chapter 1 mgt 326 fall 2012. why study finance? how firms are organized sole proprietorship – easy...
TRANSCRIPT
Chapter 1
Mgt 326 Fall 2012
Why Study Finance?
How Firms are Organized
Sole proprietorship– Easy– Most common
Partnerships– Business run by more than one owner – Limited partnership – limited liability
How Firms are Organized
Limited Liability Companies – All owners have limited liability– Flow through tax benefits – Set up to protect professionals in a partnership
due to poor performance or misconduct by one partner.
Ex: malpractice suit.
How Firms are Organized
Corporations – Legally defined, artificial being, separate from its owners
Formation – Must be legally formed. – Difficult
Ownership– Shareholders are the owners.
Dividend payments are made to the shareholders at the discretion of the corporation. Payment is proportional to the amount of shares held.
Taxation– S Corp
– C Corp
How Firms are Organized
Corporations Taxation
– S Corp Taxed once All profits pass through stock holders, no tax is paid at the
corporate level
– C Corp Subject to taxation separate from the owners tax obligations In effect shareholders pay tax twice on the corporations
profits This is referred to as double taxation
How Firms are organized - summarized
Proprietor or PartnershipAdvantages- Easy to set up Owner manager make decisions Less regulated Single taxation
Disadvantages Unlimited Liability Life of the business is limited to the
life of the owner. Difficult to transfer ownership Hard to raise capital
CorporationAdvantages Liability limited to the amount
invested Easy to transfer ownership Unlimited life
Disadvantages Harder to set up Double Taxation Highly regulated by the Fed. Owner Manager conflicts
Tax Implications for Corporations
Example You are a shareholder in a corporation. The corporation earns $5.00 per share before taxes. After it has paid taxes, it will distribute the rest of its earnings to you as a dividend. The dividend is income to you so you will then pay taxes on these earnings. The corporate tax rate is 40%, and your tax rate on the dividend is 15%. How much of the earnings remain after all taxes are paid?
What do Financial Manager’s do?
Make Investment Decisions– Weigh the cost and benefit of each investment / project– Decide whether they are good uses of the available money
Make Financing Decision– Will the manager finance the decision using additional stock
or issue debt
Manage Cash Flow.– Make sure the company has enough cash to meet the day
to day obligations.
Goal of the financial Manager– Maximize the wealth of the stockholders.
What do Financial Manager’s do?
Goal of the financial Manager– Maximize the wealth of the stockholders.
Unambiguous objective Easy to Measure Public traded are perfect for this due to the large number of buyers /
sellers Forces securities to trade near their true price
The Corporate Management Team
1 Cash & Credit Mgmt2 Inventory Management3 Capital Budgeting4 Planning and Forecasting
Board of Directors
President / CEO
VP: Marketing VP Finance (CFO) VP: Manufacturing
Controller Treasurer
1Cost Accounting2Financial Accounting3Tax Management
Agency Conflicts
Agency Problems – When managers, despite being hired as the
agents of shareholders, put their own self-interest ahead of the interests of the shareholders
Agency Conflicts
What can be done to eliminate Agency Problems– Tie Performance to compensation– Shareholders can force a resignation– Hostile take over– Legal & Regulatory Environment
Sarbanes-Oxley – also known as the Truth in Securities Act
Ethics in Business
Agency Costs– Act Honestly– Deception & Fraud can have a huge & long
lasting effect on stock price Could cause bankruptcy as with Enron and WorldCom
Conflicts of Interest– Dual Function
Disclosure Sometimes law requires one party to withdraw
Ethics in Business (cont)
Information Asymmetry– One party has information the other does not
Inside information illegal Truth in Negotiations
Ethical Consequences
Bernard Ebbers – WorldCom– Guilty of Fraud – Sentenced to 25 yes jail time
Bernard Madoff– Pleaded guilty to 11 federal felonies – massive
ponzi scheme– Sentenced to 150 years in prison – Maximum
allowed
The Stock Market
The stock market provides liquidity for a company’s shares and determine the market price.
