Sie sind auf Seite 1von 21

CHAPTER 1: THE SCOPE OF CORPORATE FINANCE

The Role of Corporate Finance in Modern Business

More than just book-keeping; corporate finance involves the creation of value
- Find ways to minimize costs
- Optimal allocation of resources
- Evaluating the tradeoff between risk and return
Finance professionals interact with a variety of divisions/organizations
within/outside the firm

The Core Principles of Finance


The time value of money
- The opportunity to earn a return on invested funds means that a dollar
today is worth more than a dollar in the future
Compensation for risk
- Investors expect compensation for bearing risk
Dont put your eggs in one basket
- Investors can achieve a more favorable trade-off between risk and return
by diversifying their portfolios
Markets are smart
- Competition for information tends to make markets efficient
No arbitrage
- Arbitrage opportunities are very scarce
- Arbitrage- process of buying something in one market at a low price and
simultaneously selling it in another market at a higher price to generate
an immediate, risk-free profit
Career Opportunities in Finance
Corporate finance- concerned with the duties of financial managers in
business, such as budgeting, financial forecasting, cash management, credit
administration, investment analysis, fund procurement
Commercial banking
1) Consumer banking- serves the financial needs of a banks individual
customers in its branch network
2) Commercial banking- involves extending credit and other banking services
to corporate clients
Investment banking- involves obtaining funding by selling securities, etc.,
providing advice on strategic transactions, and trading debt and equity
securities; high income potential and very competitive
Money management- any person or institution that acts as a fiduciarysomeone who invests and manages money on anothers behalf
Consulting- advise on business practices and strategies of corporate clients
Five Basic Corporate Finance Functions
Corporate finance- the activities involved in managing cash (money) that
flows through a business

1) FINANCING FUNCTION (capital-raising)- raising capital to support a


companys operations and investment programs
- Businesses can raise money in 2 ways:
1. Externally from investors or creditors (selling equity or issuing debt)
o Initial public offering (IPO)- corporations offer shares for sale to
the public for the first time by selling shares to outside investors
and listing them for trade on a stock exchange
o Primary market transactions- cash sales of securities to
investors by a corporation to raise capital
o Secondary market transaction- trades between investors that
generate no new cash flow for the firm
2. Internally by retaining operating cash flows
o Most common method
- Raising capital: key facts
o Most financing from internal rather than external sources
o Most external financing is debt
o Primary vs. secondary market transactions or offerings
o Financial intermediaries declining as a source of capital for large
firms
o Securities markets growing in importance
2) CAPITAL BUDGETING FUNCTION- the activities involved in selecting the
best projects in which to invest the firms funds based on their expected
risk and return
- Consists of three steps:
1. Identifying potential investments
2. Analyzing those investments to identify which will create shareholder
value
3. Implementing and monitoring the investments selected in step 2
3) FINANCIAL MANAGEMENT FUNCTION- the activities involved in
managing the firms operating cash flows as efficiently as possible
- Managing daily cash inflows and outflows
- Building a long-term financial plan
- Choosing the right mix of debt and equity
- Ensuring that companies can pay off their obligations when they come
due
o Involved obtaining seasonal financing, managing inventories,
paying suppliers, collecting from customers, and investing surplus
cash
4) CORPORATE GOVERNANCE FUNCTION- the activities involved in
developing company-wide structures and incentives that influence
managers to behave ethically and make decisions that benefit
shareholders
- Hires and promotes qualified, honest people, and structures employees
financial incentives to motivate them to maximize firm value
- In practice the incentives of stockholders, managers, and other
stockholders often conflict
- Dimensions of corporate governance:
o Board of directors

