CHAPTER 1 - CONCISE Introduction to Financial Management

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 & Partnerships

Advantages

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

Corporation

Advantages

Unlimited life Easy transfer of ownership Limited liability Ease of raising capital Double taxation Cost of set-up and report filing
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Disadvantages

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

Corporate Income Taxes 2006 More than But not more than $0 $50,000 $50,000 $75,000 $100,000 $335,000 $10 million $15 million $18.33 million $75,000 $100,000 $335,000 $10 million $15 million $18.33 million Then the tax is of the amount over 15% $0 $7,500 + 25% $13,750 + 34% $22,250 + 39% $113,900 + 34% $3,4 million + 35% $5.15 million + 38% --35% -$50,000 $75,000 $100,000 $335,000 $10 million $15 million

2005 federal personal income tax rates

Ordinary taxable income for use in filing returns due April 15, 2006. Tax rate Single filers 10% Up to $7,300 15% 25% $7,301 - $29,700 $29,701 - $71,950 Married filing jointly Married filing separately Head of household Up to $14,600 Up to $7,300 Up to $10,450 $14,601 - $59,400 $59,401 - $119,950 $7,301 - $29,700 $29,701 - $59,975 $10,451 - $39,800 $39,801-$102,800

28%
33% 35%

$71,951 - $150,150
$150,151 - $326,450 $326,451 or more

$119,951 - $182,800
$182,801 - $326,450 $326,451 or more

$59,976 - $91,400
$91,401 - $163,225 $163,226 or more

$102,801 - 166,450
$166,451 - $326,450 $326,451 or more

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)

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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. 1-14

Percentage of Revenue and Net Income from Overseas Operations for 10 WellKnown Corporations, 2001
Company % of Revenue from overseas
60.8

% of Net Income from overseas

35.9

Coca-Cola

Exxon Mobil
General Electric General Motors IBM JP Morgan Chase & Co. McDonalds Merck 3M Sears, Roebuck

69.4
32.6 26.1 57.9 35.5 63.1 18.3 52.9 10.5

60.2
25.2 60.6 48.4 51.7 61.7 58.1 47.0 7.8 1-15

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

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