Download - 361-CH1
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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