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					BUS 314 Business Finance
Foundations of Finance, 5th Ed. Chapter 1: Introduction

Finance deals with:
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Decisions by corporate officers:
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How to raise capital. Which opportunities are worth taking. How to increase owner wealth.

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Decisions by individuals:
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Where to invest my money? Should I borrow?

Ten Principles that Form the Foundations of Financial Mgmt
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1. Risk-Return Trade-off
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Never take on risk without getting compensated for it.

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2. Time Value of Money
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A dollar received today is worth more than a dollar received in the future.

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3. Cash Not Profits Is King
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Determining cash flow.

Ten Principles that Form the Foundations of Financial Mgmt
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4. Incremental Cash Flows
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It’s only what changes that counts.

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5. The Curse of Competitive Markets
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Hard to find exceptionally profitable projects.

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6. Efficient Capital Markets
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Markets adjust quickly and prices are fair.

Ten Principles that Form the Foundations of Financial Mgmt


7. Agency Problem
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Managers won’t work for owners unless it’s in their best interests

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8. Taxes Bias Business Decisions
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After tax incremental cash flows are what matter.

Ten Principles that Form the Foundations of Financial Mgmt


9. All Risk is Not Equal
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Some risk can be diversified away, some cannot.

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10. Ethical Behavior is Doing the Right Thing
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Ethical Dilemmas are Everywhere in Finance.

Key Objectives in Financial Decision Making
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Maximize the future stream of after-tax incremental cash flows taking into consideration the effects of time and risk.
Maximize shareholder wealth (i.e. maximize the company’s stock price.

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Business Organizations
Sole Proprietorship
- easy set-up
- company dies with owner - unlimited liability - limited access to capital - single taxation

Partnership
- easy set-up
- difficult to change ownership - unlimited liability - limited access to capital - single taxation

Corporation
- complicated set-up
- very easy to change ownership - limited liability - much broader access to capital - double taxation

Business Organizations
Special Types
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Limited Partnership
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Allows one or more partners limited liability based on amount of capital invested Must have one general partner with unlimited liability Limited partners may not participate in management decisions.

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S-Type Corporations
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Benefits  Limited liability  Taxed as partnership Limitations  Owners must be people  Can’t be used for joint ventures between two corporations

How the Finance Area Fits Into a Corporate Organization Structure

Board Of Directors Chief Executive Officer Vice-President Finance Or Chief Financial Officer Treasurer Controller Vice-President Production And Operations

Vice-President Marketing

Types of Taxpayers
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Individuals—employees, self-employed persons, members of partnerships  File personal tax return, pay tax on reported income Corporations—separate legal entity  File corporate tax return, pay tax on profits
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Shareholders pay taxes on distributed dividends

• Fiduciaries—estates and trusts • Pay taxes on undistributed income

Taxable Income
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Taxable Income—Gross income less tax deductible expenses, plus Interest income and dividend income Gross Income—Dollar sales from a product or service less cost of production or acquisition Tax Deductible Expenses—Operating expenses (marketing, depreciation, administrative expenses) and interest expense Dividends paid are not deductible

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Corporate Income
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Sales Cost of Goods Sold Gross Profit Operating Expenses  Administrative Expenses  Depreciation Expense Total Operating Expenses Operating Income Other Income Interest Expense Taxable Income

$1,000 $ 200 $ 800
$150 $ 50 $200 $600 $0 $250 $350

Corporate Tax Rates
Taxable Income $ 0 - $50,000 $50,001 - $75,000 $75,001 - $10,000,000 Over $10,000,000 Additional surtax: Marginal Rate 15% 25% 34% 35%

5% on income between $100,000 and $335,000 3% on income between $15,000,000 and $18,333,333

Marginal Tax Rates
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Rates applicable to next dollar of income

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Used in financial decision-making

Corporate Tax Rates
(Method that incorporates Surtaxes)
If corporate taxable income is:

Over
$0 $50,000 $75,000

But not over
$50,000 $75,000 $100,000

Tax is:
15% $7,500 + 25% $13,750 + 34%

$100,000
$335,000 $10,000,000 $15,000,000 $18,333,333

$335,000
$10,000,000 $15,000,000 $18,333,333

$22,250 + 39%
$113,900 + 34% $3,400,000 + 35% $5,150,000 + 38% 35%

Other Corporate Tax Considerations:
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Dividend Exclusion—A corporation may typically exclude 70% of any dividend received from another corporation. Depreciation Expense—A corporation may expense an asset’s cost over its useful life

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Capital Gains and Losses—Capital Gains taxed as ordinary income. Capital losses cannot be deducted from ordinary income.

Homework: Chapter 1
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Learn key terms

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Study Questions: 6, 7
Study Problems: 1, 3, 5, 8, 11

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