Problem 1: Cash Flows (20 points) Similar to P1-3
Luke plans, monitors, and assess his financial position using cash flows over a month. He has a
savings account and his bank loans money at 7.25% per year while it offers short-term investment
rates of 4%. Luke’s cash flows during December were as follows:
Item Cash Inflow Cash Outflow Clothes $620 Interest received $425 Dining out 420 Groceries
825 Salary 7,530 Auto payment 460 Utilities 395 Mortgage 1,350 Gas 280
a. Determine his total cash inflows and cash outflows.
Total cash inflow: (add the figures in cash inflow column)
= $425 + $7,530
= $7,955
Total cash outflow: (add the figures in cash outflow column)
= $620 + $420 + $825 + $460 + $395 + $1,350 + $280
= $4,350
b. Determine the net cash flow for the month of December.
Cash inflow – cash outflow
= $7,955 – $4,350
= $3,605
c. If there is a shortage, what are a few options open to Luke? Give detail explanation.
Option 1……… Option 2………
d. If there is a surplus, what would be strategies for him to follow? Give two specific
examples. 1. ______________________ 2. ___________________________
Problem 2: Marginal Cost-benefit analysis and the goal of the firm (28 points) Similar to P1-4
Jerry, capital budgeting analyst for Houston Co., has been asked to evaluate a proposal. The
manager of the automotive division believes that replacing the robotics used on the heavy truck
gear line will produce total benefits of $540,000 over the next 5 years. The existing robotics would
produce benefits of $220,000 over that same period. An initial investment of $150,000 would be
required to install the new equipment. The manager estimates that the existing robotics can be sold
for $40,000. Show how Jerry will apply marginal cost benefit analysis techniques to determine the
following:
a. The marginal added benefits of the proposed new robotics
Marginal benefits of new robotics – Marginal benefits of original robotics
= $540,000 – $220,000
= $320,000
b. The marginal added cost of the proposed new robotics
Marginal cost of new robotics – Sales price of current robotics
= $150,000 – $40,000
= $110,000
c. The net benefit of the proposed new benefits
Marginal benefits of proposed robotics – Marginal cost of proposed robotics
= $320,000 – $110,000
= $210,000
d. What should Jerry recommend the company do? Give detailed explanation as to why?
Sample Problem for No. 1 and 2
Principles of Managerial Finance
Fifteenth Edition
Chapter 1
The Role of Managerial
Finance
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Learning Goals (1 of 2)
LG 1 Define finance and the managerial finance function.
LG 2 Describe the goal of the firm, and explain why
maximizing the value of the firm is an appropriate goal
for a business.
LG 3 Identify the primary activities of the financial manager.
LG 4 Explain the key principles that financial managers use
when making business decisions.
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Learning Goals (2 of 2)
LG 5 Describe the legal forms of business organization.
LG 6 Describe the nature of the principal–agent relationship
between the owners and managers of a corporation,
and explain how various corporate governance
mechanisms attempt to manage agency problems.
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1.1 Finance and the Firm (1 of 3)
• What Is Finance?
– Finance can be defined as the science and art of managing
money
– At the personal level, finance is concerned with individuals’
decisions about:
? how much of their earnings they spend
? how much they save
? how they invest their savings
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1.1 Finance and the Firm (2 of 3)
• What Is Finance?
– In a business context, finance involves:
? how firms raise money from investors
? how firms invest money in an attempt to earn a profit
? how firms decide whether to reinvest profits in the business or
distribute them back to investors
– Managerial finance concerns the duties of the financial
manager in a business
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1.1 Finance and the Firm (3 of 3)
• What Is a Firm?
– A firm is a business organization that sells goods or services
– Firms exist because investors want access to risky
investment opportunities
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1.1 Finance and the Firm (1 of 7)
• What Is the Goal of the Firm?
– Maximize Shareholder Wealth
? The primary goal of managers should be to maximize the
wealth of the firm’s owners
? In most instances this is equivalent to maximizing the stock
price
– Maximize Profit?
? Does profit maximization lead to the highest possible share
price?
? For at least three reasons, the answer is often no:
– Timing
– Cash Flows
– Risk
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Example 1.1 (1 of 2)
Nick Dukakis, the financial manager of Neptune
Manufacturing, a producer of marine engine components, is
choosing between two investments, Rotor and Valve. The
following table shows the EPS Dukakis expects each
investment to earn over its 3-year life.
