72-270 Chapter 1_Intro

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Chapter 1 The Firm and theFinancial Manager

Organizing a Business

The Role of the Financial Manager

Who is the Financial Manager?

Goals of the Corporation

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Organizing a Business

No two companies will develop in exactly thesame way

Business fundamental determines the best legalstructure

Types of business organizations: Sole Proprietorships

Partnerships

Corporations

Hybrid forms

Limited Partnerships: limited liability

LLP/LLC: flow-through entities, with taxed on partners,business does not pay income tax

PC: taxed as a corporation

Income trust: a unique twist

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Starting as a Proprietorship

Sole owner of a business with no partnersand no shareholders

Advantages:

Ease of formation

Subject to fewer regulations

No double taxation of corporate earnings

Disadvantages: Difficult to raise capital to support growth

Unlimited liability

Limited life span

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Starting as or Growing into aPartnership

Business owned by two or moreindividuals with various privileges andresponsibilities

General (day-to-day management withunlimited liabilities) vs. limited partner (liableonly for the money invested)

Limited liability partnership

A partnership has roughly the sameadvantages and disadvantages as a soleproprietorship

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Becoming a Corporation

A corporation is a legal entity separatefrom its owners and managers

File papers and prepare reports federally

with Corporation Canada under theCanadian Business Corporate Act

Articles of incorporation

Bylaws

Public (with shares listed for trading on anexchange) vs. Private Company (withshares are closely held)

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Becoming a Corporation

Corporations

A business which is legally distinct from itsowners, who are called shareholders.

One of the key features of a corporation is theseparation of ownership and management.

This allows a corporation more flexibility andpermanence than other types of businessorganization.

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Advantages/Disadvantages ofa Corporation

Advantages:

Unlimited life

Easy transfer of ownership

Limited liability Ease of raising capital

Disadvantages:

Double taxation

Higher setup cost

Endless report filing

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A Unique Twist: Income Trust

Expand 100 times to a market capitalization of$192 billion from 1994 to 2007

Growth ends as government has announced plansin 2006 to tax trusts at the same rate ascorporations

In the past, cash distributions from income trustare only taxed in the hands of investors, not atthe firm level

Investors see trusts as tax-efficient and arewilling to pay more for a company converted intoa trust

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Basic Income Trust Structure

Copyright 2006 McGraw Hill Ryerson Limited 1-9

Income Trust Investor

(Unit-holders)

INCOME

TRUST

Operating Company

Cash Distributions

Interest, dividends, return of capital

Equity

Equity/Debt

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Tax Rates and Changes toIncome Trust Taxation

Before After

Investor IncomeTrust(Income)

Large Corp(Dividend)

IncomeTrust(Income)

Large Corp(Dividend)

TaxableCanadian

46% 46% 45.5% 45.5%

Tax-exemptCanadian

0 32% 31.5% 31.5%

Taxablenon-resident

15% 42% 41.5% 41.5%

Copyright 2006 McGraw Hill Ryerson Limited 1-10

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Organizing a Business:Summary

Sole

Proprietorship

Partnership Corporation

Who owns the

business?

The manager Partners Shareholders

Are managersand owners

separate?

No No Usually

What is the

owners

liability?

Unlimited Unlimited Limited

Are the owner& business

taxed

separately?

No No Yes

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Role of the Financial Manager

FinancialManager

Firm's

operations Investors

(2) Cash invested in firm

(2)

(3) Cash generated by operations

(3)

(4a) Cash reinvested

(4a)

(4b) Cash returned to investors

(4b)Real assets

(1) Cash raised from investors

(1)

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The role of the financial manager is todetermine:

What operating assets to invest in?

- Capital budgeting decision, e.g. EnCana hascompleted a $700m natural gas project offshoreNova Scotia in 2010

How to pay for those assets?

- Financing decision, e.g. TransCanada issued45.4 million common shares to raise $1.7 billion

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Capital Budgeting Decision

The financial manager is concerned with:

1.

The size;

2. The timing; and

3. The risks associated with realizing the futurebenefits produced by the asset

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Financing Decision

The financial manager can use:

Internal financing purchase the assets using thefirms own funds.

External financing - purchase the assets by raisingmoney from financial institutions or markets.

Capital structure mix of debt and equity capital

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Who is the Financial Manager?

Chief Financial Officer

Treasurer: cash mgmt,

raising capital, banking

relationship

Controller: preparing

financial statements,

accounting, taxes

Anyone responsible for the capital budgeting and/or thefinancing decision is known as a financial manager

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Determinants of a Firms Value

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The primary goal of any corporation is tomaximize shareholder wealth Increasing market value increases shareholder

wealth.

Thus, the objective is to maximize thefundamental share price, not just the currentprice or the profit.

.But not at the cost of unethical behavior!

Business ethics are a companys attitude andconduct towards its employees, customers,community and shareholders

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Individuals act in their own self-interest

Agency Problems

Conflicts of interest between the firms owners

(principals) and its managers (agents) areknown as agency problems.

Agency relationships result in agency costs,e.g. loss of wealth if agents pursue their own

interest, cost of monitoring the agent Agency costs are borne by the principals

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Agency Problems

Agency problems can be reduced in several

ways: Compensation plans: link the managers salary to

the fortunes of the firm

options

Board of Directors Threat of take-over

Specialist monitoring: security analysts, bankofficers

Documents

72-270 Chapter 1_Intro