Objectives of income taxation
- Raise revenues for government expenditures
- achieve socially desirable goals
- economic stabilization
Types of taxpayers
Individuals
- employees, self-employed, members of partnerships
- report income on personal tax returns
corporations
- separate legal entity
- report income on corporate tax return
- distributed dividends taxed to shareholders
fiduciaries
- Estates and trusts
- pay taxes on undistributed income
Computing taxable income
taxable income
- Gross income less tax-deductible expenses, plus interest income and dividends income
- gross income dollar sales from a product or service less cost of production or acquisition
- tax deductible expenses operating expenses "marketing, depreciation, administrative expenses" and interest expense dividends paid are not deductible
Formula for computing taxable income
sales minus cost of goods sold equals gross profit minus operating expenses equals operating income plus other income minus interest expenses equal's taxable income
Corporate tax rates
$0 -- $50,000 = 15%
$50,001 -- $75,000 = 25%
$75,001 -- $10,000,000 = 34%
over $10,000,000 = 35%
Additional surtax:
5% on income between $100,000 and $335,000
3% on income between $15 million and $18,333,333
marginal tax rates
- rates applicable to next dollar of income
- used in financial decision-making
other corporate tax considerations
dividend exclusion -- a corporation may typically exclude 70% of any dividend received from another corporation
depreciation expense -- a corporation may expense of assets cost over its useful life
capital gains and losses -- capital gains tax as ordinary income. Capital losses cannot be deducted from ordinary income
10 principles of form the foundations of financial management
principle 1: the risk return trade-off
we won't take on additional risk unless we expect to be compensated with additional returns
investment alternatives have different amounts of risk and expected returns
the more risk of investment has, the higher its expected return will be
principle 2: the time value of money
a dollar received today is worth more than a dollar received in future
because we can earn interest on money received today, it is better to receive money earlier rather than later
principle 3: Cash -- not profits -- is king
cash flow, not accounting profit, is used as our measurement tool
Cash flows, not profits, are actually received by the firm and can be reinvested
principle 4: incremental cash flows
it is only what changes that counts
the 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
principle 5: the curse of competitive markets
it is hard to find exceptionally profitable projects
if an industry is generating large profits, new entrants are usually attracted. The additional competition and added capacity can result in profits being driven down to the required rate of return
product differentiation, service and quality can insulate products from competition
principle 6: efficient capital markets
these markets are quick and the prices are right
the values of all assets in securities at any instant in time fully reflect all of available information
principle 7: the agency problem
managers won't work for the owners unless it is in their best interest
the separation of management and ownership of the firm creates an agency problem
managers may make decisions that are not in line with the goal of maximization of shareholder wealth
principle 8: taxes bias business decisions
the cash flows we consider are the after-tax incremental cash flows to the firm as a whole
principle 9: all risk is not equal
principal 10: ethical behaviors
ethical behavior is doing the right thing, and ethical dilemmas are everywhere in finance
each person has his or her own set of values, which forms the basis of personal judgments about what is the right thing
Finance and the multinational firm
US corporations are looking to international expansion
collapse of communism
acceptance of free-market system developing and third world countries
technology and the Internet
freer access to international markets
