2SG - Chapter 2 The Domestic and International Financial...

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Chapter 2 provides a look at the domestic and international marketplaces in which firms operate. The role of the financial marketplace is to allocate scarce resources from savers to investors. This chapter provides an overview of the U.S. financial system and how funds are transferred between savers and investors. The major financial intermediaries and the operation and structure of secondary security markets are discussed. Aspects of international financial markets also are covered. Efficient markets concepts, the calculation of holding period returns, and the role of taxes are discussed as well. I. Corporate and personal income taxes have important implications for financial managers. Because so many financial decisions are based on after-tax cash flows, finance and business professionals must have a basic understanding of tax matters. Specific provisions of the Federal income tax laws applicable to corporations are discussed in Appendix 2A at the end of the chapter. A. Several financial decisions that are affected by income taxes are previewed in this chapter. 1. Capital structure policy. Because interest payments on debt financing are deductible expenses when computing the income tax liability and because dividends paid on common or preferred stock are not deductible, there is a tax advantage to debt financing over equity financing. 2. Dividend policy. When dividends are paid to common stockholders, these dividends are taxed immediately as income. If, instead, the firm retains and reinvests the earnings, the price of the common stock should increase. Personal taxes on the stock price appreciation are deferred until the stock is sold. Thus, some stockholders prefer capital gains to dividend income, which would affect dividend policy. 3. Capital budgeting. Capital expenditure decisions are based on after-tax cash flows. Changes in depreciation schedules will affect the cash flows and net present value of capital investments. 4. Leasing. Tax effects can motivate leasing (rather than buying) if the tax rates 15 Chapter 2 The Domestic and International Financial Marketplace
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Contemporary Financial Management of the lessee (asset user) and the lessor (asset owner) are different. 16
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Chapter 2/The Domestic and International Financial Marketplace B. Corporate tax rates are progressive — the larger the income, the higher the tax rate. In this text, we will use an assumed marginal tax rate of 40 percent rather than the actual rate of 35 percent. This simplifies calculations, and the combined effect of state and federal income taxes might be close to 40 percent in many cases. II. The U.S. financial system serves an important function by channeling funds from saving units to investing units. A.
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2SG - Chapter 2 The Domestic and International Financial...

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