Reference Parrino, R., Kidwell, D.S., & Bates, D.S. (2012). Fundamentals Of Corporate Finance (2nd ed.). Retrieved from The University of Phoenix eBook Collection database.In-Text CitationInsert the paraphrased material (Parrino, Kidwell, & Bates, 2012, p. 1). According to Parrino, Kidwell, and Bates (2012), Insert the paraphrased material (p. 1).“Insert the quotation” (Parrino, Kidwell, & Bates, 2012, p. 1).Reference Investopedia.com. (2015). Retrieved from
http://www.investopedia.com/terms/l/llc.aspIn-Text CitationInsert the paraphrased material ("Investopedia.com", 2015). The "Investopedia.com" (2015) website Insert the paraphrased material. According to "Investopedia.com" (2015), "Insert the quotation” (Limited Liability Company - LLC).
Glossary 721Subject Index 729
Readings and Key Terms
Ch. 1 of Fundamentals of Corporate Finance o Wealth - "The economic value of the assets someone possesses" (Parrino, Kidwell, &
Bates, 2012, p. 2).Wealth, 2
o Stakeholders - "Anyone other than an owner (stockholder) with a claim on the cash flows of a firm, including employees, suppliers, creditors, and the government" (Parrino, Kidwell, & Bates, 2012, p. 2).Stakeholders, 2, 3
o Residual cash flows - "The cash remaining after a firm has paid operating expenses and what it owes creditors and in taxes; can be paid to the owners as a cash dividend or reinvested in the business" (Parrino, Kidwell, & Bates, 2012, p. 3).Residual cash flows, 3
o Bankruptcy - "Legally declared inability of an individual or a company to pay its creditors" (Parrino, Kidwell, & Bates, 2012, p. 4).
Bankruptcy, 4of Blockbuster, 200and debt financing, 5of Enron and WorldCom, 16, 18–20losses limited in, 659from mismanagement of workingcapital, 6Bankruptcy costs, 520–523direct, 521
indirect, 521–523o Capital structure - "The mix of debt and equity that is used to finance a firm"
(Parrino, Kidwell, & Bates, 2012, p. 6).Capital structure, 6, 504–530choosing, 526–529decisions on, 612dividends in management of, 556and financial risk, 510in financing plan, 609leasing, 535–544and Modigliani and Miller propositions,506–514optimal, 505–506, 520, 676pecking order theory of, 526–528for selected industries, 527trade-off theory of, 526–528use of debt in, 514–526
o Capital markets - "Financial markets where equity and debt instruments with maturities greater than one year are traded" (Parrino, Kidwell, & Bates, 2012, p.6).Capital markets, 6, 31, 32, 689–691
o Net working capital (NWC) - "The dollar difference between current assets and current liabilities" (Parrino, Kidwell, & Bates, 2012, p.6).Net working capital (NWC), 4, 6cash flow invested in, 68–69on financial statements, 53–54in working capital management, 443, 450–451
o Sole proprietorship - "A business owned by a single individual" (Parrino, Kidwell, & Bates, 2012, p. 6).Sole proprietorships, 6–7capital for, 572, 573characteristics of, 572financial liabilities of, 573–574life of, 573taxation of, 7
o Partnership - "Two or more owners who have joined together legally to manage a business and share in its profits" (Parrino, Kidwell, & Bates, 2012, p. 7).Partnerships, 7characteristics of, 572life of, 573limited liability, 8maximizing stock value for, 12taxation of, 8Partnership agreements, 572, 573
o Limited liability partnership (LLP) - "Hybrid business organizations that combine some of the advantages of corporations and partnerships; in general, income to the
partners is taxed only as personal income, but the partners have limited liability" (Parrino, Kidwell, & Bates, 2012, p. 8).Limited liability partnerships (LLPs), 8Limited partners, 7, 493Limited partnerships, 7capital for, 572, 573characteristics of, 572financial liabilities of, 573life of, 573private equity funds as, 493
o Limited liability company (LLC) - According to Investopedia.com (2015),"A corporate structure whereby the members of the company cannot be held personally liable for the company's debts or liabilities" (Limited Liability Company - LLC).Limited liability companies (LLCs),8, 571, 572capital for, 573characteristics of, 572financial liabilities of, 574life of, 573partnership agreements in, 573private equity funds as, 493taxes as C-corporations, 574n.1
o Corporation - "A legal entity formed and authorized under a state charter; in a legal sense, a corporation is a person distinct from its owners" (Parrino, Kidwell, & Bates, 2012, p. 7).
