Overview of FinanceOverview of Finance

Financial ManagementFinancial Management

The maintenance and creation of The maintenance and creation of economic value or wealth.economic value or wealth.

Goal of the FirmGoal of the Firm

1) Profit Maximization?1) Profit Maximization?

a) TIMING of Returnsa) TIMING of Returns(Time Value of Money)(Time Value of Money)

b) UNCERTAINTY of Returnsb) UNCERTAINTY of Returns(Risk )(Risk )

Goal of the FirmGoal of the Firm

2) Shareholder Wealth 2) Shareholder Wealth Maximization?Maximization?

this is the same as:this is the same as:

a) Maximizing Firm Valuea) Maximizing Firm Value

b) Maximizing Stock Priceb) Maximizing Stock Price

Legal Forms of BusinessLegal Forms of Business

1) Sole Proprietorship1) Sole Proprietorship A business owned by a single individual.A business owned by a single individual. Owner maintains title to the firm’s assets.Owner maintains title to the firm’s assets. Owner has unlimited liability.Owner has unlimited liability.

2) Partnership2) Partnership Similar to a sole proprietorship, except that Similar to a sole proprietorship, except that

there are two or more owners.there are two or more owners.

Legal Forms of BusinessLegal Forms of Business

2a) General Partnership2a) General Partnership All partners have unlimited liability.All partners have unlimited liability.

2b) Limited Partnership2b) Limited Partnership One or more limited partners (investors) One or more limited partners (investors)

whose liability is limited to the amount of whose liability is limited to the amount of their investment in the business.their investment in the business.

Legal Forms of BusinessLegal Forms of Business

3) Corporation3) Corporation A business entity that legally functions A business entity that legally functions

separate and apart from its owners.separate and apart from its owners. Owners’ liability is limited to the amount of Owners’ liability is limited to the amount of

their investment in the firm.their investment in the firm. Owners hold common stock certificates, Owners hold common stock certificates,

and ownership can be transferred by selling and ownership can be transferred by selling the certificates.the certificates.

Balance SheetBalance SheetAssetsAssets Liabilities & Owners EquityLiabilities & Owners Equity

Current AssetsCurrent Assets CashCash Marketable SecuritiesMarketable Securities Accounts ReceivableAccounts Receivable InventoriesInventories

Fixed AssetsFixed Assets LandLand Plant & EquipmentPlant & Equipment less: depreciationless: depreciation

Current LiabilitiesCurrent Liabilities Accounts PayableAccounts Payable Notes PayableNotes Payable Accrued SalariesAccrued Salaries

Long-Term LiabilitiesLong-Term Liabilities Mortgage DebtMortgage Debt DebenturesDebentures

Owners’ EquityOwners’ Equity Common Stock Common Stock Retained EarningsRetained Earnings

REVENUEREVENUE

- Cost of Goods Sold- Cost of Goods Sold

GROSS PROFITGROSS PROFIT

- Operating Expenses - Operating Expenses

NET OPERATING INCOME (NOI ) or NET OPERATING INCOME (NOI ) or

EARNINGS BEFORE INTEREST & EARNINGS BEFORE INTEREST &

TAXES (EBIT)TAXES (EBIT)

- Interest Expense- Interest Expense

- Income Taxes- Income Taxes

NET INCOMENET INCOME

- Dividends on Common & Preferred Stock- Dividends on Common & Preferred Stock

RETAINED EARNINGSRETAINED EARNINGS

Income StatementIncome Statement

Taxable Income Corporate Tax RateTaxable Income Corporate Tax Rate

$1 - $50,000 15%$1 - $50,000 15%$50,001 - $75,000 25%$50,001 - $75,000 25%$75,001 - $10 million 34%$75,001 - $10 million 34%over $10 million 35%over $10 million 35%

Corporate Income Tax RatesCorporate Income Tax Rates

other tax considerations...other tax considerations...

Dividend IncomeDividend Income:: typically 70% is excluded typically 70% is excluded from federal taxation for corporations.from federal taxation for corporations.

