MB8005
MBA Foundation Course Finance
Toronto Metropolitan University
Spring/Summer 2023
Prof. Laleh Samarbakhsh
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Today’s Agenda
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Professor Introduction
Motivation
A Key Concept in Finance
My Message
Course Outline
• Chapter 1
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Professor Introduction
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Laleh Samarbakhsh, PhD
Office: TRS 1-081
Office hour: by appointment
Email: lsamarbakhsh@ryerson.ca
About me, my research area
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Motivation
• What is Finance?
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Hybrid combo of: Economics, Accounting & Statistics
Mathematical reasoning + $$
• Subfields of Finance
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Corporate Finance, Investments, Personal Finance, Financial
Markets, Real Estate Finance, etc.
• Finance is at the core of everything we do in Business &
Management
• Finance is indispensable in everyday life
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A Key Concept in Finance
• An Example
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If I want to borrow $10,000 from you today and promise to pay
you back $10,000 a year from now, do you agree to lend me the
money?
• The essence: $1 today ≠ $1 tomorrow
• The big name: Time Value of Money
• Application
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Valuation of stock and bond
Calculation of pension and mortgage
Making capital investment decisions
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My Message
• Why is Finance hard?
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The subject matter is difficult and (maybe) new to you
Hard-working (and smart) students get good grades
Finance is useful! And it will benefit you in short and long-run
• How to get the most out of this course?
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Do readings ahead of time
Take notes during lectures
Review the lectures afterwards with your study group
Do lots of practice problems in groups and alone
Ask questions
• A little extra hard work makes up for a lot of smart, so
YOU CAN MAKE IT!
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Chapter 1
• What is Corporate Finance?
• Role of the Financial Manager
• Organizing a Business
• Goals of the Corporation
• Agency Problem
• Financial Markets
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What Is Corporate Finance?
• What long-term investments should you take on?
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Capital budgeting
E.g. Apple developed IPHONE, Google purchased Motorola
• Where will you get the long-term financing to pay for
your investment?
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Capital structure
E.g. IPOs, seasoned equity offerings, bank debts
• How will you manage day-to-day financial activities?
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Working capital management
E.g. collecting from customers, paying suppliers
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Finance at Personal Level
• Individuals are taking charge of their personal finances
with decisions such as:
• When to start saving and how much to save for
retirement.
• Whether a car loan or lease is more advantageous.
• Whether a particular stock is a good investment.
• How to evaluate the terms for a home mortgage.
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Finance at Corporate Level
• In your business career, you may face such questions as
these:
• Should your firm launch a new product?
• Which supplier should your firm choose?
• Should your firm produce a part of the product or
outsource production?
• Should your firm issue new stock or borrow money
instead?
• How can you raise money for your start-up firm?
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Role of the Financial Manager
(2)
Firm's
operations
Real assets
(1)
Financial
Manager
Investors
(4a)
(3)
(1) Cash raised from investors
(2) Cash invested in firm
(3) Cash generated by
operations
(4a) Cash reinvested
(4b) Cash returned to investors
(4b)
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Organizing a Business
• Types of business organizations
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Corporations (the focus of this course)
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Sole Proprietorships
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Partnerships
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Others
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Organizing a Business
• Sole Proprietorship / Partnership
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One individual (two or more people) own and manage the
business
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Bears all the costs, but keep all of the net profits.
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No separation of business and individual (partners)
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Advantages:
• Ease of establishment and lack of regulation
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Disadvantages:
• Unlimited liability – that individual is personally liable for all of
the firm’s liabilities (financial and legal)
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Organizing a Business
• Corporations
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A business which is legally distinct from its owners, who are
called shareholders.
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Advantages:
• Limited liability (financial and legal)
• More flexible & permanent (managers and shareholders
come and go, firm remains)
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Disadvantages:
• Taxation (firm profits + dividends to tax payers)
• Agency Issues (more later)
• Regulations and costs
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Organizing a Business
• Others
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Limited Partnerships
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Limited Liability Partnerships
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Income Trusts
• Reduce or eliminate corporate taxes
• Distribute more cash flows to unit holders
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Ownership of the Corporation
No limit on the number of owners.
– The entire ownership stake of a corporation is divided
into shares known as stock.
– The collection of all the outstanding shares of a
corporation is known as the equity of the corporation.
– An owner of a share of stock in the corporation
is known as a shareholder, stockholder, or
equity holder
– Shareholders are entitled to dividend payments
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• Usually receive a share of the dividend payments that is
proportional to the amount of stock they own
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Goals of the Corporation
• The goal of any corporation is to maximize shareholder
wealth
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Increasing market value increases shareholder wealth….
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…Thus, the objective is to maximize current share price….
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….But not at the cost of unethical behavior! (e.g. Enron,
WorldCom)
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Agency Problems
• Agency Problems
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Resulting from the separation of management and ownership
Conflicts of interest between the firm’s owners (principals) and
its managers (agents)
• Can be reduced in several ways:
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Compensation plans: firm stock and options
Board of Directors
Threat of takeovers
Specialist monitoring
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Financial Markets
Financial Markets
Stock markets
Bond markets
Firm's
operations
Financial
Manager
Investors
Real assets
Financial Intermediaries
/ Institutions
Mutual funds
Banks
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Financial Markets
• Financial Assets / Securities
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Financial assets vs. real assets
A security is a legal contract between the firm and its investors.