and agency relationships, 14, 19aligning interests of management and stockholders, 14–16for diff erent forms of business, 572, 573manager-stockholder, 14with ownership and control, 14payoff functions leading to, 658–661in private equity firms, 494
and regulatory reforms, 16–18
o Agency costs - "The costs arising from conflicts of interest between a principal and an agent; for example, between a fi rm’s owners and its management" (Parrino, Kidwell, & Bates, 2012, p. 14).Agency costs, 14, 523–526of debt, 659–660of equity, 660–661ethics conflicts involving, 19and payoff functions, 658–661in private equity firms, 494stockholder-lender, 524–526stockholder-manager, 523
Ch. 2 of Fundamentals of Corporate Finance p.24
o Financial and real assets - "Assets that are claims on the cash fl ows from other assets; business loans, stocks, and bonds are financial assets. nonfinancial assets such as plant and equipment; productive assets are real assets; many financial assets are claims on cash flows from real assets" (Parrino, Kidwell, & Bates, 2012, p. 723, 725).
o Primary and secondary markets - "A financial market in which new security issues are sold by companies directly to investors / a financial market in which new security issues are sold by companies directly to investors" (Parrino, Kidwell, & Bates, 2012, p. 725,726).
Primary markets, 30Secondary markets, 30, 271–273corporate bonds transactions in, 239efficiency of, 272–273transactions in, 271–272types of, 273
o Marketability - "The ease with which a security can be sold and converted into cash" (Parrino, Kidwell, & Bates, 2012, p. 724).
o Private and public markets - " / financial markets where securities registered with the SEC are sold" (Parrino, Kidwell, & Bates, 2012, p. 2).
Private markets, 32private equity firms, 493–494private investments in public equity, 494private placements, 32, 492–493public markets vs., 492raising capital in, 491–494Public markets, 8, 31–33. See also Initial public offeringsprivate markets vs., 492as wholesale markets, 491
o Market efficiency - "The degree to which the transaction costs of bringing buyers and sellers together are minimized / the degree to which current market prices refl ect relevant information and, therefore, the true value of the security" (Parrino, Kidwell, & Bates, 2012, p. 2).Efficient market, 33–34
o Financial intermediation - "Conversion of securities with one set of characteristics into securities with another set of characteristics" (Parrino, Kidwell, & Bates, 2012, p. 723).Financial intermediation, 34, 35
o Initial public offering (IPO) - "The first offering of a corporation’s stock to the public" (Parrino, Kidwell, & Bates, 2012, p. 724).
Initial public off erings (IPOs), 36, 37, 479–488advantages of, 480bundling options and common stock in, 654cost of, 480, 486–488, 491disadvantages of, 480–481distribution of shares, 483investment banking services for, 481–483origination of, 481–482proceeds from, 483–484underpricing of, 485–486underwriting for, 482–483as venture capitalists’ exit strategy, 478Inside directors, 17Insider trading, 299–300
o Real and nominal interest - "The interest rate that would exist in the absence of inflation / the rate of interest that is unadjusted for inflation" (Parrino, Kidwell, & Bates, 2012, p.725,726).Real rate of interest, 38–40, 259
Nominal rate of interest, 38, 676
Ch. 3 of Fundamentals of Corporate Finance p.48o Generally Accepted Accounting Principles (GAAP) - "A set of rules that defines
how companies are to prepare financial statements" (Parrino, Kidwell, & Bates, 2012, p.723).Generally accepted accounting principles(GAAP), 16, 50–52fundamental accounting principles in, 50–51international, 51–52revenue recognition under, 67–68sales vs. leases, 536for tax depreciation, 356
o Book value - "The net value of an asset or liability recorded on the fi nancial statements—normally refl ects historical cost" (Parrino, Kidwell, & Bates, 2012, p.721).Book value, 50adjusted book value valuation approach,582–584of assets, 57–58, 411of liabilities, 58market vs., 57–58of stockholders’ equity, 58Book-value balance sheet, 58–60Book value rate of return, 318
o Balance sheet - "Financial statement that shows a firm’s financial position (assets, liabilities, and equity) at a point in time" (Parrino, Kidwell, & Bates, 2012, p. 722).
Balance sheet, 52–60assets on, 52–55, 619book-value vs. market-value, 57–58common-size, 84–85dividends on, 552effect of decision making on, 4equity on, 55–57, 619finance, 411–412in financial planning models, 614, 617–622historical trends on, 617–618liabilities on, 54–55, 619pro forma, 614–615, 617–622relationship of other statements and, 66–67stock repurchases on, 552working capital accounts on, 618–619
o Income statement - "A financial statement that reports a fi rm’s revenues, expenses, and profi ts or losses over a period of time" (Parrino, Kidwell, & Bates, 2012, p. 723).