Securities and Exchange Commission- federal agency,


established in 1934, charged with oversight of the fair reporting of
financial information to investors in public companies (those whose
shares are listed for trading in a public securities markets)
o Sarbanes-Oxley Act of 2002- act of congress that established
new corporate governance standards for U.S. public companies
- Mergers and acquisitions
5) RISK MANAGEMENT FUNCTION- the activities involved in identifying,
measuring, and managing the firms exposure to all types of risk to
maintain an optimal risk-return trade-off and therefore maximize share
value
- Some risks are insurable, and some risks can be reduced through
diversification
- Financial instruments like forwards, futures, options, and swaps may also
be used to hedge market risks such as interest-rate, price, and currency
fluctuations
o Hedge- to use complex financial instruments to offset market risks
such as interest-rate and currency fluctuations
o

Forms of Business Organizations in the United States

Proprietorship- a business with a single owner


- No distinction between business and person
- Easy to set up, operate; taxed as personal income
- Personal liability, limited life, difficult to transfer
Partnership- a proprietorship with two or more owners who have joined their
skills and personal wealth this sharing is called joint and several
liability- a legal concept that makes each partner in a partnership legally
liable for all the debts of the partnership
- Two or more business owners
- Partners- liable for every other partners actions
Limited partnership- a partnership in which most of the participants (the
limited partners) have the limited liability of corporate shareholders, but their
share of the profits from the business is taxed as partnership income
- One general and many limited partners
- Real-estate, R&D companies
S Corporations- an ordinary corporation in which the stockholders have
elected to allow shareholders to be taxed as partners while still retaining their
limited-liability status as corporate stockholders
Limited-liability companies- a form of business organization that combines
the tax advantage of a partnership with the limited liability protection of a
corporation
Corporations- a legal entity, owned by the shareholders who hold its
common stock, with many of the economic rights and responsibilities enjoyed
by the individuals
- Shareholders- owner of common or preferred stock in a corporation
- Incorporation occurs at state level; based on state law
- Strengths- limited liability for investors, unlimited business life

Double taxation problem- taxation of corporate income at both


company and personal levels traditionally a significant disadvantage of
the corporate form
o The Jobs and Growth Tax Relief Reconciliation Act of 2003 (Tax Relief
Act of 2003) dramatically reduced the double taxation problem
o The Fiscal Cliff Compromise raised the tax rates but kept the same
structure

Forms of Business Organizations Used by Non-U.S. Companies

Limited-liability companies- Britain, Germany, France, Spain, Mexico, Latin


America
- Differences revolve around tax treatment of business income and the
amount of information that publicly traded companies must disclose
State-owned enterprises- historically, the telephone, television, utility,
airline and railroad companiesD in many European countries
- Privatization programs have reduced the role of the status around the
(states both sell (privatize) and purchase (nationalize) corporate equity

Why Should a Financial Manager try to Maximize?

Maximize profits?
- Earnings per share (the amount earned on behalf of each outstanding
share of common stock) are backward-looking, dependent on accounting
principles

Do not fully consider cash flow timing a manager needs to know how to
measure profits
- Focusing solely on earnings ignores risk managers not only need to
focus on expected profits, but also the risk of the investments
Maximize shareholder wealth?
- Wealth is measured by the firms stock price, which reflect the timing,
magnitude, and risk of the cash flows that investors expect a firm to
generate over time maximize stock price, not profits
- Shareholder, as residual claimants, have better incentives to maximize
firm value
o Residual claimants- corporate investors, typically common
stockholders, who have the right to receive cash flows after all
other claimants have been satisfied in full
-

Agency Costs in Corporate Finance

Agency problems- the conflict of interest between the goals of a firms


owners and its managers
- To overcome agency problems:
o Rely on market forces for managerial discipline
o Incur monitoring and bonding costs to supervise managers
o Structure executive compensation plans (incentives offered to a
manager to encourage her to act in the best interests of the
owners) to align managers interests with stockholders interests
- The actual workings of many compensation plans have been harshly
criticized in recent years

Importance of Ethics

Widespread publicity surrounding numerous ethical violations began with the


Enron collapse in late 2001
Society in general and the financial community in particular are developing
and enforcing ethical standards
Ethical behavior is necessary in order to maximize shareholders wealth

