Introduction to Financial Management Forms of Businesses Goals of the Corporation Stock Prices and Intrinsic Value Some Recent Trends Conflicts Between Managers and Shareholders
Oct 21, 2014
Introduction to Financial Management
Forms of Businesses Goals of the Corporation Stock Prices and Intrinsic Value Some Recent Trends Conflicts Between Managers and
Shareholders
Alternative Forms of Business Organization
Proprietorship Partnership Corporation
Proprietorships & Partnerships Advantages
Ease of formation Subject to few regulations No corporate income taxes
Disadvantages Difficult to raise capital Unlimited liability Limited life
Corporation Advantages
Unlimited life Easy transfer of ownership Limited liability Ease of raising capital
Disadvantages Double taxation Cost of set-up and report filing
Double Taxation of Corporate Profits/IncomeAssume Corporate and Individual Tax = 50%Earnings Before Taxes $100 EBT
($50) Corporate TaxNet 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 DIVEarnings Before Taxes $100 EBT
($50) Corporate TaxNet 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 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% --
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
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.
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?
Factors that affect stock price Projected cash
flows to shareholders
Timing of the cash flow stream
Riskiness of the cash flows
Stock Prices and Intrinsic Value In equilibrium, a stock’s price should equal its
“true” or intrinsic value. To the extent that investor perceptions are
incorrect, a stock’s 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.
Determinants of Intrinsic Value and Stock Prices (Figure 1-1)
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.
Financial Management Issues of the New Millennium
The effect of changing technology
The globalization of business1. Improvements in communications and transportation – lower transactions cost
2. Increased power of consumers – more choice, consumer sovereignty3. Increased cost of developing new products – global markets spread fixed costs over more units4. MNCs must be able to shift production globally to take advantage of cost efficiencies.
Percentage of Revenue and Net Income from Overseas Operations for 10 Well-
Known Corporations, 2001
Company % of Revenue from overseas
% of Net Income from overseas
Coca-Cola 60.8 35.9
Exxon 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
McDonald’s 63.1 61.7
Merck 18.3 58.1
3M 52.9 47.0
Sears, Roebuck 10.5 7.8
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
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