Adopted from “Foundations of Finance” – Martin Petty Keown

For TCHE302/TCH302E Classes in FTU only, no further distribution/reproduction allowed.

1.1 Identify the goal of the firm.
1.2 Understand the basic principles of finance, their importance, and the
importance of ethics and trust.
1.3 Describe the role of finance in business..
1.4 Distinguish between the different legal forms of business organization. b
The goal of the firm is to create value for the firm’s owners (that is, its
shareholders). Thus the goal of the firm is to “maximize shareholder wealth” by
maximizing the price of the existing common stock.
Good financial decisions will increase stock price and poor financial decisions
will lead to a decline in stock price.
Principle 1: Cash Flow Is What Matters
Principle 2: Money Has a Time Value
Principle 3: Risk Requires a Reward
Principle 4: Market Prices Are Generally Right
Principle 5: Conflicts of Interest Cause Agency Problems
Accounting profits are not equal to cash flows. It is possible for a firm to
generate accounting profits but not have cash or to generate cash flows but not
report accounting profits in the books.
Cash flow, and not profits, drive the value of a business.
We must determine incremental or marginal cash flows when making financial
decisions.
Incremental cash flow is the difference between the projected cash flows if the project
is selected, versus what they will be, if the project is not selected.
A dollar received today is worth more than a dollar received in the future.
Since we can earn interest on money received today, it is better to receive money
sooner rather than later.
Opportunity Cost – It is the cost of making a choice in terms of next best
alternative that must be foregone.
Example: By lending money to your friend at zero percent interest, there is an
opportunity cost of 1% that could potentially be earned by depositing the money in a
savings account in a bank.
Investors will not take on additional risk unless they expect to be compensated
with additional reward or return, or in another way of expression: high risk,
high return
Investors expect to be compensated for “delaying consumption’’ and “taking on
risk’’.
Thus, investors expect a return when they deposit their savings in a bank (ex. delayed
consumption) and they expect to earn a relatively higher rate of return on stocks
compared to a bank savings account (ex. taking on risk).
In an efficient market, the market prices of all traded assets (such as stocks and
bonds) fully reflect all available information at any instant in time.
Thus stock prices are a useful indicator of the value of the firm. Price changes
reflect changes in expected future cash flows. Good decisions will tend to
increase in stock price and vice versa.
Note there are inefficiencies in the market that may distort the market prices
from value of assets. Such inefficiencies are often caused by behavioral biases.
The separation of management and the ownership of the firm creates an agency
problem. Managers may make decisions that are not consistent with the goal of
maximizing shareholder wealth.
Agency conflict is reduced through monitoring (ex. annual reports), compensation
schemes (ex. stock options), and market mechanisms (ex. takeovers)
Three basic issues addressed by the study of finance:
What long-term investments should the firm undertake? (Capital budgeting decision)
How should the firm raise money to fund these investments? (Capital structure
decision)
How to manage cash flows arising from day-to-day operations? (Working capital
decision)
Business Forms
Sole Proprietorship
Partnership
Corporation
Hybrid
allows for the pass-through taxation of income, meaning that the corporation itself is not taxed on its income. Instead, income,
S-Type deductions, and credits pass through to shareholders, who then report these items on their personal tax returns.
LLC
Business owned by an individual
= ownership
Owner maintains title to assets and profits
Unlimited liability
Termination occurs on owner’s death or by the owner’s choice
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.
Legally functions separate and apart from its owners
Corporation can sue, be sued, purchase, sell, and own property
quyet dinh
Owners (shareholders) dictate direction and policies of the corporation,
oftentimes through elected board of directors. hoi dong quan tri
Shareholder’s liability is restricted to amount of investment in company.
Life of corporation does not depend on the owners … corporation continues to
be run by managers after transfer of ownership through sale or inheritance.
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).
sap nhap pha san
Drawbacks: No secrecy of information, maybe delays in decision making, greater
regulation, double taxation.
Assume earnings before tax = $1,000
Federal Tax @ 25% = $250
After tax income available for distribution to shareholders = $750
Compute the taxes if the company chooses to distribute the entire after-tax
profits to shareholders as dividends.

If corporation distributes profits as dividends to shareholders, shareholders will

be taxed again. co tuc

Assuming dividends are taxed @ 15%

Dividend tax = 15% of $750 = $112.50
==> Total tax = 250 + 112.5 = $362.5 or 36.25%
S-Type Corporations
Benefits
Limited liability
Taxed as partnership (no double taxation like corporations)
Limitations
Owners must be people so cannot be used for a joint ventures between two corporations
Limited Liability Companies (LLC)
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
 Change in
Liability for Ownership
Number of Owners Taxation
Firm's Debts Dissolves the
Firm
Sole One Yes Yes Personal
Proprietorship
Types of
Partnerships
1. General No Limit Each partner is Yes Personal
Partnerships liable for the entire
amount
2. Limited At least one general GP - Yes, LP - No GP - Yes, LP - No Personal
Partnerships partner (GP), no limit
on limited partners
(LP)
 Change in
Number of Liability for Ownership
Taxation
Owners Firm's Debts Dissolves the
Firm
Types of
Corporations
1. Corporation No Limit No No Both corporate
and personal taxes
2. S-corporation Maximum of 100 No No Personal
Limited Liability No Limit No No Personal
Company
Agency problem
Capital budgeting
Capital structure decisions
Corporation
Efficient market
Financial markets
General partnership
Incremental cash flow
Limited partnership
Limited Liability Company (LLC)
Partnership
Opportunity cost
Sole proprietorship
S-corporation
Working capital management