CHAPTER 2: FINANCIAL STATEMENTS AND CASH FLOW ANALYSIS


Financial Statements

Accrual-based approach- revenues are recorded at the point of sale and


costs when they are incurred, not necessarily when a firm receives or pays
out cash (used mainly by accountants)
Cash flow approach- used by financial professionals to focus attention on
current and prospective inflows and outflows of cash (used mainly by
financial professionals)
1) BALANCE SHEET
- A firms balance sheet presents a snapshot view of the companys
financial position at a specific point in time

Assets = liabilities + stockholders equity


Big Box Inc. Balance Sheet ($ thousands)

2) INCOME STATEMENT
- Income also called profit, earnings, or margin
- Income = revenue expenses
- Measures of income gross profit, operating profit, other income,
earnings before interest and taxes, pretax income, net income/net profit
after taxes
- Big Box Inc. Income Statement ($ Thousands)

3) STATEMENT OF RETAINED EARNINGS


- The statement of retained earnings reconciles the net income earned
during a given year and any cash dividends paid with the change in
retained earnings between the start and end of that year
4) STATEMENT OF CASH FLOWS
- Reconciles the firms operating, investment, and financing cash flows with
changes in its cash and marketable securities during the year
- Big Box Inc. Statement of Cash Flows ($ thousands)

Sources and uses of corporate cash


o Sources decrease in any asset, increase in any liability, net
profits after taxes, depreciation and other non-cash charges, sale of
stock
o Uses increase in any asset, decrease in any liability, net loss,
dividends paid, stock repurchase or retirement
Two methods of handling depreciation to compute cash flow

5) NOTES TO FINANCIAL STATEMENTS


-

Explanatory notes that provide detailed information on the accounting


policies, calculations, and transactions underlying entries in the financial
statements

Cash flow analysis

Although financial managers are interested in the information contained in


the firms accrual-based financial statements, their primary focus in on cash
flows
Without adequate cash to pay obligations on time, to fund operations and
growth, and to compensate owners, the firm will fail

Accounting Profit vs. Cash Flow

Accounting Profit based on accrual accounting focuses on past periods


Finance emphasizes the importance of timing You cant deposit net
income, only cash
Timing of cash flow matters. Accrual accounting may obscure timing.
Key measures of cash flow:
- Cash flow from operations total cash generated by firm (internally
generated funds) = net income + depreciation + other non-cash charges
dividends
- Operating cash flow cash flow before repaying lenders = earnings
before interest and taxes taxes + depreciation
- Free cash flow cash flow that firm could distribute to investors =
operating cash flow change in gross fixed assets change in current
assets + change in account payables + change in accrued liabilities

Types of Financial Ratios


LIQUIDITY RATIOS- measures a firms ability to satisfy its short-term
obligations as they come due
- Current ratio = current assets / current liabilities
o higher, the better
- Quick ratio = current assets inventory / current liabilities
o You take out inventory, so it will be the most liquid
- Looks at the balance sheet (current assets, inventory, and current
liabilities)
ACTIVITY RATIOS- a measure of the speed with which a firm converts
various accounts into sales or cash
- Inventory turnover ratio = COGS / inventory
o A measure of how quickly a firm sells its goods
- Average collection period = AR / average daily sales

