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The Business, Tax, and Financial Environments The Business, Tax, and Financial Environments
The Business, Tax, and Financial Environments The Business, Tax, and Financial Environments
The
TheBusiness,
Business,Tax,
Tax,and
andFinancial
Financial
Environments
Environments
2.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
After studying Chapter 2, you should be
able to:
2.3 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
The Business Environment
Advantages Disadvantages
• Simplicity • Unlimited liability
• Low setup cost • Hard to raise
additional capital
• Quick setup
• Single tax filing
• Transfer of
on individual form ownership
difficulties
2.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
The Business Environment
2.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Types of Partnerships
Advantages Disadvantages
• Can be simple • Unlimited liability for
• Low setup cost, higher the general partner
than sole • Difficult to raise
proprietorship additional capital, but
• Relatively quick setup easier than sole
proprietorship
• Limited liability for
limited partners
• Transfer of ownership
difficulties
2.9 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
The Business Environment
Advantages Disadvantages
• Limited liability • Double taxation
• Easy transfer of • More difficult to
ownership establish
• Unlimited life • More expensive
• Easier to raise large to set up and
quantities of capital maintain
2.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
The Business Environment
2.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Income Tax Example
Lisa Miller of Basket Wonders
(BW) is calculating the income tax
liability,
liability marginal tax rate,
rate and
average tax rate for the fiscal year
ending December 31.
BW’s corporate taxable income for
this fiscal year was $250,000.
2.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Income Tax Example
Income tax liability
= $22,250 + 0.39 × ($250,000 – $100,000)
$100,000
= $22,250 + $58,500
= $80,750
Marginal tax rate = 39%
Average tax rate = $80,750 / $250,000
= 32.3%
Also solve in Excel! – VW13E-02b.xlsx
2.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Depreciation
Depreciation represents the
systematic allocation of the cost of
a capital asset over a period of time
for financial reporting purposes, tax
purposes, or both.
• Generally, profitable firms prefer to use
an accelerated method for tax reporting
purposes.
2.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Common Types of Depreciation
• Straight-line (SL)
• Accelerated Types
• Double Declining Balance
(DDB)
• Modified Accelerated Cost
Recovery System (MACRS)
2.19 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Depreciation Example
Lisa Miller of Basket Wonders (BW) is
calculating the depreciation on a machine
with a depreciable basis of $100,000, a 6-
year useful life,
life and a 5-year property
class life.
She calculates the annual depreciation
charges using MACRS. [Note – ignore
“bonus” depreciation discussed in 2–25]
2.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
MACRS Example
• Assets are depreciated based on one
of eight different property classes.
• Generally, the half-year convention is
used.
• Depreciation in any particular year is
the maximum of DDB or straight-line.
A switch in depreciation methods is
made from DDB to SL during the life
of the asset.
2.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
MACRS Example
Depreciation Depreciation Net Book
Year Calculation Charge Value
0 --- --- $100,000
1 0.5X2X(1/5) X $100,000 $ 20,000 80,000
2 2 X ( 1 / 5) X $80,000 32,000 48,000
3 2 X ( 1 / 5) X $48,000 19,200 28,800
4 $28,800 / 2.5 Years 11,520 17,280
5 $28,800 / 2.5 Years 11,520 5,760
6 $28,800 / 2.5 Yrs X 0.5 5,760 0
2.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
MACRS Schedule
Recovery Property Class
Year 3-Year 5-Year 7-Year
1 33.33% 20.00% 14.29%
2 44.45 32.00 24.49
3 14.81 19.20 17.49
4 7.41 11.52 12.49
5 11.52 8.93
6 5.76 8.92
7 8.93
8 4.46
2.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Economic Stimulus Act (ESA)
of 2008
2.32 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Personal Income Taxes
• The US has a progressive tax structure with four
tax brackets of 10%, 15%,
15% 25%, 28%,
28% 33%,
33% and
35%.
35%
• The current maximum cash dividend (most) and
capital gains tax rates is 15%.
• Personal income taxes are determined by
taxable income, filing status, and various
credits.
• Result is that low income individuals pay no
federal tax and others may fluctuate between the
marginal rates.
2.33 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Financial Environment
• Businesses interact continually with
the financial markets.
• Financial Markets are composed of all
institutions and procedures for
bringing buyers and sellers of financial
instruments together.
• The purpose of financial markets is to
efficiently allocate savings to ultimate
users.
2.34 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Flow of Funds in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
2.35 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Flow of Funds in the Economy
INVESTMENT
SECTOR INVESTMENT
SECTOR
INTERMEDIARIES
FINANCIAL
FINANCIAL BROKERS
Businesses
Households
SAVINGS SECTOR
2.36 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Flow of Funds in the
Economy
INVESTMENT
SECTOR SAVINGS
SECTOR
INTERMEDIARIES
FINANCIAL
FINANCIAL BROKERS
Households
Government
SAVINGS SECTOR
2.37 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Flow of Funds in the
Economy
INVESTMENT
SECTOR FINANCIAL
BROKERS
INTERMEDIARIES
FINANCIAL
FINANCIAL BROKERS
Investment
Bankers
SECONDARY MARKET
Mortgage
Bankers
SAVINGS SECTOR
2.38 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Flow of Funds in
the Economy
INVESTMENT
SECTOR FINANCIAL
INTERMEDIARIES
INTERMEDIARIES
FINANCIAL
FINANCIAL BROKERS
Commercial Banks
Savings Institutions
SECONDARY MARKET Insurance Cos.
Pension Funds
Finance Companies
SAVINGS SECTOR
Mutual Funds
2.39 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Flow of Funds in
the Economy
INVESTMENT
SECTOR SECONDARY
MARKET
INTERMEDIARIES
FINANCIAL
FINANCIAL BROKERS
Security
Exchanges
SECONDARY MARKET
OTC
Market
SAVINGS SECTOR
2.40 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Allocation of Funds
• Funds will flow to economic units that are
willing to provide the greatest expected
return (holding risk constant).
• In a rational world, the highest expected
returns will be offered only by those
economic units with the most promising
investment opportunities.
• Result: Savings tend to be allocated to the
most efficient uses.
2.41 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Risk-Expected
Return Profile
Speculative Common Stocks
EXPECTED RETURN (%)
RISK
2.42 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
What Influences Security
Expected Returns?
2.45 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Term Structure of Interest
Rates
(Usual)
YIELD (%)
2.49 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
6. Efficient Capital Market
7. The Agency Problem
8. Taxes Bias Business Decisions
9. All Risk is Not Equal
10. Ethical Behaviour Dilemmas
2.50 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.