Business Organizations and
the Tax Environment
Chapter 6
Alternative Forms of
Business Organization
 Sole Proprietorship - unincorporated
business owned by one individual
Alternative Forms of
Business Organization
 Sole Proprietorship
 Partnership - unincorporated business
owned by two or more persons
Alternative Forms of
Business Organization
 Sole Proprietorship
 Partnership
 Corporation - 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
 Sole Proprietorship
 Partnership
 Corporation
 corporate charter is filed with the state
providing information about the company
and directors
Alternative Forms of
Business Organization
 Sole Proprietorship
 Partnership
 Corporation
 corporate charter is filed with the state
providing information about the company
and directors
 bylaws are for internal management and
procedures
Finance in the Organizational
Structure of the Firm
Board of Directors
President
VP Marketing
VP Finance
(CFO)
VP Manufacturing
Treasurer
Credit
Manager
Inventory
Manager
Controller
Director of
Capital
Budgeting
Cost
Accounting
Financial
Accounting
Tax
Department
The Goals of the
Corporation
 Stockholder wealth maximization
 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
 Stockholder wealth maximization
 Managerial incentives to maximize
shareholder wealth
The Goals of the
Corporation
 Stockholder wealth maximization
 Managerial incentives to maximize
shareholder wealth
 Social responsibility
The Goals of the
Corporation
 Stockholder wealth maximization
 Managerial incentives to maximize
shareholder wealth
 Social responsibility
 Stock price maximization and social
welfare
Managerial Actions to
Maximize Shareholder Wealth
 Profit Maximization
 Will profit maximization also result in
stock price maximization?
Managerial Actions to
Maximize Shareholder Wealth
 Profit Maximization
 Consider:
 total corporate profit versus earnings per
share (EPS)
 timing of earnings
 risk of project
 risk of financing
 dividend payout versus reinvestment
Agency Relationships
 Owner/principal hires an agent and
delegates decision-making authority to
that agent to act on behalf of the
principal
 Agency problem exists when conflict of
interest between principal and agent
 between stockholders and managers
 between stockholders and creditors
Stockholders versus
Managers
 The threat of firing
 The threat of hostile takeover
 due to underpriced stock
 may be warded off with poison pill or
greenmail
 Structuring management incentives
 executive stock options
 performance shares
Stockholders versus
Creditors
 Creditors lend based on expectations
 riskiness of the firms existing assets
 expectations concerning the riskiness of
future asset additions
 the firm’s existing capital structure
 expectations concerning future capital
structure changes (amount of debt)
 Stakeholders must be treated fairly
Factors Affecting Stock Prices
The External Environment
 Legal constraints
 General level of economic activity
 Tax laws
 Conditions in the stock market
Factors Affecting Stock Prices
External Constraints
 Antitrust laws
 Environmental regulations
 Product and workplace safety
regulations
 Employment practice rules
 Federal reserve policy
 International developments
Factors Affecting Stock Prices
Strategic Policy Decisions
Controlled by Management
 Types of product or services
produced
 Production methods used
 Relative use of debt financing
 Dividend policy
Factors Affecting Stock Prices
Level of Economic Activity and
Corporate Taxes
Expected profitability
Timing of cash flows
Degree of risk
Factors Affecting Stock Prices
Stock Market Conditions
Stock price
Business Ethics
 Company’s attitude and conduct toward
its stakeholders (employees, customers,
stockholders…)
 Ethical behavior requires fair and honest
treatment toward all parties
Business Ethics
 Avoids fines and legal expenses
 Builds public trust
 Attracts business from customers who
appreciate and support the firm’s
policies
 Attracts and keeps employees of the
highest caliber
 Supports the economic viability of the
communities in which it operates
Forms of Businesses in
Other Countries
 Public limited company (PLC)
 Aktiengesellshaft (AG)
 Sociedad Anónima (SA)
 Industrial groups
 keiretsu
 chaebol
Multinational Corporations
 Operate in more than one country
 To seek new markets
 To seek raw materials
 To seek new technology
 To seek production efficiency
 To avoid political and regulatory hurdles
Multinational versus Domestic
Managerial Finance
 Different currency denominations
Multinational versus Domestic
Managerial Finance
 Different currency denominations
 Economic and legal ramifications
 Language differences
 Cultural differences
Multinational versus Domestic
Managerial Finance
 Different currency denominations
 Economic and legal ramifications
 Language differences
 Cultural differences
 Role of governments
Multinational versus Domestic
Managerial Finance
 Different currency denominations
 Economic and legal ramifications
 Language differences
 Cultural differences
 Role of governments
 Political risk
The Federal Income Tax
System
 Count on changes
 indexed items
 new tax laws
Individual Income Taxes
 Progressive tax: higher tax on higher
incomes
 Taxable income is gross income minus
exemptions and allowable deductions
 Marginal tax rate is the tax on the last
unit of income
 Average tax rate is taxes paid divided by
taxable income
Taxes On Dividend and
Interest Income
 Dividends are paid out of earnings that
have already been taxed
 Interest 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.
10%

 14.3%
1  0.30
Individual Income Taxes
 Interest paid by individuals is generally
not deductible, with the exception of
mortgage interest
 Capital gains versus ordinary income
 profit from sale of capital asset
 benefits of long-term capital gains
 Business versus personal expenses
Corporate Income Taxes
 Interest and dividend income received by
a corporation
 70% of dividends received by another
corporation is excluded from taxable
income
 Interest and dividends paid by a
corporation
 interest is deducted from income
Corporate Income Taxes
 Corporate capital gains
 currently taxed at same rate
 Corporate loss carryback and carryover
 losses can be carried back 2 years and
carried over to the next 20 years
 Accumulated earnings tax
Corporate Income Taxes
 Consolidated corporate tax returns
 if own 80% or more
 S Corporations
 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
I. Developed
Markets
Australia
Tax Rate
Canada
44.6
France
36.7
Germany
57.4/44.1
Italy
53.2
Japan
51.6
Netherlands
35.0
Switzerland
28.5
United Kingdom
31.0
United States
40.0
36.0%
Corporate Tax Rates
in Other Countries
II. Emerging Markets Tax Rate
Brazil
25.0
Chile
15.0
China, PR
33.0
India
35.0
Indonesia
30.0
Korea
30.8
Malaysia
30.0
Mexico
34.0
Philippines
35.0
Thailand
30.0
Depreciation
 Expensing the price of a long-term asset
over time
End of Chapter 6
Business
Organizations
and the
Tax Environment