It represents a claim on the firm’s assets and the cash those
assets will produce.
• Financial Markets
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Market where securities are issued and traded
Stock market vs. fixed-income (bond) market
Exchanges vs. over-the-counter
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Financial Markets
• Primary Market vs. Secondary Market
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Primary Market : market for the sale of new securities by
corporations
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Secondary Market : market in which already issued securities
are traded among investors
• Capital Market vs. Money Market
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Capital Market: market for long-term financing
Money Market: market for short-term financing
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Financial Markets
• Financial Institutions
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Banks
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Credit unions
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Insurance companies
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Mutual funds
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Pension funds
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……
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Financial Trading Terminology
• Bid price: The highest price in a market for which someone is
willing to purchase a security.
• Ask (or offer) price: The lowest price in a market for which
someone is willing to sell a security.
• Bid-ask spread is an implicit transaction cost investors
have to pay in order to trade quickly
• Limit order: Order to buy at a specified price; until your order
matches the ask price (the amount for which someone will sell
the stock to you), no trade will take place.
• Market order: Order to buy immediately because it
automatically takes the best ask price already posted;
customers end up always buying at the ask (the higher price)
and selling at the bid (the lower price).
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1.2 The Three Types of Firms (1 of 5)
• Canada Revenue Agency allowed an exemption for
double taxation flow-through entities (income
trust).
– Business Income Trusts
– Energy Trusts
– Real Estate Investment Trust (REIT)
• REITs continue to have no tax at the business level
beyond 2011 but the other forms of income trusts are
now taxed.
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Key Terms and Definitions (2 of 5)
Flow-through entity: A business in which all income
produced flows to the investors and virtually no
earnings are retained within the business.
Income trust: A trust that holds income-producing
assets directly or holds all the debt and equity securities
of an income-producing corporation within the trust.
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Key Terms and Definitions (3 of 5)
Business income trust: An income trust that holds all
the debt and equity securities of a corporation (the
underlying business).
Energy trust: An income trust that holds resource
properties directly or holds all the debt and equity
securities of a resource corporation within the trust.
Unit holders: The owners of an income trust.
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Key Terms and Definitions (4 of 5)
Real estate investment trust (REIT): An income trust
that holds real estate properties directly or holds all the
debt and equity securities of a corporation that owns
real estate properties.
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Example 1.1: Taxation of Corporate
Earnings (1 of 5)
You are a shareholder in a corporation. Some of your
shares are held inside your tax-free savings account
(TFSA), so any earnings there are not taxed; income
from shares held outside your TFSA is taxable. The
corporation earns $5.00 per share before taxes.
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Example 1.1: Taxation of Corporate
Earnings (2 of 5)
After the corporation has paid taxes, it will distribute the
rest of its earnings to you as a dividend. The corporate
tax rate is 35% and your tax rate on dividend income
outside your TFSA is 24%. How much of the earnings
remains after all taxes are paid?
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Example 1.1: Taxation of Corporate
Earnings (Solution) (3 of 5)
• Corporate Earnings taxes are calculated as:
– $5.00 minus Corporate tax 35% on $5.00.
• No taxes on dividends of shares inside your TFSA tax
rate of 24% on the dividend for the shares outside
your TFSA.
• The amount left over is what remains after all taxes
are paid.
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Example 1.1: Taxation of Corporate
Earnings (Solution) (4 of 5)
• $5 per share × 0.35 = $1.75 in taxes at the corporate
level, leaving $5 − $1.75 = $3.25 in after-tax earnings
per share to distribute.
• You will pay $3.25 × 0.24 = $0.78 in taxes on that
dividend, leaving you with $2.47 from the original $5
after all taxes.
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Example 1.1: Taxation of Corporate
Earnings (5 of 5)
• Shares within TFSA allows you to keep $3.25 of the
original $5.00 in earnings:
– your total effective tax rate is the corporate tax rate
of 35%.
• Shares outside your TFSA allows you to keep $2.47 of
the original $5.00 in earnings:
– your total effective tax rate is (1.75 + .78)/5 =
2.53/5 = 50.6%.
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Example 1.2: Taxation of a Real Estate
Investment Trust (REIT)
• Rework Example 1.1 assuming the corporation in that
example was actually a real estate investment trust
and flowed through all earnings to trust unit owners.
• Again, assume you hold some of the trust units within
your TFSA so they are not subject to personal taxes.
For investments held outside your TFSA, your tax rate
is 46%.
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Example 1.2: Taxation of a Real Estate
Investment Trust (REIT) (Solution)
• For each unit within your TFSA, you will pay no tax at
the personal level, leaving you the full $5.00 amount.
• For each distribution from the units outside your
TFSA, you will pay $5.00 × 0.46 = $2.30 in taxes
leaving you with $2.70 from the original $5.00.
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