Income statement, 60–63common-size, 85–86in financial planning models, 613, 616–617pro forma, 613, 616–617
relationship of other statements and, 66–67o Statement of cash flows - "A financial statement that shows a firm’s cash receipts
and cash payments and investments for a period of time" (Parrino, Kidwell, & Bates, 2012, p. 726).
Statement of cash flows, 63–67
o Depreciation - "Allocation of the cost of an asset over its estimated life to reflect the wear and tear on the asset as it is used to produce the firm’s goods and services" (Parrino, Kidwell, & Bates, 2012, p. 722).
Depreciation, 54–55. See also Incremental depreciation and amortization accelerated, 55, 61and cash flow invested in long-term assets, 70and FCF, 349GAAP vs. IRS rules for, 356–359on statement of cash flows, 64, 65straight-line, 55, 61–62, 358Depreciation charges, 358Depreciation expense, 61–62
o Treasury stock - "Stock that the firm has repurchased from investors" (Parrino, Kidwell, & Bates, 2012, p. 727).
Treasury stock, 56
o Market value - "The price at which an item can be sold" (Parrino, Kidwell, & Bates, 2012, p. 724).
Market value (MV), 50, 57of assets, 57–58, 411–412book value vs., 57–58of common stock, 56of liabilities, 58of stockholders’ equity, 58in WACC, 428Market-value balance sheet, 58–60
Market-value ratios, 89, 100–101o Cash flows to investors - from the sale of securities to investors" (Parrino, Kidwell,
o Average and marginal tax rate - "Total taxes paid divided by taxable income / the tax rate paid on the last dollar of income earned" (Parrino, Kidwell, & Bates, 2012, p. 722,724).
o Key finance axioms - A statement or idea that people accept as self-evidently true
Identify and define various axioms of finance, such as agency, financial intermediation, stakeholders, IPO, liquidity, and so on.The Risk-Return Trade-offThe more risk an investment has, the higher its expected return should be If you bet on a horse, you want greater odds on the long shot If you invest in a risky business Semiconductor, oil wells, junk bonds), you should demand a greater return. Every decision you make should be evaluated for riskThe Time Value of MoneyA dollar received today is worth more than a dollar received in the future If you receive a dollar today, you can invest it and earn more Because of inflation, a dollar you receive today will buy more than a dollar you receive in the future So the sooner you get the money, the better The sooner you invest your money, the better (i.e. retirement)Cash is KingYou can not spend profit or net income. These are paper figures only Cash is what is received by the firm and can be reinvested or used to pay bills. Cash flow does not equal net income; there are timing differences in accrual accounting between when you record a transaction and when you receive or pay the cashIncremental Cash FlowsIt’s only the increase or decrease in cash that really counts. It’s the difference between cash flows if the project is done versus if the project is not done Consider all related cash flows, i.e., equip., inventory, etc.Curse of Competitive MarketsIt’s hard to find and maintain exceptionally profitable projects. High profits attract competitionHow to keep very profitable projects Product differentiation (Kleenex, Xerox),Low cost (Costco, Honda), Service and quality (Mercedes, Lexus)Efficient Capital MarketsThe markets are quick and the prices are right. Information is incorporated into security prices at the speed of light! Assuming the information is correct, then the
prices will reflect all publicly available information regarding the value of the firm. Example: announcing a stock splitThe Agency ProblemManagers are typically not the owners of a company. Managers may make decisions that are in their best interests and not in line with the long term best interests of the ownersExample, cutting Research and Development costs on new products to maximize current incomeTaxes Bias Business DecisionsBecause cash is king, we must consider the after-tax cash flow on an investment. The tax consequences of a business decision will impact (reduce) cash flow. Companies are given tax incentives by the government to influence their decisions. Examples : investment tax credit and environmental credits reduce taxes; purchase of PriusAll Risk is Not EqualSome risk can be diversified away and some cannot Don’t put all your eggs in one basketDiversification creates offsets between good results and bad results. Example: drilling for oil wellsEthical Behavior Means Doing the Right ThingEthical Dilemmas are everywhere in finance; just read the news (back date stock options, Madoff). Unethical behavior eliminates trust, results in loss of public confidenceShareholder value suffers and it takes a long time to recoverSocial responsibility means firms have to be responsible to more than just owners, all stakeholders.http://10axioms.blogspot.com/2011/05/10-axioms-of-financial-management.html
