Summary of:
Fundamentals of Financial Management 12the Edition
By Brigham and Houston
Summarized: Chapters 1,2,3,4,5,11
CHAPTER 1 An Overview of Financial Management
1-1 What is Finance
Finance is generally divided into three areas:
1. Financial management
Decisions related to assets, capital, running of the firm so to maximize its value
2. Capital markets
Deals with interest rates, stock, bonds
3. Investments
Deals with stock, bonds, security analysis, portfolio theory, market analysis
1-3 Forms of Business Organization
Proprietorship
An unincorporated business owned by one individual.
advantages:
They are easily and inexpensively formed,
they are subject to few government regulations, and
they are subject to lower income taxes than are corporations.
limitations:
Proprietors have unlimited personal liability for the business’s debts,
The life of the business is limited to the life of the individual who created
it
proprietorships have difficulty obtaining large sums of capital
Partnership
An unincorporated business owned by two or more persons.
Two or more persons come together as co-owners
General Partnership: All partners are fully responsible for liabilities
incurred by the partnership.
Limited Partnerships: One or more partners can have limited liability,
restricted to the amount of capital invested in the partnership. There
must be at least one general partner with unlimited liability. Limited
partners cannot participate in the management of the business and their
names cannot appear in the name of the firm.
By Olivier van Dijk & Yenneke de Moes 1
,Corporation (C-corporation)
A legal entity created by a state, separate and distinct from its owners and
managers, having unlimited life, easy transferability of ownership, and limited
liability.
Legally functions separately and apart from its owners
Corporation can sue, be sued, purchase, sell, and own property
Owners (shareholders) dictate direction and policies of the corporation,
often through elected board of directors.
Shareholder’s liability is restricted to amount of investment in company
Life of corporation does not depend on the owners … corporation
continues to exist through easy transfer of ownership
Taxed separately
Benefits: Limited liability, Easy to transfer ownership, Easier to raise capital,
Unlimited life (unless the firm goes through corporate restructuring such as
mergers and bankruptcies)
Drawbacks: No secrecy of information, maybe delays in decision making, Greater
regulation, double taxation. The corporations earnings are taxed, and paid out
dividends are taxed again.
EXAMPLE double taxation
Assume earnings before tax = $1,000
Federal Tax @25% = $250
After tax Income available for distribution to shareholders= $750
Examine the tax effects, if the company chooses to distribute the after-tax
profits to shareholders as dividends.
If corporation distributes all the profits as dividends to shareholders ==>
Shareholders will be taxed again.
Assume dividends are taxed @15%
= 15% of $750 = $112.50
==>Total tax = 250 + 112.5 = $362.5 or 36.25%
The following are hybrid organizations
S Corporation
A special designation that allows small businesses that meet qualifications to be
taxed as if they were a proprietorship or a partnership rather than a corporation.
Benefits
Limited liability
Taxed as partnership (no double taxation like corporations)
Limitations
Owners must be people so cannot be used for joint ventures between two
corporations
By Olivier van Dijk & Yenneke de Moes 2
, Limited Liability Company (LLC)
A relatively new type of organization that is a hybrid between a partnership and
a corporation.
Benefits
Limited liability
Taxed like a partnership
Limitations
Qualifications vary from state to state
Cannot appear like a corporation otherwise it will be taxed like one
Limited Liability Partnership (LLP)
Similar to an LLC but used for professional firms in the fields of accounting, law,
and architecture. It has limited liability like corporations but is taxed like
partnerships.
1-4 Stock Prices and Shareholder Value
Shareholder Wealth Maximization
The primary goal for managers of publicly owned companies implies that
decisions should be made to maximize the long-run value of the firm’s common
stock.
Shareholders wealth = shares outstanding x market price per share
1-5 Intrinsic Values, Stock Prices, and Executive Compensation
Intrinsic Value
An estimate of a stock’s “true” value based on accurate risk and return data. The
intrinsic value can be estimated but not measured precisely.
Market Price
The stock value based on perceived but possibly incorrect information as seen by
the marginal investor.
Marginal Investor
An investor whose views determine the actual stock price.
Equilibrium
The situation in which the actual market price equals the intrinsic value, so
investors are indifferent between buying or selling a stock.
Estimating intrinsic values is what security analysis is all about and is what
distinguishes successful from unsuccessful investors.
By Olivier van Dijk & Yenneke de Moes 3