Earnings per share (EPS)
Investment
Year 1
Year 2
Year 3
Total for years 1, 2, and 3
Rotor
$1.40
$1.00
$0.40
$2.80
Valve
0.60
1.00
1.40
3.00
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Example 1.1 (2 of 2)
If Dukakis thought he should make decisions to maximize
profits, he would recommend that Neptune invest in Valve
rather than Rotor because it results in higher total earnings
per share over the 3-year period ($3.00 EPS compared with
$2.80 EPS).
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1.1 Finance and the Firm (2 of 7)
• What Is the Goal of the Firm?
– Maximize Stakeholders’ Welfare?
? Some suggest a balanced consideration of the welfare of
shareholders and other firm stakeholders
– Stakeholders include employees, suppliers, customers,
and even members of the local community where a firm is
located
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1.1 Finance and the Firm (3 of 7)
• What Is the Goal of the Firm?
– Maximize Stakeholders’ Welfare?
? Flaws in neglecting shareholder wealth maximization:
– Maximizing shareholder wealth does not in any way imply
that managers should ignore the interests of everyone
connected to a firm who is not a shareholder
– To maximize shareholder value, managers must
necessarily assess the long-term consequences of their
actions
– The stakeholder perspective is intrinsically difficult to
implement, and advocates of the idea that managers
should consider all stakeholders’ interests along with those
of shareholders do not typically indicate how managers
should carry it out
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1.1 Finance and the Firm (4 of 7)
• What Is the Goal of the Firm?
– Maximize Stakeholders’ Welfare?
? Flaws in neglecting shareholder wealth maximization:
– Many people misinterpret the statement that managers
should maximize shareholder wealth as implying that
managers should take any action, including illegal or
unethical actions, that increases the stock price
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1.1 Finance and the Firm (5 of 7)
• The Role of Business Ethics
– Business ethics are the standards of conduct or moral
judgment that apply to persons engaged in commerce
– The goal of such standards is to motivate business and
market participants to adhere to both the letter and the spirit
of laws and regulations concerned with business and
professional practice
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1.1 Finance and the Firm (6 of 7)
• The Role of Business Ethics
– Ethical Guidelines
? Is the action arbitrary or capricious? Does it unfairly single out
an individual or group?
? Does the action violate the moral or legal rights of any
individual or group?
? Does the action conform to accepted moral standards?
? Are there alternative courses of action that are less likely to
cause actual or potential harm?
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1.1 Finance and the Firm (7 of 7)
• The Role of Business Ethics
– Ethics and Share Price
? An effective ethics program can enhance corporate value by
producing positive benefits
? Ethical behavior is for achieving the firm’s goal of owner wealth
maximization
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1.2 Managing the Firm (1 of 7)
• The Managerial Finance Function
– Financial Managers’ Key Decisions
? Investment Decisions
? Capital Budgeting Decisions
? Financing Decisions
– Capital Structure Decisions
• The money that firms raise to finance their activities
– Working Capital Decisions
• Decisions that refer to the management of a firm’s
short-term resources
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Figure 1.1 Financial Activities
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1.2 Managing the Firm (2 of 7)
• The Managerial Finance Function
– Principles That Guide Managers’ Decisions
?
?
?
?
?
Time Value of Money
Tradeoff between Return and Risk
Cash Is King
Competitive Financial Markets
Incentives are Important
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1.2 Managing the Firm (3 of 7)
• The Managerial Finance Function
– Principal–Agent Problem
? A problem that arises because the owners of a firm and its
managers are not the same people and the agent does not act
in the interest of the principal
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1.2 Managing the Firm (4 of 7)
• The Managerial Finance Function
– Organization of the Finance Function
? CEO
– CFO
• Treasurer
• Controller
• Director of Investor Relations
• Director of Internal Audit
• Foreign Exchange Manager
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Figure 1.2 Corporate Organization
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1.2 Managing the Firm (5 of 7)
• The Managerial Finance Function
– Relationship to Economics
? Marginal Cost–Benefit Analysis
– Economic principle that states that financial decisions
should be made and actions taken only when the marginal
benefits exceed the marginal costs
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Example 1.2 (1 of 2)
Jamie Teng is a financial manager for Nord Department
Stores, a large chain of upscale stores operating primarily in
the western United States. She is currently trying to decide
whether to replace one of the firm’s computer servers with a
new, more sophisticated one that would both speed
processing and handle a larger volume of transactions. The
new computer server would require a cash outlay of $8,000,
and the old one could be sold to net $2,000. The future
benefits from faster processing would be $10,000 in today’s
dollars. The benefits over a similar period from the old
computer (measured in today’s dollars) would be $3,000.
