BUS1 170 Lecture Notes - Lecture 1: Double Taxation, Limited Liability Company, Enron Scandal

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Chapter 1
Finance- the study of how people and businesses evaluate investments and raise capital to fund
Three basic questions addressed by the study of finance:
1. What long-term investments should the firm undertake? (Capital budgeting)
2. How should the firm raise money to fund these investments? (Capital structure)
3. How can the firm best manage its cash flows as they arise in its day-to-day operations?
(Working capital management)
Why Study Finance?
Knowledge of financial tools is critical to making good decisions in both corporate world
and personal lives.
Management majors
Strategic planning, organizational behavior, human relationships
Marketing majors
Product pricing, advertisement
All of these involve spending money today in hopes of generating more money in the
Education- is it an investment decision or not?
Business Organizations Formations:
1. Sole Proprietorship
a. It is business owned by a single individual who is entitled to all of the firm’s
profit and is responsible for all of the firm’s debt.
b. There is no separation between the business and the owner when it comes to
debts or being sued.
Partnership &
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c. The sole proprietors typically raise money by investing their own funds and by
borrowing from a bank.
d. Advantages:
i. Easy to start
ii. No need to consult others while making decisions
iii. Taxed at the personal tax rate
e. Disadvantages:
i. Personally liable for the business debts (unlimited liability)
ii. The business ceases on the death of the proprietor
iii. Harder to raise money
f. i.e.) Ebay, Kinkos
2a. Partnership
g. A general partnership is an association of two or more persons who come
together as co-owners for the purpose of operating a business for profit. Just as
with the sole proprietorship, there is no separation between the general
partnership and its owners with respect to debts or being sued
h. Advantages:
i. Relatively easy to start
ii. Taxed at the personal tax rate
iii. Access of funds from multiple sources or partners
i. Disadvantages:
i. Partners jointly share unlimited liability
ii. It is not always easy to transfer ownership
j. i.e.) Microsoft, Apple, HP, McDonalds
2b. Limited Partnership (LP)
k. In limited partnerships, there are two classes of partners: general and limited.
l. The general partner runs the business and faces unlimited liability for the
firm’s debts.
m. Limited partner is only liable up to the amount the limited partner invested.
n. The life of the limited partnership is tied to the life of the general partner.
3. Corporation
o. If very large sums of money are needed to build a business, then the typical
organizational form chosen is the corporation. The corporation is legally
owned by its current set of stockholders, or owners.
p. Corporation is “an artificial being, invisible, intangible, and existing only in the
contemplation of the law.”
q. Corporation legally functions separately and apart from its owners (the
shareholders). Corporation can individually sue and be sued.
r. The Board of Directors are elected by the shareholders, and the board appoints
the senior management of the firm.
s. Advantages:
i. Liabilities of owners is limited to invested funds
ii. Life of corporation is not tied to the owner
iii. Easier to transfer ownership
iv. Easier to raise capital
t. Disadvantages:
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i. Greater regulation
ii. Double taxation of dividends- shareholders get taxed twice on dividends
Limited Liability Company (LLC)
Combines tax benefits of a partnership (no double taxations of earnings) with the
limited liability benefit of corporation (the owner’s liability is limited to what they
Regulated by state law
The Goal of the Financial Manager
The goal of the financial manager must be consistent with the mission of the corporation,
which is to maximize shareholder’s wealth.
Corporate Mission
While managers have to cater to all the stakeholders (such as consumers, employees,
suppliers etc.), they need to pay particular attention to the shareholders.
If managers fail to pursue shareholder wealth maximization, they will lose the support of
investors and lenders. The business may cease to exist and ultimately, the managers will
lose their jobs.
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