o Determine difference between nominal and real interest rates.The nominal interest rate (or money interest rate) is the percentage increase in money you pay the lender for the use of the money you borrowed. For instance, imagine that you borrowed $100 from your bank one year ago at 8% interest on your loan. When you repay the loan, you must repay the $100 you borrowed plus $8 in interest—a total of $108.But the nominal interest rate doesn’t take inflation into account. In other words, it is unadjusted for inflation. To continue our scenario, suppose on your way to the bank a newspaper headline caught your eye stating: “Inflation at 5% This Year!” Inflation is a rise in the general price level. A 5% inflation rate means that an average basket of goods you purchased this year is 5% more expensive when compared to last year. This leads to the concept of the real, or inflation-adjusted, interest rate. The real interest rate measures the percentage increase in purchasing power the lender receives when the borrower repays the loan with interest.. In our earlier example, the lender earned 8% or $8 on the $100 loan. Fortunately, the market for U.S. Treasury securities provides a way to estimate both nominal and real interest rates. You can start comparing current real and nominal interest rates by looking at rates on comparable maturity Treasury securities—pick one that is not adjusted for inflation and one that is adjusted for inflation (more about these below). Chart 1 illustrates that
there is certainly a difference between the real and nominal interest rates. This difference gives us an idea of the current inflation premium.100 loan.
Interest Rates in the Real World. Advertised interest rates that you may see at banks or other financial service providers are typically nominal interest rates. This means its up to you to estimate how much of the interest rate a bank may pay you on a savings deposit is really an increase in your purchasing power and how much is simply making up for yearly inflation.Now, let’s look at some of the inflation-adjusted securities that provide a real interest rate. The blue line in Chart 1 plotted the inflation-adjusted interest rates paid on these securities over the past several years, In 1997, the U.S. government began offering bonds called Treasury Inflation-Protected Securities (TIPS). Unlike other investments that pay a nominal interest rate, TIPS earn a real interest rate. The TIPS securities earn a fixed rate of interest just like many other types of government bonds. But, in addition to the fixed rate, the principal value of your TIPS bond is adjusted for inflation. So, at maturity, TIPS investors receive an inflation-adjusted principal amount. Also, for the unlikely event of deflation, there is a safeguard built into the TIPS system: the final payment of principal cannot be less than the original par value. I-bonds, issued by the U.S. Treasury, are another type of investment that earns a real rate of return. Unlike TIPS investors, who receive an adjusted principal value at the end of the investment time period, I-Bond investors receive interest payments that are adjusted for inflation twice each year.As with any investment or loan, it’s simply important to understand the interest rate that you are paying or receiving. With this knowledge, you will be able to compare it with other investments or loans and make sure you are getting a deal that is right for you and your financial situation.http://www.frbsf.org/education/publications/doctor-econ/2003/august/real-nominal-interest-rate
o Determine difference between private and public markets.On the private market transactions are directly between two parties and can take any form the parties agree to. Public Market - Transactions in public markets are conducted on organized exchanges. Securities traded on public markets use standardized contracts because they involve so many parties.http://www.answers.com/Q/Private_market_vs_public_market
o Determine difference between financial and real assets.
Businesses are evaluated according to the assessment of both financial and real assets and the ability of each to generate cash flow. Financial assets usually show continued growth and increased value, but the building and vehicle components of the real assets lose value over time. Real estate is a stable real asset that generally appreciates over time and adds value to the business portfolio.Businesses require both financial and real assets to continue to deliver their products and meet the financial obligations that enable them to remain in operation. Financial assets generate the income to purchase real assets, and in turn, real assets are used to produce goods and services to generate revenue. A diversified portfolio with a balance of financial and real assets creates a strong company that is able to weather the ups and downs of the financial market.
o Understand financial intermediation.The process performed by banks of taking in funds from a depositor and then lending them out to a borrower. The banking business thrives on the financial intermediation abilities of financial institutions that allow them to lend out money at relatively high rates of interest while receiving money on deposit at relatively low rates of interest.http://www.businessdictionary.com/definition/financial-intermediation.html
o Finanacial statements
o Identify the components of a balance sheet.
