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What is Finance?
Goal of the Firm
What is Finance?
Financial management is concerned with the maintenance and creation of economic value or wealth Financial management is concerned with investment, financing, and management of assets with some overall goal in mind Investment decision: total assets needed (the lefthand side of the balance sheet) Financing decision: total debts and equities (the right-hand side of balance sheet) Assets management decision: How to manage assets efficiently
Investment decision
Large capital expenditure Research and development Merger and aquisition Ownership structure Capital efficiency Working capital management
Financing Decision
Capital structure Dividend policy Lease vs borrow Risk management Auditing and reporting Planning (business, tax)
Management Decision
Performance measurement Budget Incentive design Investor relation Regulatory requirement
Table 1.1 J and S Corporation Taxable Income Sales Cost of goods sold Gross profit Operating expenses Administrative expenses Depreciation expenses Marketing expenses Total operating expenses Operating Income (EBIT) Other income Interest expenses Taxable income 50,000,000 -23,000,000 27,000,000 4,000,000 1,500,000 4,500,000 -10,000,000 17,000,000 0 -1,000,000 16,000,000
Corporate Tax Rates Rates 15% 25% 34% 39% Income Level Rates $0-$50,000 34% $50,001-$75,000 35% $75,001-$100,000 38% 100,001-$335,000 35% Income Level $335,001-$10,000,000 $10,000,001-$15,000,000 $15,000,001-$18,333,333 over $18,333,333
Tax Calculations Earnings $50,000 $75,000-$50,000 $100,000-$75,000 $335,000-$100,000 $10,000,000-$335,000 $15,000,000-$10,000,000 $16,000,000-$15,000,000 Total Tax Liability X Marginal Tax Rate Taxes x 15% $7,500 x 25% 6,250 x 34% 8,500 x 39% 91,650 x 34% 3,286,100 x 35% 1,750,000 x 38% 380,000 $5,530,000
Principle 1: The risk-return trade-off, we wont take on additional risk unless we expect to be compensated with additional return
- Investment alternatives have different amount of risk. The more risk an investment has the higher will be its expected return
Principle 2: The time value of money, a dollar received today is worth more than a dollar received in the future
- Because we can earn interest on money received today
Principle 4: Incremental cash flows, its only what changes that counts
- the difference between the cash flows if the project is taken on versus what they will be if the project is not taken on
Principle 5: The curse of competitive markets, why its hard to find exceptionally profitable project
- If an industry is generating large profits, new entrants are usually attracted.
Principle 6: Efficient capital markets, the markets are quick and the prices are right
- investor competing for profits ensure that security prices appropriately reflect the expected earnings and risks involved and thus the true value of the firm
Principle 7: The agency problem, managers wont work for owners unless its in their best interest
- Problem resulting from conflict of interest between the manager and the stockholder - Manager may make decision that are not in line with the goal of maximization of shareholder wealth
Principle 9: All risk is not equal, some risk can be diversified away, and some cannot
Diversification allow good and bad event to cancel out, thereby reducing total variability (risk) without affecting expected return A projects risk changes depending on whether you measure it standing alone or together with other projects
Principle 10: Ethical behavior is doing the right thing, and the ethical dilemmas are everywhere in finance
- unethical behavior eliminate trust, and without trust business cannot interact
Board of Director
Chief Executive Officer
Vice PresidentMarketing
Treasurer
Duties: Cash management, credit mgt Capital expenditures, raising capital, financial planning, mgt of foreign currencies
Controller
Duties: Taxes, financial statement, cost accounting, data processing
Government