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CHAPTER 1 - CONCISEIntroduction to FinancialManagement

Forms of Businesses

Goals of the Corporation

Stock Prices and Intrinsic Value Some Recent Trends

Conflicts Between Managers and

Shareholders

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Alternative Forms of Business

Organization

Proprietorship Partnership

Corporation

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Proprietorships & PartnershipsAdvantages

Ease of formation

Subject to few regulations

No corporate income taxes

Disadvantages

Difficult to raise capital

Unlimited liability

Limited life

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CorporationAdvantages

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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Double Taxation of Corporate Profits/Income

Assume Corporate and Individual Tax = 50%

Earnings Before Taxes $100 EBT

($50) Corporate Tax

Net Income After Tax $50 NIAT (Profits)

Assume 100% Div. Payout $50 Dividend Income

($25) Personal Income Tax

$25 After-tax Income

New Tax Code (2003): Max. Tax Rate of 15% for DIV

Earnings Before Taxes $100 EBT

($50) Corporate Tax

Net Income After Tax $50 NIAT

Assume 100% DIV $50 Dividend Income

($7.50) Income Tax @ 15%

$42.50 After-tax Income

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Corporate Income Taxes 2006

More than But not more than Then the tax is of the amount over

$0 $50,000 15% $0

$50,000 $75,000 $7,500 + 25% $50,000

$75,000 $100,000 $13,750 + 34% $75,000

$100,000 $335,000 $22,250 + 39% $100,000

$335,000 $10 million $113,900 + 34% $335,000

$10 million $15 million $3,4 million + 35% $10 million

$15 million $18.33 million $5.15 million + 38% $15 million

$18.33 million --35% --

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2005 federal personal income tax rates

Ordinary taxable income for use in filing returns due April 15, 2006.

Tax rate Single filers Married filing jointly Married filing separately Head of household

10% Up to $7,300 Up to $14,600 Up to $7,300 Up to $10,450

15% $7,301 - $29,700 $14,601 - $59,400 $7,301 - $29,700 $10,451 - $39,800

25% $29,701 - $71,950 $59,401 - $119,950 $29,701 - $59,975 $39,801-$102,800

28% $71,951 - $150,150 $119,951 - $182,800 $59,976 - $91,400 $102,801 - 166,450

33% $150,151 - $326,450 $182,801 - $326,450 $91,401 - $163,225 $166,451 - $326,450

35% $326,451 or more $326,451 or more $163,226 or more $326,451 or more

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Alternative Forms of Business

Organization Sole proprietorship 73% of firms,

but only 7% of sales revenue

Partnership 7% of firms, 5% ofsales

Corporation 20% of firms, but88% of sales revenue.

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Financial Goals of the Corporation The primary financial goal is

shareholder wealth maximization,

which translates to maximizing stockprice. Do firms have any responsibilities to

society at large?

Is stock price maximization good or badfor society?

Should firms behave ethically?

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Factors that affect stock price Projected cash

flows to

shareholders Timing of the

cash flow stream

Riskiness of thecash flows

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Stock Prices and Intrinsic Value In equilibrium, a stocks price should equal its

true or intrinsic value.

To the extent that investor perceptions areincorrect, a stocks price in the short run maydeviate from its intrinsic value.

Ideally, managers should avoid actions thatreduce intrinsic value, even if those decisionsincrease the stock price in the short run.

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Determinants of Intrinsic Value

and Stock Prices (Figure 1-1)

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Some Important Trends Recent corporate scandals have

reinforced the importance of business

ethics, and have spurred additionalregulations and corporate oversight.

The effects of changing informationtechnology have had a profound effecton all aspects of business finance.

The continued globalization of business.

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Financial Management Issues

of the New Millennium The effect of changing

technology

The globalization of business1. Improvements in communications andtransportation lower transactions cost

2. Increased power of consumers morechoice, consumer sovereignty

3. Increased cost of developing newproducts global markets spread fixed costsover more units

4. MNCs must be able to shift productionglobally to take advantage of costefficiencies.

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Percentage of Revenue and Net Incomefrom Overseas Operations for 10 Well-

Known Corporations, 2001Company % of Revenue

from overseas% of Net Income

from overseas

Coca-Cola 60.8 35.9Exxon Mobil 69.4 60.2

General Electric 32.6 25.2

General Motors 26.1 60.6

IBM 57.9 48.4

JP Morgan Chase & Co. 35.5 51.7

McDonalds 63.1 61.7

Merck 18.3 58.1

3M 52.9 47.0

Sears, Roebuck 10.5 7.8

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Conflicts Between Managers and

Stockholders Managers are naturally inclined to act in their

own best interests (which are not always the

same as the interest of stockholders). 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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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