The three key sections of a balance sheet are:AssetsLiabilitiesOwner’s equityAssets and liabilities are sub-divided into current (short-term) and non-current (long-term) and may have several components within each sub-division such as cash at bank, inventory, property, accounts payable, or business bank loans. The individual items will differ depending on the nature of the business and industry.It is called a balance sheet because assets minus liabilities (net assets) must equal the owner’s equity (they must balance). A balance sheet is based on the formula:Owner’s equity = Assets – Liabilities
o Explain the balance sheet identity and why it must balance.The balance sheet reflects a company’s health. It lists the assets and liabilities for a specified period, such as the most recent quarter or a fiscal year. Potential investors or loan officers examine the balance sheet when a business applies for a commercial mortgage or other loan. One of the calculations they make is balance sheet identity.http://smallbusiness.chron.com/balance-sheet-identity-37248.html
A balance sheet should always balance. The name "balance sheet" is based on the fact that assets will equal liabilities and equity every time.The assets on the balance sheet consist of things of value that the company owns or will receive in the future and which are measurable. Liabilities are what the company owes, such as taxes, payables, salaries and debt. The equity sections displays the company's retained earnings and the capital that has been contributed by shareholders.The balance between assets, liability and equity makes sense when applied to a simpler example, such as buying a car for $10,000. In this case, you might use a $5,000 loan (debt), and $5,000 cash (equity) to purchase it. Your assets are worth $10,000 total, while your debt is $5,000 and equity is $5,000. In this simple example, assets equal debt plus equity.
http://www.investopedia.com/ask/answers/09/does-balance-sheet-always-balance.aspo Describe how market values differ from book values.
Book value is the price paid for a particular asset. This price never changes so long as you own the asset. On the other hand, market value is the current price at which you can sell an asset.For example, if you bought a house 10 years ago for $300,000, its book value for your entire period of ownership will remain $300,000. If you can sell the house today for $500,000, this would be the market value.Book values are useful to help track profits and losses. If you have owned an investment for a long period of time, the difference between book and market values indicates the profit (or loss) incurred.
The need for book value also arises when it comes to generally accepted accounting principles. According to these rules, hard assets (like buildings and equipment) listed on a company's balance sheet can only be stated according to book value. This sometimes creates problems for companies with assets that have greatly appreciated - these assets cannot be re-priced and added to the overall value of the company.
o Identify the components of an income statement.
The income statement consists of revenues and expenses along with the resulting net income or loss over a period of time due to earning activities. The income statement shows investors and management if the firm made money during the period reported.The operating section of an income statement includes revenue and expenses. Revenue consists of cash inflows or other enhancements of assets of an entity, and expenses consist of cash outflows or other using-up of assets or incurring of liabilities.The non-operating section includes revenues and gains from non-primary business activities, items that are either unusual or infrequent, finance costs like interest expense, and income tax expense.The "bottom line" of an income statement is the net income that is calculated after subtracting the expenses from revenue. It is important to investors - also on a per share basis (as earnings per share, EPS) - as it represents the profit for the accounting period attributable to the shareholders.https://www.boundless.com/finance/textbooks/boundless-finance-textbook/financial-statements-taxes-and-cash-flow-2/the-income-statement-32/elements-of-the-income-statement-179-8370/
o Identify the basic income statement equation and the information it provides.
The income statement is one of the three primary financial statements used to assess a company’s performance and financial position (the two others being the balance sheet and the cash flow statement). The income statement summarizes the revenues and expenses generated by the company over the entire reporting period.How it works/Example:The income statement is also known as a profit and loss (P&L) statement, statement of earnings, statement of operations or statement of income. The basic equation on which an income statement is based is:Revenues – Expenses = Net Income
All companies need to generate revenue to stay in business. Revenues are used to pay expenses,interest payments on debt and taxes owed to the government. After the costs of doing business are paid, the amount left over is called net income. Net income is theoretically available to shareholders, though instead of paying out dividends, the firm's management often chooses to retain earnings for future investment in the business.Income statements are all organized the same way, regardless of industry. The basic outline is shown in the following example:
Income Statement for Company XYZ, Inc.for the year ended December 31, 2008
Total Revenue $100,000
Cost of Goods Sold ($ 20,000)Gross Profit $ 80,000
Interest Expense ($ 10,000)Earnings before tax (EBT) $ 40,000
Taxes ($ 10,000)Net Income $ 30,000
Number of Shares Outstanding 30,000
Earnings Per Share (EPS) $1.00
Anyone interested in active investing, picking stocks or investigating the financial health of a company must know how to read financial statements, including the income statement. The importance of the information contained in the income statement cannot be overemphasized.A firm's ability or inability to generate earnings over the long term is the key driver of stock and bondprices. Operating profit (EBIT) is the source of debt repayment, and if a company can't generate enough EBIT to pay its debt obligations, it will have to enter bankruptcy or sell itself. Net income is the source of compensation to shareholders (owners of the company), and if a company cannot generate enough profit to compensate owners for the risks they've taken, the value of the
owners' shares willplummet. Conversely, if a company is healthy and growing, higher stock and bond prices will reflect the increased availability of profits.Please note that earnings/net income/profits are not the same as cash or cash flow. It is possible for a firm to be profitable on the income statement, but not be generating cash flow, and vice versa. To see a company's cash flow, you will need to examine its statement of cash flows
o Understand the calcualtion of cash flows from operating, investing, and financing activities required in the statement of cash flows.