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Example 1.2 (2 of 2)
Applying marginal cost–benefit analysis, Jamie organizes
the data as follows:
Benefits with new computer
Less: Benefits with old computer
(1) Marginal benefits
Cost of new computer
Less: Proceeds from sale of old computer
$10,000
3,000
$ 7,000
$ 8,000
2,000
(2) Marginal costs
$ 6,000
Net benefit [(1) – (2)]
$ 1,000
Because the marginal benefits of $7,000 exceed the
marginal costs of $6,000, Jamie recommends purchasing
the new computer to replace the old one. The firm will
experience a net benefit of $1,000 as a result of this action.
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1.2 Managing the Firm (6 of 7)
• The Managerial Finance Function
– Relationship to Accounting
? Emphasis on Cash Flows
– Accrual Basis
• Recognizes revenue at the time of sale and
recognizes expenses when they are incurred
– Cash Basis
• Recognizes revenues and expenses only with respect
to actual inflows and outflows of cash
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Example 1.3 (1 of 2)
Nassau Corporation, a small yacht dealer, sold one yacht for
$1,000,000 in the calendar year just ended. Nassau
originally purchased the yacht for $800,000. Although the
firm paid in full for the yacht during the year, at year’s end it
has yet to collect the $1,000,000 from the customer. The
accounting view and the financial view of the firm’s
performance during the year are given by the following
income and cash flow statements, respectively.
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Example 1.3 (2 of 2)
Accounting view (accrual basis)
Financial view (cash basis)
Nassau Corporation income
statement for the year ended 12/31
Nassau Corporation cash flow
statement for the year ended 12/31
Sales revenue
Cash inflow
Less: Costs
Net profit
$1,000,000
800,000
$ 200,000
Less: Cash outflow
Net cash flow
$
0
800,000
?$800,000
In an accounting sense, Nassau Corporation is profitable,
but in terms of actual cash flow, it has a problem. Its lack of
cash flow resulted from the uncollected accounts receivable
of $1,000,000. Without adequate cash inflows to meet its
obligations, the firm will not survive, regardless of its level of
profits.
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Personal Finance Example 1.4 (1 of 2)
Individuals rarely use accrual concepts. Rather, they rely mainly
on cash flows to measure their financial outcomes. Generally,
individuals plan, monitor, and assess their financial activities using
cash flows over a given period, typically a month or a year. Ann
Bach projects her cash flows during October 2018 as follows:
Amount
Item
Net pay received
Rent
Car payment
Utilities
Groceries
Clothes
Dining out
Gasoline
Interest income
Misc. expense
Totals
Inflow
$4,400
blank
blank
blank
blank
blank
blank
blank
220
_____
$4,620
Outflow
?$1,200
?450
?300
?800
?750
?650
?260
Blank
?425
?$4,835
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Personal Finance Example 1.4 (2 of 2)
Ann subtracts her total outflows of $4,835 from her total
inflows of $4,620 and finds that her net cash flow for October
will be – $215. To cover the $215 shortfall, Ann will have to
either borrow $215 (putting it on a credit card is a form of
borrowing) or withdraw $215 from her savings. Alternatively,
she may decide to reduce her outflows in areas of
discretionary spending such as clothing purchases, dining
out, or those items that make up the $425 of miscellaneous
expense.
