Unformatted text preview: tate. Forming a corporation requires preparing a charter and a
set of bylaws. Public corporations must incur the expense of
preparing and disclosing information to their shareholders and
various regulatory bodies.
Double taxation. Unlike income from a sole proprietorship and
general partnership, which is taxed once, income paid to
owners is subject to double taxation. That is, the corporation
pays taxes on taxable income and individual shareholders pay
taxes on the income received.
Separation of ownership and management. In many
corporations, especially larger ones, managers and owners
represent separate groups. Their interests may conflict.
21 Financial management involves three major types of
decisions: (1) long-term investment decisions, (2) long-term
financing decisions, and (3) working capital management
These decisions concern the acquisition and allocation of
resources among the firm’s various activities. The first two
decisions are long term in nature and the third is short term.
Managers should not consider these decisions on a
piecemeal basis but as an integrated whole because they are
seldom independent of one another. Investment decisions
typically affect financing decisions and vice versa.
For example, a decision to build a new plant or to buy new
equipment requires other decisions on how to obtain the
funds needed to finance the project and to manage the asset
23 Long-term investment decisions involve determining the
type and amount of assets that the firm wants to hold. That
is, investing concerns allocating or using funds.
The financial manager makes investment decisions about all
types of assets – items on the left-hand side of the balance
sheet. These decisions often involve buying, holding,
reducing, replacing, selling, and managing assets.
The process of planning and managing a firm’s long-term
investments is called capital budgeting. Common questions
involving long-term investments include:
• In what lines of business should the firm engage?
• Should the firm acquire other companies?
• What sorts of property, plant, and equipment should the firm
24 • Should the firm modernize or sell an old production facility?
• Should the firm introduce a more efficient distribution system
than the current one?
As these examples show, investment decisions involve not only
those that create revenues and profits, but also those that save
money. The answers to these questions flow from the firm’s
long-term investment strategy.
Making investment decisions requires applying a key principle
of financial management.
The investment principle states that the firm should invest in
assets and projects yielding a return greater than the minimum
acceptable hurdle rate. A hurdle rate is the minimum
acceptable rate of return for investing...
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