Under U.S. and ISA GAAP, the statement of cash flow can be presented by means of two ways:The indirect methodThe direct methodThe Indirect MethodThe indirect method is preferred by most firms because is shows a reconciliation from reported net income to cash provided by operations.Calculating Cash flow from OperationsHere are the steps for calculating the cash flow from operations using the indirect method:Start with net income.Add back non-cash expenses.(Such as depreciation and amortization)Adjust for gains and losses on sales on assets.Add back lossesSubtract out gainsAccount for changes in all non-cash current assets.Account for changes in all current assets and liabilities except notes payable and dividends payable.In general, candidates should utilize the following rules:(Such as depreciation and amortization)The following example illustrates a typical net cash flow from operating activities:
Cash Flow from Investment ActivitiesCash Flow from investing activities includes purchasing and selling long-term assets and marketable securities (other than cash equivalents), as well as making and collecting on loans.Here's the calculation of the cash flows from investing using the indirect method:
Cash Flow from Financing ActivitiesCash Flow from financing activities includes issuing and buying back capital stock, as well as borrowing and repaying loans on a short- or long-term basis (issuing bonds and notes). Dividends paid are also included in this category, but the repayment of accounts payable or accrued liabilities is not.Here's the calculation of the cash flows from financing using the indirect method:
o Understand the difference between marginal and average tax rates.
The difference between marginal and average tax rates is a fairly important concept for all tax payers to better understand the way the government gets paid. You’ve probably heard both terms, but maybe never knew what they were. Well, let’s fix that.Marginal Tax Rate Your marginal tax rate is the highest rate that you are taxed. For many people, a portion of their income is taxed at one rate, and the rest is taxed at another rate. For instance, if you make right around $40,000 a year, you may pay 15% on the first $20,000 or so and 28% on anything over $20,000. So, let’s break that down: 15% of $20,000 is $3,000 28% of $20,000 is $5,600 Total tax liability is $8,600 In this case, your marginal tax rate would be 28%, the highest rate at which your income is taxed. Average Tax Rate The average tax rate is the actual percentage of income going to pay taxes. In the example above we can calculate average tax rate as follows: $8,600 / $40,000 = .215 * 100 = 21.5% So, in this example, your average tax rate is 21.5%, a bit lower than your 28% marginal rate. It’s good to know this because this represents your actual tax liability. Why the Two Tax Rates? In the United States, we have something called a progressive tax system, meaning, the more money you make, the higher your tax rate. If the person in the example above only made $20,000, he’d wouldn’t have had to pay the 28%…instead only the 15% would apply. Our progressive tax system taxes you at a lower rate for the first so many dollars you make, everything over that amount gets taxed at a higher rate, and so on until you reach the cap, which, for 2008, was 35%. So, it all boils down to this, your marginal tax rate is the highest rate at which you’re taxed, but it does not represent the percentage of your income that goes toward paying taxes. That number is the average tax rate.https://answers.yahoo.com/question/index?qid=20101010231157AANR6E0
o Understand how each of the financial statements articulates with the other.
