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Chapter 1 The Firm and theFinancial Manager
Organizing a Business
The Role of the Financial Manager
Who is the Financial Manager?
Goals of the Corporation
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Organizing a Business
No two companies will develop in exactly thesame way
Business fundamental determines the best legalstructure
Types of business organizations: Sole Proprietorships
Partnerships
Corporations
Hybrid forms
Limited Partnerships: limited liability
LLP/LLC: flow-through entities, with taxed on partners,business does not pay income tax
PC: taxed as a corporation
Income trust: a unique twist
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Starting as a Proprietorship
Sole owner of a business with no partnersand no shareholders
Advantages:
Ease of formation
Subject to fewer regulations
No double taxation of corporate earnings
Disadvantages: Difficult to raise capital to support growth
Unlimited liability
Limited life span
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Starting as or Growing into aPartnership
Business owned by two or moreindividuals with various privileges andresponsibilities
General (day-to-day management withunlimited liabilities) vs. limited partner (liableonly for the money invested)
Limited liability partnership
A partnership has roughly the sameadvantages and disadvantages as a soleproprietorship
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Becoming a Corporation
A corporation is a legal entity separatefrom its owners and managers
File papers and prepare reports federally
with Corporation Canada under theCanadian Business Corporate Act
Articles of incorporation
Bylaws
Public (with shares listed for trading on anexchange) vs. Private Company (withshares are closely held)
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Becoming a Corporation
Corporations
A business which is legally distinct from itsowners, who are called shareholders.
One of the key features of a corporation is theseparation of ownership and management.
This allows a corporation more flexibility andpermanence than other types of businessorganization.
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Advantages/Disadvantages ofa Corporation
Advantages:
Unlimited life
Easy transfer of ownership
Limited liability Ease of raising capital
Disadvantages:
Double taxation
Higher setup cost
Endless report filing
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A Unique Twist: Income Trust
Expand 100 times to a market capitalization of$192 billion from 1994 to 2007
Growth ends as government has announced plansin 2006 to tax trusts at the same rate ascorporations
In the past, cash distributions from income trustare only taxed in the hands of investors, not atthe firm level
Investors see trusts as tax-efficient and arewilling to pay more for a company converted intoa trust
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Basic Income Trust Structure
Copyright 2006 McGraw Hill Ryerson Limited 1-9
Income Trust Investor
(Unit-holders)
INCOME
TRUST
Operating Company
Cash Distributions
Interest, dividends, return of capital
Equity
Equity/Debt
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Tax Rates and Changes toIncome Trust Taxation
Before After
Investor IncomeTrust(Income)
Large Corp(Dividend)
IncomeTrust(Income)
Large Corp(Dividend)
TaxableCanadian
46% 46% 45.5% 45.5%
Tax-exemptCanadian
0 32% 31.5% 31.5%
Taxablenon-resident
15% 42% 41.5% 41.5%
Copyright 2006 McGraw Hill Ryerson Limited 1-10
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Organizing a Business:Summary
Sole
Proprietorship
Partnership Corporation
Who owns the
business?
The manager Partners Shareholders
Are managersand owners
separate?
No No Usually
What is the
owners
liability?
Unlimited Unlimited Limited
Are the owner& business
taxed
separately?
No No Yes
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Role of the Financial Manager
FinancialManager
Firm's
operations Investors
(2) Cash invested in firm
(2)
(3) Cash generated by operations
(3)
(4a) Cash reinvested
(4a)
(4b) Cash returned to investors
(4b)Real assets
(1) Cash raised from investors
(1)
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Role of the Financial Manager
The role of the financial manager is todetermine:
What operating assets to invest in?
- Capital budgeting decision, e.g. EnCana hascompleted a $700m natural gas project offshoreNova Scotia in 2010
How to pay for those assets?
- Financing decision, e.g. TransCanada issued45.4 million common shares to raise $1.7 billion
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Role of the Financial Manager
Capital Budgeting Decision
The financial manager is concerned with:
1.
The size;
2. The timing; and
3. The risks associated with realizing the futurebenefits produced by the asset
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Role of the Financial Manager
Financing Decision
The financial manager can use:
Internal financing purchase the assets using thefirms own funds.
External financing - purchase the assets by raisingmoney from financial institutions or markets.
Capital structure mix of debt and equity capital
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Who is the Financial Manager?
Chief Financial Officer
Treasurer: cash mgmt,
raising capital, banking
relationship
Controller: preparing
financial statements,
accounting, taxes
Anyone responsible for the capital budgeting and/or thefinancing decision is known as a financial manager
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Determinants of a Firms Value
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Goals of the Corporation
The primary goal of any corporation is tomaximize shareholder wealth Increasing market value increases shareholder
wealth.
Thus, the objective is to maximize thefundamental share price, not just the currentprice or the profit.
.But not at the cost of unethical behavior!
Business ethics are a companys attitude andconduct towards its employees, customers,community and shareholders
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Goals of the Corporation
Individuals act in their own self-interest
Agency Problems
Conflicts of interest between the firms owners
(principals) and its managers (agents) areknown as agency problems.
Agency relationships result in agency costs,e.g. loss of wealth if agents pursue their own
interest, cost of monitoring the agent Agency costs are borne by the principals
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Goals of the Corporation
Agency Problems
Agency problems can be reduced in several
ways: Compensation plans: link the managers salary to
the fortunes of the firm
options
Board of Directors Threat of take-over
Specialist monitoring: security analysts, bankofficers