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1.2 Managing the Firm (7 of 7)
• The Managerial Finance Function
– Relationship to Accounting
? Decision Making
– Accountants devote most of their attention to the collection
and presentation of financial data
– Financial managers evaluate the accounting statements,
develop additional data, and make decisions based on
their assessment of the associated returns and risks
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (1 of 13)
• Legal Forms of Business Organizations
– Sole Proprietorships
? Businesses owned by one person and operated for his or her
own profit
– Unlimited Liability
• The condition of a sole proprietorship, giving creditors
the right to make claims against the owner’s personal
assets to recover debts owed by the business
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (2 of 13)
• Legal Forms of Business Organizations
– Partnerships
? Businesses owned by two or more people and operated for
profit
– Articles of Partnership
• The written contract used to formally establish a
business partnership
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (3 of 13)
• Legal Forms of Business Organizations
– Corporations
? Legal business entities with rights and duties similar to those of
individuals but with a legal identity distinct from its owners
? Stockholders
– The owners of a corporation, whose ownership, or equity,
takes the form of common stock or, less frequently,
preferred stock
? Limited Liability
– A legal provision that limits stockholders’ liability for a
corporation’s debt to the amount they initially invested in
the firm by purchasing stock
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (4 of 13)
• Legal Forms of Business Organizations
– Corporations
? Stock
– A security that represents an ownership interest in a
corporation
? Dividends
– Periodic distributions of cash to the stockholders of a firm
? Board of Directors
– Group elected by the firm’s stockholders and typically
responsible for approving strategic goals and plans, setting
general policy, guiding corporate affairs, and approving
major expenditures
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (5 of 13)
• Legal Forms of Business Organizations
– Corporations
? President or Chief Executive Officer (CEO)
– Corporate official responsible for managing the firm’s
day-to-day operations and carrying out the policies
established by the board of directors
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Table 1.1 Strengths and Weaknesses of
the Common Legal Forms of Business
Organization (1 of 2)
Strengths
Sole proprietorship
Partnership
Corporation
• Owner receives all
profits (and sustains all
losses)
• Low organizational
costs
• Income included and
taxed on proprietor’s
personal tax return
• Independence
• Secrecy
• Ease of dissolution
• Can raise more funds
than sole
proprietorships
• Borrowing power
enhanced by more
owners
• More available brain
power and managerial
skill
• Income included and
taxed on partner’s
personal tax return
• Owners have limited liability,
which guarantees that they cannot
lose more than they invested
• Can achieve large size via sale of
ownership (stock)
• Ownership (stock) is readily
transferable
• Long life of firm
• Can hire professional managers
• Has better access to financing
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Table 1.1 Strengths and Weaknesses of
the Common Legal Forms of Business
Organization (2 of 2)
Weaknesses
Sole proprietorship
Partnership
Corporation
• Owner has unlimited
liability in that total
wealth can be taken to
satisfy debts
• Limited fund-raising
power tends to inhibit
growth
• Proprietor must be jackof-all-trades
• Difficult to give
employees long-run
career opportunities
• Lacks continuity when
proprietor dies
• Owners have unlimited
liability and may have to
cover debts of other
partners
• Partnership is dissolved
when a partner dies
• Difficult to liquidate or
transfer partnership
• Taxes are generally higher
because corporate income is
taxed, and dividends paid to
owners are also taxed at a
maximum 15% rate
• More expensive to organize than
other business forms
• Subject to greater government
regulation
• Lacks secrecy because
regulations require firms to
disclose financial results
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Matter of Fact (1 of 2)
Number of Businesses and Income Earned by Type of
U.S. Firm
Although sole proprietorships greatly outnumber
partnerships and corporations combined, they generate the
lowest level of income. In total, sole proprietorships
accounted for almost three-quarters of the number of
business establishments in operation, but they earned just
10% of all business income. Corporations, on the other
hand, accounted for just 17% of the number of businesses,
but they earned almost two-thirds of all business income.
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Matter of Fact (2 of 2)
blank
Sole
proprietorships Partnerships
Number of firms (millions)
25.3
Corporations
3.4
5.8
Percentage of all firms
73%
10%
17%
Percentage of all business
income
10%
26%
64%
Source: Overview of Approaches to Corporate Integration, Joint Committee on
Taxation, United States Congress, May 17, 2016.
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (6 of 13)
• Business Organizational Forms and Taxation
• Prior to 2018
– Proprietorships and partnerships taxed according to the
