Goals of the Corporation

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TOPIC 1 COMPANY GOALS

• Goals of the Corporation
• Forms of Businesses
• 10 Fundamental Principles
• Career Opportunities

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POSSIBLE GOALS FOR A COMPANY

• 1. MAXIMIZE PROFITS
• 2. MAXIMIZE CUSTOMER SATISFACTION
• 3. MAXIMIZE SALES
• 4. MAXIMIZE COMPANY SIZE
• 5. MAXIMIZE STOCKHOLDER WEALTH

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HOW DO YOU MEASURE STOCKHOLDER WEALTH?
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Financial Goals of the Corporation

• The primary financial goal is shareholder wealth
  maximization, which translates to maximizing
  stock price.
• Do firms have any responsibilities to society at
  large?
• Is stock price maximization good or bad for
  society?
• Should firms behave ethically?

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Is stock price maximization the same as profit
maximization?

• No, despite a generally high correlation amongst
  stock price, EPS, and cash flow.
• Current stock price relies upon current earnings,
  as well as future earnings and cash flow.
• Some actions may cause an increase in earnings,
  yet cause the stock price to decrease (and vice
  versa).

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P/E RATIOS
Price of the stock / EPS
EPS is simply the total net income or net profit
of the company divided by the number of shares
outstanding.
CO. A CO. B EPS 1 1 P/E
RATIO 10x 12x
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Basic Valuation Model

• To estimate an assets value, one estimates the
  cash flow for each period t (CFt), the life of
  the asset (n), and the appropriate discount rate
  (k)
• Throughout the course, we discuss how to estimate
  the inputs and how financial management is used
  to improve them and thus maximize a firms value.

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Factors that affect stock price

• Projected cash flows to shareholders
• Timing of the cash flow stream
• Riskiness of the cash flows

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Factors that Affect the Level and Riskiness of
Cash Flows

• Decisions made by financial managers
• Investment decisions
• Financing decisions (the relative use of debt
  financing)
• Dividend policy decisions
• The external environment

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Agency relationships

• An agency relationship exists whenever a
  principal hires an agent to act on their behalf.
• Within a corporation, agency relationships exist
  between
• Shareholders and managers
• Shareholders and creditors

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Shareholders versus Managers

• Managers are naturally inclined to act in their
  own best interests.
• But the following factors affect managerial
  behavior
• Managerial compensation plans
• Direct intervention by shareholders
• The threat of firing
• The threat of takeover

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Shareholders versus Creditors

• Shareholders (through managers) could take
  actions to maximize stock price that are
  detrimental to creditors.
• In the long run, such actions will raise the cost
  of debt and ultimately lower stock price.

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Alternative Forms of Business Organization

• Sole proprietorship
• Partnership
• Corporation

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Sole proprietorships Partnerships

• Advantages
• Ease of formation
• Subject to few regulations
• No corporate income taxes
• Disadvantages
• Difficult to raise capital
• Unlimited liability
• Limited life

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WHAT IS THE BIGGEST ADVANTAGE OF
CORPORATIONS? WHAT IS THE BIGGEST DISADVANTAGE
OF CORPORATIONS?
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Corporation

• Advantages
• Unlimited life
• Easy transfer of ownership
• Limited liability
• Ease of raising capital
• Disadvantages
• Double taxation
• Cost of set-up and report filing

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ZEROING OUT A CORPORATION
Small corporations often pay no federal income
tax because they make their taxable income zero.
Therefore, for these companies there is no
double taxation. How do they do this without
reducing their true income?
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• SUB-CHAPTER S CORPORATIONS

Must consist of a small number of
stockholders. Are taxed as a partnership.
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Responsibility of the Financial Staff

• Maximize stock value by
• Forecasting and planning
• Investment and financing decisions
• Coordination and control
• Transactions in the financial markets
• Managing risk

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10 FUNDAMENTAL PRINCIPLES

• 1. There is a risk-return tradeoff.
• 2. Money has a time value
• 3. Cash is kingnot profits
• 4. Incremental changes in cash flows only
• 5. The curse of competitive markets
• 6. The capital markets are efficient
• 7. Managers will pursue their own self
  interests
• 8. Taxes influence business decisions
• 9. Some risk can be diversified away
• 10. Ethical decisions are everywhere

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CAREER OPPORTUNITIES

• CORPORATE
• Financial Managers
• Financial Analysts
• INVESTMENTS
• Corporate
• Personal
• GLOBAL