Chapter 30 provides knowledge of financial management in not-for-profit businesses. This chapter presents the following content: For-profit (investor-owned) vs. not-for-profit businesses, goals of the firm.
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Chapter 30
Financial Management in NotforProfit Businesses
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Topics in Chapter
Forprofit (investorowned) vs. notfor profit businesses
Goals of the firm
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What are the key features of
investorowned firms?
Owners (shareholders) are well defined, and they exercise control by voting for the firm’s board of directors
Firm’s residual earnings belong to the
owners, so management is responsible
to the owners for the firm’s profitability
Firm is subject to taxation at the federal, state, and local levels
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What is a notforprofit
corporation?
One that is organized and operated
solely for religious, charitable, scientific, public safety, literary, or educational
purposes
Generally, qualify for taxexempt status
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InvestorOwned vs. Notfor
Profit Businesses
Notforprofit corporations have no
shareholders, so all residual earnings
are retained within the firm
Control of notforprofit firms rests with a board of trustees composed mainly of
community leaders who have no
economic interests in the firm
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Goals for InvestorOwned and NotforProfit Businesses
shareholders, they are not concerned with the goal of maximizing shareholder wealth.
firm’s mission statement. They generally
relate to providing some socially valuable
service in a financially sound manner.
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Is the WACC relevant to not forprofit businesses?
Yes. The WACC estimation for notfor profit firms parallels that for investor
owned firms
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WACC for InvestorOwned
and NotforProfit Businesses
Because notforprofit firms pay no
taxes, there are no tax effects
associated with debt financing
A notforprofit firm’s cost of equity, or
cost of fund capital, is much more
controversial than for an investorowned firm
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What is fund capital?
Notforprofit firms raise the equivalent
of equity capital, called fund capital, by retaining profits, receiving government grants, and receiving private
contributions
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The firm’s opportunity cost of fund
capital should rise as more and more debt is used, and the firm should be subject to the same financial distress and agency costs from using debt as encountered by investorowned firms
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Implementation Problems with the Tradeoff Theory
raising equity capital.
typical equity markets. It’s harder for them to raise fund capital.
delay worthy projects because of insufficient funding, or to use more than the theoretically optimal amount of debt.
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Capital Budgeting for Notfor Profits
investment should be fully understood in
order to ensure the firm’s longterm financial health.
projects could lead to bankruptcy and
closure, which obviously would eliminate the social value provided by the firm to the
community.
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What is social value?
Social value are those benefits realized from capital investment in addition to
cash flow returns, such as charity care and other community services
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What are municipal bonds?
Bonds issued by state and local
governments
Municipal bonds are exempt from
federal income taxes and state income taxes in the state of issue
“Roll overs”
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NotforProfit Health Care and Municipal Bonds
Notforprofit firms cannot issue
municipal bonds directly to investors. The bonds are issued through some
municipal health facilities authority
The authority acts only as a conduit for the issuing corporation
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Sources of Fund Capital
Excess of revenues over expenses
Charitable contributions
Government grants
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Impact of Nonaccess to
Equity Markets
The lack of access to equity capital
effectively imposes capital rationing, so the firm may not be able to undertake all projects deemed worthwhile
In order to invest in projects considered necessary, the firm may have to take on more than the optimal amount of debt
capital