same progressive rate structure as individual taxpayers
– Corporations taxed according to an alternative, mostly
progressive rate structure
• Marginal vs. Average Tax Rate
? The marginal tax rate represents the rate at which the next
dollar of income is taxed while the average tax rate equals
taxes paid divided by taxable income
? The marginal rate does not usually equal the average rate
under a progressive tax rate structure
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (7 of 13)
• Business Organizational Forms and Taxation
• After 2018 (Tax Cuts and Jobs Act)
– Proprietorships and partnerships still taxed according to a
(revised) progressive rate structure
– Corporations taxed at a flat rate of 21%
– Under a flat tax, the marginal and average tax rates are
equal
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (8 of 13)
• Legal Forms of Business Organizations
– Business Organizational Forms and Taxation
? Double Taxation
– A situation facing corporations in which income from the
business is taxed twice—once at the business level and
once at the individual level when cash is distributed to
shareholders
? Ordinary Income versus Capital Gains
– Ordinary income is income earned by a business through
the sale of goods or services while capital gains is income
earned by selling an asset for more than it cost
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Table 1.2 2018 Tax Rate Schedule for Single
Taxpayer (Tax Rates Faced by Pass-Through
Businesses Like Proprietorships and Partnerships)
Tax calculation
Base tax
+
(Marginal rate × amount over
bracket lower limit)
$ 0 to $ 9,525
$
0
+
(10% × amount over $ 0)
9,525 to 38,700
$
953
+
(12% × amount over $ 9,525)
38,700 to 82,500
$
4,454
+
(22% × amount over $ 38,700)
82,500 to 157,500
$ 14,090
+
(24% × amount over $ 82,500)
157,500 to 200,000
$ 32,090
+
(32% × amount over $157,500)
200,000 to 500,000
$ 45,690
+
(35% × amount over $200,000)
$150,690
+
(37% × amount over $500,000)
Taxable income brackets
Over 500,000
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Pre-2018 Corporate Tax Rate Schedule
Tax calculation
Taxable income brackets
$0
Base tax
+
(Marginal rate × amount over
bracket lower limit)
to $ 50,000
$
0
+
(15% × amount over $ 0)
50,000
to
75,000
$
7,500
+
(25% × amount over $ 50,000)
75,000
to 100,000
$
13,750
+
(34% × amount over $ 75,000)
100,000
to 335,000
$
22,250
+
(39% × amount over $ 100,000)
335,000 to 10,000,000
$ 113,900
+
(34% × amount over $335,000)
10,000,000 to 15,000,000
$3,400,000
+
(35% × amount over $10,000,000)
15,000,000 to 18,333,333
$5,150,000
+
(38% × amount over $15,000,000)
Over 18,333,333
$6,416,667
+
(35% × amount over $18,333,333)
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Example 1.5 (1 of 2)
Dan Webster is the sole proprietor of Webster Manufacturing.
This year Webster earned $80,000 before taxes from his
business. Assuming that Dan has no other income, the taxes
he will owe on his business income (based on 2018 tax law)
are as follows:
Total taxes due = (0.10 × $9,525) + [0.12 × ($38,700 ? $9,525)]
+ [0.22 × ($80,000 ? $38,700)]
= $953 + $3,501 + $9,086
= $13,540
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Example 1.5 (2 of 2)
Notice that Webster’s tax liability has two components. The
first $4,454 in tax, denoted in Table 1.2 as the base tax, is
calculated by multiplying 10% times Webster’s first $9,525 in
income and then multiplying 12% times Webster’s next
$29,175 in income. The sum of those two calculations is the
$4,454 base tax from line 3 in Table 1.2. On top of that,
Webster must pay an additional 22% in taxes on income
above $38,700.
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Figure 1.3 Marginal and Average Tax Rates
at Different Income Levels for a Single
Taxpayer (2018 Tax Rates)
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Pre-2018 Marginal and Average Tax Rates
at Different Income Levels for a Single
Taxpayer
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Example 1.6 (1 of 2)
Peter Strong is a partner in Argaiv Software, and from that
business he earned taxable income of $300,000. Assuming that
this is Peter’s only source of income, from Table 1.2 we can see
that based on Peter’s tax bracket, he faces a marginal tax rate of
35%. How much in tax does Peter owe, and what is his average
tax rate? Table 1.2 shows a base tax of $45,690 for individuals
with income above $200,000 but below $500,000. Here’s where
that base tax comes from:
Base tax = (0.10 × $9,525) + (0.12 × $29,175) + (0.22 × $43,800)
+ (0.24 × $75,000) + (0.32 × $42,500)
= $953 + $3,501 + $9,636 + $18,000 + $13,600
= $45,690
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Example 1.6 (2 of 2)
In other words, based on his first $200,000 in partnership
earnings, Peter owes $45,690 in taxes. In addition to that base
tax, Peter must pay 35% tax on the last $100,000 that he earns,
so his total tax bill is
Total taxes due = $45,690 + (0.35 × $100,000) = $80,690
Given Peter’s total tax bill, we can calculate the average tax rate
by dividing taxes due by taxable income, as follows:
Average tax rate = $80,690 ÷ $300,000 = 0.269 = 26.9%
Again we stress that in many cases the marginal tax rate and the
average tax rate are not equal, and in such cases, managers
should focus on the marginal tax rate when they make decisions
about how to invest the firm’s money.
