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UT Knoxville FINC 300 - Corporate Finance and Financial Manager
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FINC 300 1st Edition Lecture 2What is Finance? Types of Firms Financial Decisions The Financial Cycle What is Finance? • Science and art of managing money• Used by businesses and individuals• Math for the real world**Most financial concepts boil down to the idea that $1 today is worth more than $1 tomorrow. • There are many financial decisions a firm must make, the first of which is how to form and organize the business. Types of Firms: Sole proprietorships- Businesses owned by one owner with unlimited liability• Most common type of firm in the world, makes small portion of revenue• Easy to set up, difficult to transfer• Life is limited to lifetime of ownerMany business start as sole proprietorships and change as they grow.Partnership- Business owned by more than one person with unlimited liability.• All owners have unlimited liabilityThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.• All partners must be living for business to continueLimited Partnership- Special kind of partnership in which there are both general partners and limited partners.• Limited partners have no management authority and limited liability. They are only responsible for the amount they invested.EX: law firms, accounting firms, medical practices• Limited Liability Company (LLC)- Similar to Limited Partnership, without general partner; all members are limited.• All Members have limited liability and can manage.Corporation (C-Corp)- Legally defined, artificial being (Legal entity), separate from its owners.• Responsible for 85% worldwide revenues• They hold many of the same legal powers as individuals• They can enter contracts, acquire assets, incur obligations (debts)• Solely responsible for obligations (owners are NOT liable)• Owners have limited Liability• Must be legally formed• Requires state consent for charter• No limit to number of owners.Greatest Advantages: Corporations can raise substantial amounts of capital by selling ownership shares to outside investors. Greatest disadvantage: Double- taxationOwners are called: Shareholders, stockholders, equity holdersStock- ownership/equity of corporation divided into sharesEquity- all the outstanding shares of a corporation (market value of company)Owners are compensated with a Dividend PaymentDividend Payment- A portion of the revenues paid out to equity holders in proportion to the amount of stock they own. However, they are made at the discretion of the company and are not guaranteed. Dividend example: Helen owns 10.2% of the stock of Median Corp. If Median makes a dividend payment of $25,000,000 paid proportionally to its shareholders, how much of this amount would Helen receive? • 25,000,000 * 0.102 = $2,550,000One of the greatest disadvantages to incorporating is the difference in Taxation: Double taxation: First the corporation pays tax on its profits and then when the remaining profits are distributed to the shareholders as dividends, the shareholders pay their own personal income tax on this income. • Essentially: Shareholders pay taxes twice.Tax examples: Valiant Corp. is a C corporation that earned $3.40 per share before it paid any taxes. Valiant Corp. retained $1 of after-tax earnings for reinvestment and distributed what remained in dividend payments. If the corporate tax rate was 35% and dividend earnings were taxed at 12.5%, 1. What was the value of the dividend earnings received after-tax by a holder of 100,000 shares of Valiant Corp.? 2. What was the total amount of taxes paid per share? 1. $3.40/share @ 35% tax (3.40*0.35)= $1.19 paid in taxes/share$3.40 – 1.19= $2.21 remains after Valiant pays taxes$2.21-1.00 (Valiant retains $1 /share) = $1.21 remain for dividendsShareholders pay 12.5% tax on $1.21/share (1.21*0.125)=0.1513$1.21-0.1513=$1.0588/share after personal taxes paid• Answer: $1.0588*100,000=$105,880 paid in dividends for shareholder with 100,000 shares. 2. $1.19+0.513= $1.3413 total paid in taxes.A C-corp earns $8.30 per share before taxes and pays a dividend of $4/share. The corporate tax rate is 39%, the personal tax rate on dividends is 15%, and the personal tax rate on non-dividend income is 36%. What is the after-tax amount of the dividend? • After tax amt of Div= Div.rate(1-tax rate) = 4.00(1-0.15) = $3.40Board of Directors (BOD): • Elected by Shareholders • Ultimate decision making authorityo Determine how top executives are paido Monitor company performanceo Answer to shareholdersChief Executive Officer (CEO): • Hired by BOD• Institutes policies created by BOD on a day-to-day basis.Agency Problems can arise from the separation of Ownership and Control. However, these problems can be mitigated by aligning the interests of owners and managers through the use of:• Compensation ties to performance• Threat of punishment and takeovrFinancial Decisions#1 Goal of the firm is to maximize the wealth of shareholders through investment and financing decisions on behalf of the owners, the shareholders. - Investment Decisions revolve around deciding good uses for the money stockholders have invested. - Financing Decisions are about how to pay for the investment decisions. Selling equity (stock) or borrowing (bonds and debt)Financial institutions aid with the cycle by: • Moving funds from those who have extra funds (savers and investors) to those who need funds (borrowers and firms) • Moving funds through time • Spreading risk across large investor bases Financial Markets Primary Market:– The corporation issues new shares of stock and sells them directly to investors, with or without the aid of an investment bank. Secondary Market:– Existing shares of stock are sold between investors without the involvement of the


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UT Knoxville FINC 300 - Corporate Finance and Financial Manager

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