Primary Market– Issues new shares. These go to investors
Secondary Market– Shares trade between investors, with out the involvement of
the corporation.
The stock market acts as a score card for management and how well of a job they are doing, based upon the stock price.
NYSE
Physical Location Market Makers or Specialist
– Individuals on the trading floor of a stock exchange who match buyers with sellers
– They post two prices for every stock they make a market for Bid price – Ask price –
– The Specialist will buy or sell (up to a limited amount of shares) and make the trade, even if they don’t have another customer willing to take the other side of the trade.
– This way they make sure the market is liquid
NYSE cont
Auction Market – Licensed holders can go to the companies trading
posts and directly sell or buy shares
Bid Ask Spread– Transaction cost – Small spread
NASDAC
National Association of Security Dealers Automated Quotation
– Over the Counter (OTC) Market– The major difference between NYSE and NASDAC is that on
the NYSE each stock only has one market maker– On NASDAC, stocks can and do have multiple market
makers who compete with each other Each Market maker must post bid and ask prices in the
NASDAQ network where they can be viewed by all participants. The NASDAQ system posts the best prices first and fills orders
accordingly
Listing Standards
These are the requirements that have to be met to be traded on the exchange.– Require enough shares for liquidity.– The two exchanges compete over the listings of
larger companies.
Financial Institutions
Banks and Credit Unions– Deposits
Loans money to people
Insurance companies– Premiums and investment earnings
Invests mostly in bond, some stocks, using the investment income to pay claims
Mutual Funds– Peoples investments (savings)
Buys stocks bonds and other financial instruments on behalf of its investors
Financial Institutions
Pension Funds– Retirement savings contributed through the workplace
Similar to mutual funds, except with the purpose of providing retirement income.
Hedge Funds – Investments by wealthy individuals and endowments
Invests in any kind of investment in an attempt to maximize returns.
Financial Institutions
Venture Capital – Investments by wealthy individuals and
endowments Invest in start up, entrepreneurial firms
Private Equity Funds– Investments by wealthy individuals and
endowments Purchases whole companies by using a small amount of
equity and borrowing the rest.
Factors that influence stock prices
• Internal Factors (ie influenced by management)– Projected Earnings Per Share – Timing of projected earnings– Riskiness of the projected earnings– Debt Policy – Dividend Policy
Factors that influence stock prices
• External factors (ie beyond management’s control) – Antitrust laws– Environmental regulations– Product and workplace safety regulations– Federal Reserve Monetary Policy– Government Fiscal Policy – International Developments
What Jobs Can Finance majors pursue?
Private sector– Stock Broker– Personal Investment Counselor
Public Sector– Program Manager– Budget Analyst– Cost Analyst
Corporations and Small Businesses– Budget Analyst– Cost Analyst– Capital Manager– Program Manager
The Difference between Finance & Accounting
Finance– Focused on the future– Deals with uncertainty– Primarily concerned with deciding how to acquire,
generate and distribute assets & capital resources– Strategic decision making
The Difference between Finance & Accounting
Accounting– Focused on the past– Very little uncertainty– Primarily concerned with keeping track of how
assets and capital are distributed – Limited decision making
Risk
The chance that an outcome other than that which was expected will occur
For finance Risk = Uncertainty of cash flows
Rate of Return
Also known as Yield, Return on Investment (ROI), Profit Percentage
The percent increase in the price of a financial asset
Formula for calculating RoR– (Sales – COGS) / COGS– (New Price – Old Price) / Old Price
Rate of Return (cont)
In finance we are more concerned with RoR than we are Profit– Consider the 2 investments
Rate of Return (cont)
The second option has a higher profit, however the first option was more profitable because you got more money with respect to the amount of money invested.
Investments expressed as RoR can be compared on the same basis with out bias.
What are the goals of the Corporation?
The primary goal is to Maximize Shareholder Wealth– Why– How is this measured