Introduction To Financial Management, Lecture Notes - Financial Management, Study notes for Financial Management. University of Michigan (MI)

Financial Management

Description: Forms of Businesses, Goals of the Corporation, Stock Prices and Intrinsic Value, Some Recent Trends, Conflicts Between Managers and Shareholders
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CHAPTER 1 An Overview of Financial Management

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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

 Disadvantages

 Difficult to raise capital

 Unlimited liability

 Limited life

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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/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 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 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% 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 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.

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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.

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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

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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

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