"Financial statement articulation" describes how different financial statements link together. For example, the same net income figure appears on a year's income
statement, statement of stockholders' equity, and statement of cash flows. "Articulation" is based on the mathematical properties of accounting records; failure to articulate in the following ways indicates that the financial statements are in error.Net income reconciles to statement of retained earningsNet income at the bottom of the income statement should equal Net income on the statement of retained earnings, presented as part of the statement of stockholders' equity. Note that this link works for "net income attributable to shareholders," also known as "net income attributable to the parent company." It does not always work for "consolidated net income."Net income reconciles to cash flows statementNet income at the bottom of the income statement should equal net income on the cash flows statement, as presented at the beginning of operating cash flows, under the indirect method. This works for "consolidated net income" only.Current assets and liabilities reconcile to cash flows statementUnder the indirect method, operating cash flows present a series of changes in current assets and liabilities. These changes should equal changes in all current assets and liabilities presented in the balance sheet.Stockholders' equity on the balance sheet reconciles to the stockholders' equity statementAll stockholders' equity items listed on the balance sheet should equal individual stockholder equity balances listed in the statement of stockholders' equity. Most statements of stockholders' equity are presented in the columnar format. The numbers in the last row should equal the year-end balances on the balance sheet.Cash on the balance sheet reconciles to the cash flows statementCash, usually presented as "cash and cash equivalents" on the balance sheet, should equal cash presented on the statement of cash flows.Reconciliation to notesNotes to the financial statements provide more detail explaining values in the financial statements themselves. Values in the notes sometimes, but not always, reconcile to the financial statements themselves.Financial statement "articulation" describes how financial statements should link together. Ultimately, the income statement, the statement of cash flows, and the statement of stockholders' equity explain how balances in the balance sheet change from one period to the next.
o Fundamental decisions in financial managementThere are two fundamental types of financial decisions that the finance team needs to make in a business: investment and financing. The two decisions boil down to how to spend money and how to borrow money. Recall that the overall goal of financial decisions is to maximize shareholder value, so every decision must be put in that context.InvestmentAn investment decision revolves around spending capital on assets that will yield the highest return for the company over a desired time period. In other words, the decision is about what to buy so that the company will gain the most value.
To do so, the company needs to find a balance between its short-term and long-term goals. In the very short-term, a company needs money to pay its bills, but keeping all of its cash means that it isn't investing in things that will help it grow in the future. On the other end of the spectrum is a purely long-term view. A company that invests all of its money will maximize its long-term growth prospects, but if it doesn't hold enough cash, it can't pay its bills and will go out of business soon. Companies thus need to find the right mix between long-term and short-term investment.The investment decision also concerns what specific investments to make. Since there is no guarantee of a return for most investments, the finance department must determine an expected return. This return is not guaranteed, but is the average return on an investment if it were to be made many times.The investments must meet three main criteria:It must maximize the value of the firm, after considering the amount of risk the company is comfortable with (risk aversion).It must be financed appropriately (we will talk more about this shortly).If there is no investment opportunity that fills (1) and (2), the cash must be returned to shareholder in order to maximize shareholder value.FinancingAll functions of a company need to be paid for one way or another. It is up to the finance department to figure out how to pay for them through the process of financing.There are two ways to finance an investment: using a company's own money or by raising money from external funders. Each has its advantages and disadvantages.There are two ways to raise money from external funders: by taking on debt or selling equity. Taking on debt is the same as taking on a loan. The loan has to be paid back with interest, which is the cost of borrowing. Selling equity is essentially selling part of your company . When a company goes public, for example, they decide to sell their company to the public instead of to private investors. Going public entails selling stocks which represent owning a small part of the company. The company is selling itself to the public in return for money.https://www.boundless.com/finance/textbooks/boundless-finance-textbook/introduction-to-the-field-and-goals-of-financial-management-1/introducing-finance-22/types-of-financial-decisions-investment-and-financing-145-3871/
o Understand the concerns of capital budgeting, financing, and working capital decisions and how they affect the balance sheet.
Organizational structures and forms
o Identify forms of business organization and their respective strengths and weaknesses.
Week 1 Electronic Reserve VideosTypes of corporate business structures include General corporations, Subchapter S corporations, and Limited Liability corporations. Each type is explained. Pros and cons of the Subchapter S corporations are included.
Answering a series of targeted questions helps determine the type of business entity that works best for an entrepreneur. Three types of business structure are sole proprietorship, partnership, and corporation.
