CHAPTER 1 CONCISE Introduction to Financial Management

1
CHAPTER 1 - CONCISEIntroduction to Financial
Management

• Forms of Businesses
• Goals of the Corporation
• Stock Prices and Intrinsic Value
• Some Recent Trends
• Conflicts Between Managers and Shareholders

2
Alternative Forms of Business Organization

• Proprietorship
• Partnership
• Corporation

3
Proprietorships Partnerships

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

4
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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• 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 _at_ 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 ratesOrdinary
  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 of sales
• Corporation 20 of firms, but 88 of sales
  revenue.

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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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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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Stock Prices and Intrinsic Value

• In equilibrium, a stocks price should equal its
  true or intrinsic value.
• To the extent that investor perceptions are
  incorrect, a stocks price in the short run may
  deviate from its intrinsic value.
• Ideally, managers should avoid actions that
  reduce intrinsic value, even if those decisions
  increase the stock price in the short run.

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Determinants of Intrinsic Value and Stock Prices
(Figure 1-1)
13
Some Important Trends

• Recent corporate scandals have reinforced the
  importance of business ethics, and have spurred
  additional regulations and corporate oversight.
• The effects of changing information technology
  have had a profound effect on 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 business
• 1. Improvements in communications and
  transportation lower transactions cost
• 2. Increased power of consumers more choice,
  consumer sovereignty
• 3. Increased cost of developing new products
  global markets spread fixed costs over more units
• 4. MNCs must be able to shift production
  globally to take advantage of cost efficiencies.

15
Percentage of Revenue and Net Income from
Overseas Operations for 10 Well-Known
Corporations, 2001
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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