Financial Management

Financial management involves the solution of the three major. decisions. Together, they determine the value of the firm to its shareholders. Assuming that our objective is to maximize this value, the firm should strive for an optimal combination of the three interrelated decisions, solved jointly. The decision to invest in a new capital project, for example, necessitates financing the investment. The financing decision, in turn, influences, and is influenced by, the dividend decision, for retained earnings used in internal financing represent dividends forgone by stockholders. With a proper conceptual framework, joint decisions that tend to be optimal can be reached. The main thing is that the financial manager relate each decision to its effect on the valuation of the firm.

Because valuation concepts are basic to understanding financial management, these concepts are investigated in depth in Chapters 2, 3, and 4. Thus the first four chapters serve as the foundation for the subsequent development of the book. They introduce key concepts: the time value of money, market efficiency, risk return trade offs, valuation in a market protfolio context, and the valuation of relative financial claims using the option pricing model. These concepts will be applied in the remainder of the book.