5 Focuses of Organizational Structure – Strengths and Weaknesses1. Functional StructureStrengthsEasier to manage work within a groupContains people who “speak the same language” and nurtures technical expertise, attracts and develops expertsLower labor costsWorkload can be balanced upon demandWeaknessesCoordination and communication between departments may be slower and less accurateIndividual department managers have limited decision making authorityDifferent departments have different priorities; resolving conflicts may be costly; customers’ interests could be overlooked2. Product or Service-Based StructureStrengthsResponsibility for each product can be pinpointed at the division levelFocus on one product can produce higher quality “state-of-the-art” outputTeam spirit develops around each product lineCompetition among divisions can boost businessEncourages independent decision makingQuicker response to customer requestWeaknessesLess sharing of resources across divisionsMore duplication of effort resulting in higher costsCustomers who want more than one product/service will have to work with more than one divisionCompany may be slow to recognize that a product should be changed, dropped or addedCould be stifled by one product focus3. Customer or Geography-Based StructureStrengthsUnique needs of each type of customer are well servedFocus on customers’ needs and preferences
Unprofitable product lines more likely to be droppedWeaknessesMay be less sharing of resources across division/departmental boundariesMore duplication of effort and infrastructure resulting in higher costsInternal systems may evolve in different ways to serve different customer segments4. Business Process Team StructureStrengthsFocus on organization is outward to customerReduces number of levels of management – “flatten organizations” (reduced management cost; less need for coordination)Time and money saved due to reduced need to pass information up and down the hierarchy and between departmentsPromotes self-management by employees (greater job satisfaction because of more involvement)Broadens individuals’ knowledge and skill basesFaster decision making, reduced cycle time and improved responsiveness to customersWeaknessesInvolves major transformation of the organization (difficult, timely and costly change; new systems required for virtually everything)Company may need to retain functional expertise if not sufficient within each processMay require major and costly training initiative5. Matrix (Hybrid) Structure (contains more than one focus; has two or more bosses)StrengthsEnables organization to use its resources efficiently (provides flexibility to assign staff to project requirements and reassign as needed)Takes full advantage of the use of teams (maintaining in-depth technical expertise in critical functions)Provides individuals an opportunity to work with different skills and expertiseRequires managers to cooperate with one another and moderates their power over subordinatesWeaknessesMultiple bosses may result in confusionSlows down decision makingConflicting demands from bosses leads to personal stress and reduced work qualityPower struggle between managers regarding resourcesCan disrupt the work and get in the way of customer serviceSubordinates may play one boss against another
Confl icts of interest between a principal and an agent
o Know the concept of wealth maximization
Wealth maximization is a modern approach to financial management. Maximization of profit used to be the main aim of a business and financial management till the concept of wealth maximization came into being. It is a superior goal compared to profit maximization as it takes broader arena into consideration. Wealth or Value of a business is defined as the market price of the capital invested by shareholders. Wealth maximization simply means maximization of shareholder’s wealth. It is combination of two words viz. wealth and maximization. Wealth of a shareholder maximize when the net worth of a company maximizes. To be even more meticulous, a shareholder holds share in the company /business and his wealth will improve if the share price in the market increases which in turn is a function of net worth. This is because wealth maximization is also known as net worth maximization.Finance managers are the agents of shareholders and their job is to look after the interest of the shareholders. The objective of any shareholder or investor would be good return on their capital and safety of their capital. Both these objectives are well served by wealth maximization as a decision criterion to business.How to calculate wealth?Wealth is said to be generated by any financial decision if the present value of future cash flows relevant to that decision is greater than the costs incurred to undertake that activity. Wealth is equal to the present value of all future cash flows less the cost. In essence, it is the net present value of a financial decision.Wealth = Present Value of cash inflows – Cost.
http://www.efinancemanagement.com/financial-management/wealth-maximizationo Understand the difference between profit and stock valuation.
The relationship between a company's earnings and its stock price can be complicated. High profits don't necessarily mean a high stock price, and big losses don't always lead to a low stock price. Of course, without earnings it is hard for companies to stay in business for long. You could say that two of the major factors that influence stock price are current earnings and promise of future earnings.
o Identify the major factors that affect stock prices.
Have you ever wondered about what factors affect a stock's price? Stock prices are determined in the marketplace, where seller supply meets buyer demand. But unfortunately, there is no clean equation that tells us exactly how a stock price will behave. That said, we do know a few things about the forces that move a stock up or down. These forces fall into three categories:fundamental factors, technical factors and market sentiment.Fundamental FactorsIn an efficient market, stock prices would be determined primarily by fundamentals,
which, at the basic level, refer to a combination of two things: 1) An earnings base (earnings per share (EPS), for example) and 2) a valuation multiple (a P/E ratio, for example).An owner of a common stock has a claim on earnings, and earnings per share (EPS) is the owner's return on his or her investment. When you buy a stock, you are purchasing a proportional share of an entire future stream of earnings. That's the reason for the valuation multiple: it is the price you are willing to pay for the future stream of earnings.Part of these earnings may be distributed as dividends, while the remainder will be retained by the company (on your behalf) for reinvestment. We can think of the future earnings stream as a function of both the current level of earnings and the expected growth in this earnings base.As shown in the diagram, the valuation multiple (P/E), or the stock price as some multiple of EPS, is a way of representing the discounted present value of the anticipated future earnings stream. (To learn about present value, see Understanding the Time Value of Money.)
