Business Organizations and the Tax Environment Chapter 6

Alternative Forms of Business Organization uSole Proprietorship - unincorporated business owned by one individual

Alternative Forms of Business Organization uSole Proprietorship uPartnership - unincorporated business owned by two or more persons

Alternative Forms of Business Organization uSole Proprietorship uPartnership uCorporation - legal entity created by a state, separate and distinct from its owners and managers, having unlimited life, easy transferability of ownership, and limited liability

Alternative Forms of Business Organization uSole Proprietorship uPartnership uCorporation F corporate charter is filed with the state providing information about the company and directors

Alternative Forms of Business Organization uSole Proprietorship uPartnership uCorporation F corporate charter is filed with the state providing information about the company and directors F bylaws are for internal management and procedures

Finance in the Organizational Structure of the Firm Board of Directors VP Manufacturing VP Finance (CFO) VP Marketing ControllerTreasurer Tax Department Financial Accounting Cost Accounting Credit Manager Inventory Manager Director of Capital Budgeting President

The Goals of the Corporation uStockholder wealth maximization F considers the risk and timing associated with expected earnings per share in order to maximize the price of the firm’s common stock

The Goals of the Corporation uStockholder wealth maximization uManagerial incentives to maximize shareholder wealth

The Goals of the Corporation uStockholder wealth maximization uManagerial incentives to maximize shareholder wealth uSocial responsibility

The Goals of the Corporation uStockholder wealth maximization uManagerial incentives to maximize shareholder wealth uSocial responsibility uStock price maximization and social welfare

uProfit Maximization F Will profit maximization also result in stock price maximization? Managerial Actions to Maximize Shareholder Wealth

uProfit Maximization F Consider: v total corporate profit versus earnings per share (EPS) v timing of earnings v risk of project v risk of financing v dividend payout versus reinvestment

Agency Relationships uOwner/principal hires an agent and delegates decision-making authority to that agent to act on behalf of the principal uAgency problem exists when conflict of interest between principal and agent F between stockholders and managers F between stockholders and creditors

Stockholders versus Managers uThe threat of firing uThe threat of hostile takeover F due to underpriced stock F may be warded off with poison pill or greenmail uStructuring management incentives F executive stock options F performance shares

Stockholders versus Creditors uCreditors lend based on expectations F riskiness of the firms existing assets F expectations concerning the riskiness of future asset additions F the firm’s existing capital structure F expectations concerning future capital structure changes (amount of debt) uStakeholders must be treated fairly

Factors Affecting Stock Prices The External Environment uLegal constraints uGeneral level of economic activity uTax laws uConditions in the stock market

Factors Affecting Stock Prices External Constraints uAntitrust laws uEnvironmental regulations uProduct and workplace safety regulations uEmployment practice rules uFederal reserve policy uInternational developments

Factors Affecting Stock Prices Strategic Policy Decisions Controlled by Management uTypes of product or services produced uProduction methods used uRelative use of debt financing uDividend policy

Factors Affecting Stock Prices Level of Economic Activity and Corporate Taxes uExpected profitability uTiming of cash flows uDegree of risk

Factors Affecting Stock Prices Stock Market Conditions uStock price

Business Ethics uCompany’s attitude and conduct toward its stakeholders (employees, customers, stockholders…) uEthical behavior requires fair and honest treatment toward all parties

Business Ethics uAvoids fines and legal expenses uBuilds public trust uAttracts business from customers who appreciate and support the firm’s policies uAttracts and keeps employees of the highest caliber uSupports the economic viability of the communities in which it operates

Forms of Businesses in Other Countries uPublic limited company (PLC) uAktiengesellshaft (AG) uSociedad Anónima (SA) uIndustrial groups F keiretsu F chaebol

Multinational Corporations uOperate in more than one country F To seek new markets F To seek raw materials F To seek new technology F To seek production efficiency F To avoid political and regulatory hurdles

Multinational versus Domestic Managerial Finance uDifferent currency denominations

uEconomic and legal ramifications uLanguage differences uCultural differences Multinational versus Domestic Managerial Finance

uDifferent currency denominations uEconomic and legal ramifications uLanguage differences uCultural differences uRole of governments Multinational versus Domestic Managerial Finance

uDifferent currency denominations uEconomic and legal ramifications uLanguage differences uCultural differences uRole of governments uPolitical risk

The Federal Income Tax System uCount on changes F indexed items F new tax laws

Individual Income Taxes uProgressive tax: higher tax on higher incomes uTaxable income is gross income minus exemptions and allowable deductions uMarginal tax rate is the tax on the last unit of income uAverage tax rate is taxes paid divided by taxable income

Taxes On Dividend and Interest Income uDividends are paid out of earnings that have already been taxed uInterest on most state and local government bonds (municipals) is not subject to federal income taxes

Comparing Yields Tax-free and Taxable Equivalent pre-tax yield on a taxable investment Yield on tax-free investment 1 - Marginal tax rate = A taxpayer in the 30% marginal tax bracket who could buy a municipal bond that yields 10 % would have to receive a before-tax yield of 14.3% on a corporate or US Treasury bond to have the same after-tax yield.

Individual Income Taxes uInterest paid by individuals is generally not deductible, with the exception of mortgage interest uCapital gains versus ordinary income F profit from sale of capital asset F benefits of long-term capital gains uBusiness versus personal expenses

Corporate Income Taxes uInterest and dividend income received by a corporation F 70% of dividends received by another corporation is excluded from taxable income uInterest and dividends paid by a corporation F interest is deducted from income

Corporate Income Taxes uCorporate capital gains F currently taxed at same rate uCorporate loss carryback and carryover F losses can be carried back 2 years and carried over to the next 20 years uAccumulated earnings tax

Corporate Income Taxes uConsolidated corporate tax returns F if own 80% or more uS Corporations F small corporation that elects to be taxed as a proprietorship or partnership yet retains limited liability and other benefits of incorporating

Corporate Tax Rates in Other Countries

Depreciation uExpensing the price of a long-term asset over time

End of Chapter 6 Business Organizations and the Tax Environment