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Example 1.7
Suppose that Argaiv Software (from Example 1.6) is organized as a
corporation rather than as a partnership, and suppose also that
Argaiv paid $300,000 in dividends to shareholders. For individuals,
the tax code applies a different marginal rate to dividends than to
ordinary income, with the top marginal tax rate on dividends equal
to 23.8%. On the $300,000 in corporate taxable income, Argaiv will
pay taxes of $63,000 (0.21 × $300,000), and its shareholders could
pay as much as $71,400 (0.238 × $300,000) in taxes on the
dividends that they receive. Therefore, the total tax burden faced by
Argaiv and its shareholders is as high as $134,400, compared to the
total tax bill of $80,690 that would be owed if Argaiv were organized
as a partnership as in the previous example. The taxes paid on
Argaiv dividends by its shareholders could be less than shown here
if shareholders are not in the highest individual tax bracket.
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (9 of 13)
• Legal Forms of Business Organizations
– Business Organizational Forms and Taxation
? Ordinary Income
– Income earned by a business through the sale of goods or
services
? Capital Gain
– Income earned by selling an asset for more than its cost
– For corporations, ordinary income and capital gains are
treated the same for tax purposes
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (10 of 13)
• Legal Forms of Business Organizations
– Business Organizational Forms and Taxation
? Interest received by corporations is taxed as ordinary income,
while dividends received get a special tax break that moderates
the effect of double taxation
? Dividends received by the firm for stock held in other corporations
are usually subject to a 50% exclusion for tax purposes
– The dividend exclusion in effect eliminates half of the
potential tax liability from dividends received by the second
and any subsequent corporations
? In calculating their taxes, corporations can deduct operating
expenses, as well as interest expenses they pay to lenders
– The tax deductibility of these expenses reduces their after-tax
cost
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Example 1.8 (1 of 2)
Two corporations, Debt Co. and No-Debt Co., earned $200,000
before interest and taxes this year. During the year, Debt Co. paid
$30,000 in interest. No-Debt Co. had no debt and no interest
expense. How do the after-tax earnings of these firms compare?
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Debt Co.
No-Debt Co.
Earnings before interest and taxes
$200,000
$200,000
30,000
0
$170,000
$200,000
35,700
42,000
$134,300
$158,000
Less: Interest expense
Earnings before taxes
Less: Taxes (21%)
Earnings after taxes
Difference in earnings after taxes
$23,700
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Example 1.8 (2 of 2)
Both firms face a 21% flat tax rate. Debt Co. had $30,000 more
interest expense than No-Debt Co., but Debt Co.’s earnings after
taxes are only $23,700 less than those of No-Debt Co. This
difference is attributable to Debt Co.’s $30,000 interest expense
deduction, which provides a tax savings of $6,300 (the tax bill is
$35,700 for Debt Co. versus $42,000 for No-Debt Co.). The tax
savings can be calculated directly by multiplying the 21% tax rate
by the interest expense (0.21 × $30,000 = $6,300). Similarly, the
$23,700 after-tax interest expense can be calculated directly by
multiplying 1 minus the tax rate by the interest expense [(1 ? 0.21)
× $30,000 = $23,700].
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (11 of 13)
• Legal Forms of Business Organizations
– Other Limited Liability Organizations
?
?
?
?
Limited partnership (LP)
S corporation (S corp)
Limited liability company (LLC)
Limited liability partnership (LLP)
• Agency Problems and Agency Costs
– Agency Costs
? Costs that shareholders bear due to managers’ pursuit of their
own interests
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (12 of 13)
• Corporate Governance
– The rules, processes, and laws by which companies are
operated, controlled, and regulated
– Internal Corporate Governance Mechanisms
? Stock Options
– Securities that allow managers to buy shares of stock at a
fixed price
? Restricted Stock
– Shares of stock paid out as part of a compensation
package that do not fully transfer from the company to the
employee until certain conditions are met
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1.3 Organizational Forms, Taxation, and
the Principal–Agent Relationship (13 of 13)
• Corporate Governance
– External Corporate Governance Mechanisms
? Individual versus Institutional Investors
– Activist Investors
• Investors who specialize in influencing management
? The Threat of Takeover
– Government Regulation
? Sarbanes-Oxley Act of 2002
– An act aimed at eliminating corporate disclosure and conflict
of interest problems
– Contains provisions concerning corporate financial
disclosures and the relationships among corporations,
analysts, auditors, attorneys, directors, officers, and
shareholders
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1.4 Developing Skills for Your Career
• Critical Thinking
• Communication and Collaboration
• Financial Computing Skills
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Review of Learning Goals (1 of 8)
• LG 1
– Define finance and the managerial finance function.
? Finance is the science and art of how individuals and firms
raise, allocate, and invest money. It affects virtually all aspects
of business
? Managerial finance is concerned with the duties of the financial
manager working in a business. Financial managers
administer the