productive cash flows from firm assets.

  • Optimizing the timing of cash flows.

  • Finding an optimal trade-off between risk and return.

• Key Management Decisions:

  • Selection of products and services and their delivery methods.

  • Determining the capital structure mix of debt versus equity.

  • Deciding the percentage of net income after tax to pay out as dividends versus retaining and reinvesting into the firm for growth.

• External Factors: Legal constraints, overall economic health, changes in tax laws, Federal Reserve interest rates, and stock market conditions.

• Profit Maximization vs. Wealth Maximization: Maximizing profits does not maximize shareholder wealth because achieving maximum short-term profit often requires taking on excessive debt and bankruptcy risk.

Intrinsic Value and Market Equilibrium

• Intrinsic Value: The estimated value of a stock calculated by an analyst using all available public information and growth rate expectations.

• Market Price: The current trading price of a stock in the market (e.g., Skyworks).

• Equilibrium: The state where a stock's intrinsic value equals its market price.

  • Overpriced Stock: When market price exceeds intrinsic value, investors sell the stock, causing the price to decline toward equilibrium.

  • Underpriced Stock: When market price is below intrinsic value, investor buying prompts dealers to raise prices toward equilibrium.

Global and Technological Shift Factors

• Globalization: Increased international competition requires firms to produce and sell globally, supported by communication tools like Zoom and reduced trade barriers such as the European Union.

• Development Costs: High sophistication in new medical and high-tech products raises initial development costs.

• Banking Regulations: The Glass Steagall Act was removed in 1999 to allow US commercial and investment banks to compete globally, followed by regulatory adjustments after the 08/09 financial crisis.

• Information Technology: Modern corporate roles require strong computer, quantitative, Excel, and data management skills to reduce costs and expand market reach.

Business Ethics and Social Responsibility

• Corporate Social Responsibility: Initiatives like the Ronald McDonald House by McDonald's or the children's hospital by Dell enhance public perception, customer demand, and employee retention.

• Impact of Unethical Behavior: Allegations or media reports of fraud can immediately cut a firm's stock price in half overnight (e.g., dropping from $\\n40$ to $\\n20$ per share).

• Economic Benefits of Ethics: Prevents legal fines and expenses, builds public trust, attracts quality employees, and ensures long-term profitability.

Corporate Governance and Agency Relationships

• Agency Relationship Definition: A legal structure where an asset owner (principal) grants authority to another party (agent) to enter into contracts on their behalf.

• Stockholders vs. Managers:

  • Stockholders are the principals; managers act as agents.

  • Mechanisms to Align Interests: Managerial compensation tied to performance bonuses, direct shareholder intervention, threat of firing, and SEC requirements for transparent CEO compensation.

  • Activist Shareholders: Activists and corporate raiders like Carl Icahn pressure corporate management (e.g., Apple) to distribute cash reserves as dividends.

  • Threat of Takeovers: Low stock prices encourage corporate raiders to acquire controlling interest, replace top management, optimize asset productivity, raise the stock price, and sell the firm.

• Stockholders/Managers vs. Creditors:

  • Creditors supply capital and act as principals relative to managers and stockholders.

  • Capital Structure Shift Risk: Increasing total debt (e.g., taking capital structure debt from $20\%$ up to $40\%$) lowers the firm's financial rating, raising required returns and reducing the value of existing bonds.

  • Duty to Creditors: Management must protect existing creditors from detrimental increases in asset risk and unfavorable capital structure decisions.

Exam 1 goes all the way through Ch 5 topic 4 “Present Value of a Single Sum”

Ch 5 vid

Calculator worth with time value of money use calculator enter in 0 if there is nothing to be entered to ensure your outcome isn’t messed up.