Tax Code & Money Market – Financial Management Test
This chapter includes discussions on Tax Code & Money Market – Financial Management. Test 1 is based on this chapter.
key features of the tax code
1) corporate taxes 2) individual taxes
proprietorship disadvantages
limited life unlimited liability difficult to raise capital to support growth
partnership advantages
ease of formation subject to few regulations no corporate income taxes
partnership disadvantages
limited life unlimited liability difficult to raise capital to support growth
corporation
a corporation is a legal entity separate from its owners and managers
corporation advantages
unlimited life easy transfer of ownership limited liability ease of raising capital
corporation disadvantages
double taxation cost of set-up and report filing
corporate taxation
1) progressive rate up to $18.3 million taxable income below $18.3M, the marginal rate is not equal to the average rate above $18.3M, the marginal rate and the averate rate are 35% 2) corporations may deduct interst expenses save for dividend payments carry back losses for 2 years, carry forward losses for 20 years exclude 70% of dividend income if it owns less than 20% of the company’s stock
individual taxation
progressive tax rates from 10-35% capital gains tax rate 15% dividends are taxed the same as capital gains 15% interest on municipal bonds is not taxed at the federal level
agency problem
managers may act in their own interests and not on behalf of the owners (stockholders)
corporate governance
the set of rules that control a company’s behavior towards it directors, managers, employees, shareholders, creditors, customers, competitors, and community corporate governance may help control agency problems
management’s primary objective
maximize shareholder wealth
3 aspects of Cash Flows that affect an investment’s value
amount of the expected cash flows (bigger = better) timing of the cash flows (sooner = better) risk of the cash flows (less = better)
free cash flows (fcf)
the cash flows that are available (or free) for distribution to all investors (stockholders and creditors) fcf = sales rev – operating costs – operating taxes – required investments in operating capital
weighted average cost of capital (WACC)
the average rate of return required by all of the company’s investors
WACC is affected by
capital structure interest rates risk of the firm investors’ overall attitude toward risk
3 types of transfer of capital from savers to borrowers
1) direct transfer – corporation issues commercial paper to an insurance company 2) through an investment banking house – an IPO, seasoned equity offering, or debt placement–company sells security to the investment banking house which then sells the security to the investor 3) through a financial intermediary – an individual deposits money into a bank and gets a certificate of deposit, then the bank makes a commercial loan to a company
Tax Code & Money Market
the cost of capital
the interest rate
objective of the firm
maximize shareholder wealth
corporate finance provides the skills managers need to
identify and select corporate strategies and individual projects that add value to their firm forecast the funding requirements of their company and devise strategies for acquiring for those funds
types of business organizations
sole proprietorship partnership corporation
proprietorship advantages
ease of formation subject to few regulations no corporate income taxes
the cost of equity
the cost of equity capital cost of equity = required return required return = dividend yield + capital gain
4 factors that affect the cost of money
production opportunities time preferences for consumption risk expected inflation
economic conditions that affect the cost of money
federal reserve policies budget deficits/surpluses level of business activity (recession/boom) international trade deficits/surpluses
international conditions that affect the cost of money
country risk (political, economic, and social environs) exchange rate risk
factors that affect exchange rate risk
international trade deficits/surpluses relative inflation and interest rates country risk
money market (debt)
t-bills cds eurodollars fed funds
money market (equity)
n/a
money market (derivatives)
options futures forward contract
capital market (debt)
t-bonds agency bonds municipals corporate bonds
capital market (equity)
common stock preferred stock
capital market (derivatives)
leaps swaps
financial institutions
commercial banks investment banks savings and loans mutual savings banks credit unions live insurance companies mutual funds (exchanged traded funds [etfs])) pension funds hedge funds private equity funds
types of markets
market–a method of exchanging one asset for another physical assets vs. financial assets spot markets vs. future markets money markets vs. capital markets primary markets vs. secondary markets
primary vs. secondary security sales
1) primary new issue (IPO or seasoned) key factor–issuer receives the proceedsd fromt he sale 2) seconday existing owner sells to another party key factor–issuing firms does not reap the proceedsd and is not directly involved in the transaction
secondary market organization
1) by location 2) by the way that orders from buyers and sellers are matched
physical locations vs. computer/telephone networks
1) physical location exchanges nyse amex cbot tokyo stock exchange 2) computer/telephone exchanges nasdaq government bond markets foreign exchanged markets
types of orders
market order limit order
market order
transact as quickly as possible at current price
limit order
transact only if specific situation occurs
auction markets
participants have a seat on the exchange, meet face-t0-face, and place orders for themselves or for clients nyse and amex are the two largest
dealer markets
dealers keep an inventory of the stock and place bids and ask advertisements, which are prices at which they are willing to buy and sell nasdaq
electronic communications networks (ecns)
computerized system matches orders from buyers and sellers and automatically executes transaction
over the counter markets (otc)
the otc market is the equivalent of a computer bulliten board which allows potential buyers and sellers to post an offer no dealers
securitization
the process of pooling existing (or original) securities and then selling them to investors — the new securities are based on the original securities
free cash flows (fcf)
the amount of cash available from operations for distribution to all investors a company’s value depends upon the amount of fcf it can generate
5 uses of fcf
pay interest on debt pay principle on debt pay dividends buy-back stock buy non-operating assets
weighted average cost of capital (wacc)
1) cost of debt market interest rates market risk aversion 2) cost of equity firm’s debt/equity mix firm’s business risk
operating current assets (opca)
current assets needed to support operations cash inventory receivables
operating current liabilities (opca)
current liabilities resulting as a normal part of operations accounts payable accrurals
net operating working capital (nowc)
opca – opcl
net operating profit after taxes (nopat)
ebit (1 – tax rate)
total net operating capital (operating capital)
nowc + net fixed assets
return on ivested capital (roic)
nopat / operating capital
economic value added (eva)
nopat – wacc * capital
market value added (mva)
book value of the firm – market value of the firm
market value
(# shares of stock) (price per share) + value of debt
book value
total common equity + value of debt