Learning Goals
1. Define finance, its major areas and
opportunities available in this field, and the
legal forms of business organization.
2. Describe the managerial finance function and
its relationship to economics and accounting.
3. Identify the primary activities of the
financial manager.
4. Explain the goal of the firm, corporate
governance, the role of ethics, and
the agency issue.
Copyright 2006 Pearson Addison-Wesley.
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What is Finance?
Finance can be defined as the art and
science of managing money.
Finance is concerned with the process,
institutions, markets, and instruments
involved in the transfer of money among
individuals, businesses, and
governments.
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Corporate Organization
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Career Opportunities
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Costs
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$100,000
CASH
$
(80,000)
(80,000)
$ 20,000
$(80,000)
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Primary Activities of
the Financial Manager
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Year 1
Year 2
Year 3
Rotor
1.40
1.00
0.40
2.80
Valve
0.60
1.00
1.40
3.00
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risk of cash
flows
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Corporate Governance
Corporate Governance is the system used to
direct and control a corporation.
It defines the rights and responsibilities of key
corporate participants such as shareholders, the
board of directors, officers and managers, and
other stakeholders.
The structure of corporate governance was
previously described in Figure 1.1.
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SOX:
established an oversight board to monitor the
accounting industry;
tightened audit regulations and controls;
toughened penalties against executives who commit
corporate fraud;
strengthened accounting disclosure requirements;
established corporate board structure guidelines.
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Business Taxes
Both individuals and businesses must pay taxes
on income.
The income of sole proprietorships and partnerships is
taxed as the income of the individual owners, whereas
corporate income is subject to corporate taxes.
Both individuals and businesses can earn two types of
incomeordinary income and capital gains income.
Under current law, tax treatment of ordinary income and
capital gains income change frequently due frequently
changing tax laws.
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Business Taxation:
Average & Marginal Tax Rates
A firms marginal tax rate represents the
rate at which additional income is taxed.
The average tax rate is the firms taxes
divided by taxable income.
Example
What is the marginal and average tax rate for the previous example?
Marginal Tax Rate
= 34%
= $15,450/$80,000 = 19.31%
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Business Taxation:
Tax on Interest & Dividend Income
For corporations only, 70% of all dividend
income received from an investment in the stock
of another corporation in which the firm has less
than 20% ownership is excluded from taxation.
This exclusion is provided to avoid triple
taxation for corporations.
Unlike dividend income, all interest income
received is fully taxed.
Copyright 2006 Pearson Addison-Wesley.
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Business Taxation:
Debt versus Equity Financing
In calculating taxes, corporations may deduct operating
expenses and interest expense but not dividends paid.
This creates a built-in tax advantage for using debt
financing as the following example will demonstrate.
Example
Two companies, Debt Co. and No Debt Co., both
expect in the coming year to have EBIT of $200,000.
During the year, Debt Co. will have to pay $30,000 in
interest expenses. No Debt Co. has no debt and will
pay not interest expenses.
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Business Taxation:
Debt versus Equity Financing (cont.)
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Business Taxation:
Debt versus Equity Financing (cont.)
As the example shows, the use of debt
financing can increase cash flow and EPS,
and decrease taxes paid.
The tax deductibility of interest and other
certain expenses reduces their actual
(after-tax) cost to the profitable firm.
It is the non-deductibility of dividends paid
that results in double taxation under the
corporate form of organization.
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