Chapter 1An Introduction to the Foundations of Financial Management—The Ties That BindChapter ObjectivesThe Goal of the FirmBenefits of Maximizing Shareholder WealthProfit MaximizationLegal Forms of Business OrganizationSole ProprietorshipPartnershipsCorporationHow The Finance Area Fits Into a CorporationObjectives of Income TaxationTypes of TaxpayersTaxable IncomeCorporate IncomeCorporate Tax RatesMarginal Tax RatesOther Corporate Tax ConsiderationsTen Principles That Form The Foundations of Financial ManagementPrinciple 1: The Risk-Return Trade-offPrinciple 2: The Time Value of MoneyPrinciple 3: Cash—Not Profits—Is KingPrinciple 4: Incremental Cash FlowsPrinciple 5: The Curse of Competitive MarketsPrinciple 6: Efficient Capital MarketsPrinciple 7: The Agency ProblemPrinciple 8: Taxes Bias Business DecisionsPrinciple 9: All Risk is Not EqualPrinciple 10: Ethical Behavior Is Doing The Right Thing, and Ethical Dilemmas Are Everywhere In FinanceFinance And The Multinational FirmChapter 1Chapter 1An Introduction to the An Introduction to the Foundations of Financial Foundations of Financial Management—The Ties That Management—The Ties That BindBindChapter ObjectivesChapter ObjectivesIdentify the Goal of the FirmCompare the various legal forms of business organizationDescribe the corporate tax features that affect business decisionsDescribe the impact of the tragedies of September 11 on corporate financeExplain the 10 principles that form the foundations of financial managementExplain what has led to the era of the multinational corporationThe Goal of the FirmThe Goal of the FirmThe Goal of the firm is maximization of shareholder wealth orMaximization of the price of the existing common stockBenefits of Maximizing Benefits of Maximizing Shareholder WealthShareholder WealthDirect benefit to shareholdersSocietal benefits as businesses compete to create wealthIncludes effects of all financial decisionsProfit MaximizationProfit MaximizationStresses the efficient use of capital resourcesNot specific to time frame for profits to be measuredGoals are not precise, allow for misinterpretationIgnores uncertainty and timingLegal Forms of Business Legal Forms of Business OrganizationOrganizationSole ProprietorshipPartnershipCorporationSole ProprietorshipSole ProprietorshipOwned by an individualOwner holds title to assetsUnlimited liabilityTermination occurs on owner’s death or by owner’s choicePartnershipsPartnershipsGeneral Partnership–Each partner is fully responsible for liabilities or–Joint Unlimited LiabilityLimited Partnership–Allows one or more partners limited liability–Must have one general partner with unlimited liability–Names of limited partners may not appear in name of firm–Limited partners may not participate in management decisions.Two or more ownersCorporationCorporationMost large companies are corporationsSeparate legal entity–Can sue, be sued, purchase, sell and own propertyShareholders are the legal ownersLife continues with transfer of ownershipTaxed separatelyHow The Finance Area Fits How The Finance Area Fits Into a CorporationInto a CorporationC o r p o r a t e O r g a n i z a t i o n a l S t r u c t u r eV i c e - P r e s i d e n t - - M a r k e t i n gT r e a s u r e rC o n t r o l l e rV i c e - P r e s i d e n t F i n a n c eo rC h i e f F i n a n c i a l O f f i c e rV i c e - P r e s i d e n t P r o d u c t i o na n dO p e r a t i o n sC h i e f E x e c u t i v e O f f i c e rB o a r do fD i r e c t o r sObjectives of Income TaxationObjectives of Income TaxationRaise revenues for government expendituresAchieve socially desirable goalsAchieve economic stabilizationTypes of TaxpayersTypes of TaxpayersIndividuals—employees, self-employed persons, members of partnershipsReport income on personal tax returnCorporations—separate legal entityReport income on corporate tax returnDistributed dividends taxed to shareholdersFiduciaries—estates and trustsPay taxes on undistributed incomeTaxable IncomeTaxable Income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 deductibleCorporate IncomeCorporate IncomeSales $1,000Cost of Goods Sold $ 200Gross Profit $ 800Operating Expenses–Administrative Expenses $150–Depreciation Expense $ 50Total Operating Expenses $200Operating Income $600Other Income $0Interest Expense $250Taxable Income $350Corporate Tax RatesCorporate Tax RatesIncome Rate$ 0 - $50,000 15%$50,001 - $75,000 25%$75,001 - $10,000,000 34%Over $10,000,000 35%Additional surtax:5% on income between $100,000 and $335,0003% on income between $15,000,000 and $18,333,333Marginal Tax RatesMarginal Tax RatesRates applicable to next dollar of incomeUsed in financial decision-makingOther Corporate Tax Other Corporate Tax ConsiderationsConsiderations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Capital Gains and Losses—Capital Gains taxed as ordinary income. Capital losses cannot be deducted from ordinary income.Ten Principles That Form The Ten Principles That Form The Foundations of Financial Foundations of Financial ManagementManagementPrinciple 1: The Risk-Return Principle 1: The Risk-Return Trade-offTrade-offWe won’t take on additional risk unless we expect to be compensated with additional return.Investment alternatives have different amounts of risk and expected returns.The more risk an investment has, the higher will be its expected return.Principle 2: The Time Value of Principle 2: The Time Value of MoneyMoneyA dollar received today is worth more than a dollar received in the future.Because we can earn interest on money received today, it is better to receive money earlier rather than later.Principle 3: Cash—Not ProfitsPrinciple 3: Cash—Not Profits—Is King—Is KingCash Flow, not accounting profit, is used to measure wealth.Cash flows, not profits, are actually received by the firm and can be reinvested.Principle