Part 1
Introduction to Managerial Finance
Chapters in This Part
Chapter 1 The Role of Managerial Finance
Chapter 2 The Financial Market Environment
Integrative Case 1: Merit Enterprise Corp.
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Chapter 1
The Role of Managerial Finance
Instructor’s Resources
Overview
This chapter introduces the students to the field of finance and explores career opportunities in both financial services
and managerial finance. The three basic legal forms of business organization (sole proprietorship, partnership, and
corporation) and their strengths and weaknesses are described. The managerial finance function is defined and
differentiated from economics and accounting. A discussion of the financial manager’s goals—maximizing
shareholder wealth and preserving stakeholder wealth—and the role of ethics in meeting these goals is presented.
The chapter then summarizes the three key activities of the financial manager: financial analysis and planning,
making investment decisions, and making financing decisions. The chapter includes discussion of the agency
problem—the conflict that exists between managers and owners in a large corporation.
This chapter, and all that follow, emphasizes how the chapter content plays a vital role in the student’s professional
and personal life. Each chapter includes an early discussion of the relevance of the topic to majors in accounting,
information systems, management, marketing, and operations. Throughout each chapter are detailed examples of
how the chapter’s topic relates to the student’s financial life. These pedagogic tools should motivate students to
grasp quickly an understanding of the chapter content and employ it in both their professional and personal lives.
Suggested Answer to Opener-in-Review Question
Facebook sold shares to investors at $38 each in its IPO. One year later, its stock price was hovering around
$26. What was the percentage drop in Facebook shares in its first year as a public company? Just after the
IPO, Facebook’s CEO, Mark Zuckerberg, owned 443 million shares. What was the total value of his
Facebook stock immediately after the IPO and one year later? How much wealth did Zuckerberg personally
lose over the year?
Percentage drop in Facebook shares in its first year as a public company
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Answers to Review Questions
1. Finance is the art and science of managing money. Finance affects all individuals, businesses, and
2. Financial services is the area of finance concerned with the design and delivery of advice and financial
3. Sole proprietorships are the most common form of business organization, while corporations are responsible
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Chapter 1 The Role of Managerial Finance 3
4. Stockholders are the owners of a corporation, whose ownership, or equity, takes the form of common stock
5. The most popular form of limited liability organizations other than corporations are:
6. Virtually every function within a firm is in some way connected with the receipt or disbursement of cash. The
7. The goal of a firm, and therefore of all managers, is to maximize shareholder wealth. This goal is measured
8. Profit maximization is not consistent with wealth maximization due to: (1) the timing, (2) earnings that do not
represent cash flows available to stockholders, and (3) a failure to consider risk.
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Chapter 1 The Role of Managerial Finance 4
9. Risk is the chance that actual outcomes may differ from expected outcomes. Financial managers must
10. In recent years, the magnitude and severity of “white collar crime” has increased dramatically, with a
11.The treasurer or the chief financial manager typically manages a firm’s cash, investing surplus funds when
12. Finance is often considered a form of applied economics. Firms operate within the economy and must be
13. Accountants operate on an accrual basis, recognizing revenues at the point of sale and expenses when
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Chapter 1 The Role of Managerial Finance 5
14. The two key activities of the financial manager as related to a firm’s balance sheet are
15. Corporate governance refers to a system of organizational control that is used to define and establish lines of
The Sarbanes-Oxley Act of 2002 is directed toward reducing the apparent conflicts of interest that exist in
16. Agency problems arise when managers deviate from the goal of maximization of shareholder wealth by
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Chapter 1 The Role of Managerial Finance 6
17. Structuring expenditures are currently the most popular way to deal with the agency problem—and also the
18. Market forces—for example, shareholder activism from large institutional investors—can reduce or avoid the
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Chapter 1 The Role of Managerial Finance 7
Suggested Answer to Focus on Practice Box: Professional Certifications
in Finance
Why do employers value having employees with professional certifications?
Studying to pass certification exams allows employees to continue their education beyond their undergraduate
Suggested Answer to Focus on Ethics Box: Critics See Ethical
Dilemmas in Google Glass
Is the goal of maximization of shareholder wealth necessarily ethical or unethical?
What responsibility, if any, does Google have to protect the privacy of those who interact with other people
wearing Glass?
Google has a responsibility to ensure that its products and users of its product protect the privacy of those who
Answers to Warm-Up Exercises
E1-1. Comparison of advantages and disadvantages of a partnership versus incorporation.
Answer: While Jack and Ann disagree over whether or not their firm should incorporate or remain as a
partnership, each form of business organization has its advantages and disadvantages. One advantage of
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Chapter 1 The Role of Managerial Finance 8
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Chapter 1 The Role of Managerial Finance 9
E1-2 Timings of cash flows
Answer: Based on the information provided, the choice is not obvious. Even though the second project is expected
E1-3. Cash flow vs. accrued profits
Answer: It is not unusual for a firm to be profitable yet experience a cash crunch. The most common cause is when
E1-4. Sunk costs
Answer: Marginal cost-benefit analysis ignores sunk costs, so the $2.5 million dollars is irrelevant to the current
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Chapter 1 The Role of Managerial Finance 10
E1-5. Agency costs
Answer: Agency costs are the costs borne by stockholders to maintain a governance structure that ensures
Solutions to Problems
P1-1. Liability comparisons
LG 2; Basic
a. Ms. Harper has unlimited liability.