DepreciationDepreciation:: typically use straight-line, typically use straight-line, double-declining balancedouble-declining balance

Operating lossesOperating losses:: may be carried back 2 may be carried back 2 years or carried forward 20 years.years or carried forward 20 years.

Capital gainsCapital gains:: taxed as ordinary income. taxed as ordinary income. Net capital lossesNet capital losses:: may be carried back 3 may be carried back 3

years or carried forward 5 years and applied years or carried forward 5 years and applied against net capital gains.against net capital gains.

Corporate Tax ExampleCorporate Tax Example

Space Cow Computer has sales of Space Cow Computer has sales of $32 $32 millionmillion, cost of goods sold of , cost of goods sold of 60%60% of sales, of sales, cash operating expenses of cash operating expenses of $2.4 million$2.4 million, and , and $1.4 million$1.4 million in depreciation expense. The in depreciation expense. The firm received firm received $400,000$400,000 in dividend income, in dividend income, and has and has $12 million$12 million in in 9.5%9.5% bonds bonds outstanding. outstanding. Calculate the firm’s tax Calculate the firm’s tax liability.liability.

SalesSales $32,000,000 $32,000,000

Cost of Goods SoldCost of Goods Sold (19,200,000) (19,200,000)

Operating ExpensesOperating Expenses (2,400,000) (2,400,000)

Depreciation ExpenseDepreciation Expense (1,400,000) (1,400,000)

EBIT or NOIEBIT or NOI 9,000,000 9,000,000Dividend Income $400,000Dividend Income $400,000

less 70% less 70% (280,000)(280,000) 120,000 120,000

Interest ExpenseInterest Expense (1,140,000)(1,140,000)

Taxable IncomeTaxable Income 7,980,000 7,980,000

Income Income tax rate tax rate tax paymenttax payment

$50,000 x .15 = $ 7,500$50,000 x .15 = $ 7,500

$25,000 x .25 = 6,250$25,000 x .25 = 6,250

$7,905,000 x .34 = 2,687,700$7,905,000 x .34 = 2,687,700

Total Tax payment $2,701,450Total Tax payment $2,701,450

Corporate Tax ExampleCorporate Tax Example

Barn Yard Brewery has sales of Barn Yard Brewery has sales of $40 million$40 million, , cost of goods sold of cost of goods sold of $19.5 million$19.5 million, cash , cash operating expenses of operating expenses of $3 million$3 million, and , and $1 $1 millionmillion in depreciation expense. The firm in depreciation expense. The firm received received $50,000$50,000 in dividend income. Also, in dividend income. Also, the firm sold the firm sold 5,0005,000 shares of AT&T stock shares of AT&T stock for for $76$76 that it had purchased for that it had purchased for $55$55 four four years ago, and sold property for years ago, and sold property for $4 million$4 million that originally cost the firm that originally cost the firm $3.5 million$3.5 million..

Calculate the firm’s tax liability.Calculate the firm’s tax liability.

SalesSales $40,000,000 $40,000,000

Cost of Goods SoldCost of Goods Sold (19,500,000) (19,500,000)

Deprec. & Operating ExpensesDeprec. & Operating Expenses (4,000,000)(4,000,000)

EBIT or NOIEBIT or NOI 16,500,00016,500,000Dividend Income 50,000Dividend Income 50,000

less 70% (35,000)less 70% (35,000) 15,000 15,000

Ordinary IncomeOrdinary Income $16,515,000 $16,515,000

Capital Gains:Capital Gains:

stock: 5,000 ($76-$55)stock: 5,000 ($76-$55) 105,000 105,000

property: $4m - $3.5mproperty: $4m - $3.5m 500,000 500,000

Taxable Income Taxable Income $17,120,000 $17,120,000

Taxable tax taxTaxable tax tax

Income Income rate rate payment payment

$50,000 x .15 = $ 7,500$50,000 x .15 = $ 7,500

$25,000 x .25 = 6,250$25,000 x .25 = 6,250

$9,925,000 x .34 = 3,374,500$9,925,000 x .34 = 3,374,500

$7,120,000 x .35 = 2,492,000$7,120,000 x .35 = 2,492,000

Total taxes paid: $5,880,250Total taxes paid: $5,880,250