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Chapter 1 The Role of Managerial Finance 11
P1-2. Accrual income vs. cash flow for a period
LG 4; Basic
a. Sales $760,000
b. Cash receipts $690,000
c. The cash flow statement is more useful to the financial manager. The accounting net income includes
P1-3. Cash flow statement
LG 4; Intermediate
a. Total cash inflow: $450 $4,500 $4,950
b. Net cash flow: Total cash inflows – Total cash outflows = $4,950 $4,357 $593
c. If Jane is facing a shortage, she could cut back on some of her discretionary items, including clothing,
d. If Jane has a surplus in August, she should compare these cash flows to those of other months and
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Chapter 1 The Role of Managerial Finance 12
P1-4. Marginal cost-benefit analysis and the goal of the firm
PG 3, 5; Challenge
a. Marginal benefits of new robotics Marginal benefits of original robotics Marginal benefits of
b. Marginal cost of new robotics – Sales price of current robotics = Marginal cost of proposed robotics
c. Net benefits of new robotics Marginal benefits of proposed robotics Marginal cost of proposed
robotics
d. Ken Allen should recommend the new robotics be used on the heavy truck gear line. The marginal
e. Ken Allen should determine whether there will be additional training necessary with the new robotics,
P1-5. Identifying agency problems, costs, and resolutions
LG 4; Intermediate
a. In this case the employee is being compensated for unproductive time. The company must pay
b. The costs to the firm are in the form of opportunity costs. Money budgeted to cover the inflated costs
c. The manager may negotiate a deal with the merging competitor that is extremely beneficial to the
d. Generally, part-time or temporary workers are not as productive as full-time employees. These
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Chapter 1 The Role of Managerial Finance 13
P1-6. Ethics Problem
LG 3; Intermediate
The phrase “ethical constraints” is quite broad. The company may be referring to legal issues and the fact
Case
Case studies are available on www.myfinancelab.com.
Assessing the Goal of Sports Products, Inc.
a. Maximization of shareholder wealth, which means maximization of share price, should be the primary goal of
b. Yes, there appears to be an agency problem. Although compensation for management is tied to profits, it is not
c. The firm’s approach to pollution control seems to be questionable ethically. While it is unclear whether their acts
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Chapter 1 The Role of Managerial Finance 14
d. From the information given there appears to be a weak corporate governance system. The fact that
e. Some specific recommendations for the firm include:
Tie management, and possibly employee, compensation to share price or a performance-based measure and
Comply with all federal and state laws as well as accepted standards of conduct or moral judgment.
Establish a corporate ethics policy, to be read and signed by all employees.
Set up a corporate governance system that has as its basis the oversight and welfare of all the stakeholders
(Other answers are, of course, possible.)
Spreadsheet Exercise
The answer to Chapter 1’s Monsanto spreadsheet problem is located on the Instructor’s Resource Center
at www.pearsonhighered.com/irc under the Instructor’s Manual.
Group Exercise
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Chapter 1 The Role of Managerial Finance 15
Group exercises are available on www.myfinancelab.com.
Notes for Adopters
The motivation for these group exercises is to place the learning goals of each chapter within the context of a
fictitious firm while giving students a valuable set of teamwork skills. Creativity is encouraged, while the strong
links of each assignment to a real-world, shadow firm should ground each group’s work in reality. Any of these
assignments and their deliverables can be modified to better fit within an adopter’s course goals as they were
designed with an eye toward flexibility of use. The learning through these exercises should be something students
enjoy, being both applicable to the real world and less confining than traditional homework.
The first issue for adopters to address is group composition and size. Should students self-separate or be divided by
their instructor? How big should the groups be? This is a semester–long assignment and students will need to get
along with their fellow group members. If students choose their own groups it may, though not always, reduce the
incidence of intra-group squabbles. Diversity within the groups might then be sacrificed, however. One strategy is
to ask students to first pair–off. The instructor can then join the pairs into groups of four. This pairing of the pairs
could be done randomly through a number-in-the-hat selection process, as could the entire group setup.
Group size does matter and these exercises were designed for a workload spread across a minimum of three
students. Larger groups would lessen the homework load; however, the issue of free-riding is often more prevalent
in larger groups, where slackers can hide. Management of larger groups is also more challenging for the
participants. The suggested group size is between three and five students.
Group leadership is another issue. The best situation might be rotating the CEO/leader, where each group member
has several opportunities to be in charge. Last, these exercises were designed to allow students freedom but with
the responsibility of working somewhat independently of their instructor. In this vein, the instructions for each
assignment have been written to be relatively self-explanatory.
Chapter 1
This first chapter asks students to name their fictitious firm and describe its business. As this firm is going public,
students are asked to explain why it is appropriate for them to go public and also discuss different managerial roles
within the corporation. The group must choose a shadow firm to follow that is publicly held, allowing them to
gather a substantial amount of information about it on the Internet. This publicly traded firm should be in an
industry related to their fictitious firm.
The most important counsel students could get at the outset is to spend time making these initial decisions. Later
work is going to build on these choices, and careful choosing is paramount. For example, in choosing the shadow
firm, students should pick a well-established firm whose information, including financials, will be easily found.
This also impacts their decisions regarding their own fictitious firm. Throughout many of the subsequent chapters,
students will be taking real-world information from their shadow firm and applying it to their fictitious firm;
dressing their own firm with the clothes of the shadow firm. Students should feel comfortable in these clothes, so
encouraging them to choose industries they’re familiar with, or interested in, is helpful.
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