Average amount of time that elapses from a sale on credit until the
payment becomes usable funds for a firm
o It can signal really bad things are happening
o Lower, the better if it is increases it could mean you are not
collecting or you have inventory that is aging
- Average sales per day = annual sales / 365
- Fixed asset turnover = sales / net fixed assets
o A measure of the efficiency with which a firm uses its fixed assets
o Higher, the better
- Total asset turnover = sales / total assets
o Measure of the efficiency with which a firm uses all its assets to
generate sales
o Higher, the better
DEBT RATIOS- a measure of the proportion of total assets financed by a
firms creditors
o You have book value or market value
- Debt ratio = total liabilities / total assets
o Measure of the proportion of total assets financed by a firms
creditors
o Its hard to say if the debt ratio increases or decreases, if its good or
bad
- Assets-to-equity ratio = total assets / common stock equity
o Measure of the proportion of total assets financed by a firms equity
- Debt-equity ratio = long-term debt / stockholders equity
o Measure of the firms financial leverage
o Its hard to say if the debt ratio increases or decreases, if its good or
bad
- Times interest earned ratio = EBIT / interest expense
o Measure of firms ability to make contractual interest payments
o EBIT = gross income operating expenses depreciation
amortization
o Higher, the better
PROFITABILITY RATIOS- relate a firms earnings to its sales, assets, or
equity
- Gross profit margin = gross profits / sales
o Measure of profitability that represents the percentage of each
sales dollar remaining after a firm has paid for its goods
- Operating profit margin = EBIT / sales
o Measure of profitability that represents the percentage of each
sales dollar remaining after deducting all costs and expenses other
than interest and taxes
o Higher, the better
- Net profit margin = net income / sales
o Measure of profitability that represents the percentage of each
sales dollar remaining after all costs and expenses, including
interest, taxes, and preferred stock dividends, have been deducted
- Earnings per share = net income / number of shares of common stock
outstanding
o

o Higher, the better


Return on total assets = net income / total assets
o Measure of the overall effectiveness of management in generating
returns to common stockholders with its available assets
o Higher, the better
- Return on common equity = net income / stockholders equity
o Measure that captures the return earned on the common
stockholders (owners) investment in a firm
o Closest thing to a universal ratio so it can be compared across
industries around the world
o Higher, the better
MARKET RATIOS- relate a firms market value to certain accounting values
- Price/earnings (P/E) ratio = market price per share of common stock /
earnings per share
o Measure of a firms long term growth prospects that represents the
amount investors are willing to pay for each dollar of a firms
earnings
- Book value per share = common stock equity / number of shares of
common stock outstanding
- Market-to-book (M/B) ratio = market value per share of common
stock / book value per share of common stock
o Book value per share = common stock equity / number of common
shares outstanding
o Values the company as a company
o Measure used to access a firms future performance by relating its
market value per share to its book value per share
o Higher, the better
Benchmarking- comparison of a companys ration values to industry
competitors ratios; firms financial ratios compared at the same point in time
Trend analysis- performance evaluation over time; developing trends can be
seen using multi-year comparisons
-

Corporate Taxes
Significant cash outflow
Ordinary income tax- income resulting from the sale of the firms goods
and services
- Progressive tax rate schedule
o Average tax rate- a firms tax liability dividend by its pretax
income
o Marginal tax rate- the tax rate applicable to a firms next dollar of
earnings
Capital gains tax- under existing tax laws, use ordinary income tax rates for
capital gains taxes
Demonstrating Translation Exposure (wont be on exam)

Translation exposure is a purely accounting concept

It measures the potential change in a consolidated financial statement


from a change in exchange rates
Key measure is the difference between exposed assets and exposed liabilities
- Exp assets: those whose $ value will change if ER changes
- Exp liabilities: those whose $ value will change if ER changes
- $ values of non-exposed assets do not change if ER changes
Assume a US Firm has a UK subsidiary and that ER initially $2.00/, but then
changes to $1.50/ (pound depreciates)
- Under Current Rate method, all assets and liab translated at new (current)
ER of $1.50/
- Equity accounts translated at old ER of $2.00/
In our example, US parent company suffered $5,000,000 translation loss
- $ value assets declined by $7.5 mm ($30 mm - $22.5 mm)
- $ value liab declined by only $2.5 mn ($30 mm-$27.5 mm)
- $ value of equity accounts remain unchanged; translated at historical ER
Translation loss accounted for in a Cumulative Translation Adjustment
equity account
- Debit (loss) balance increased by translation losses, reduced by
translation gains
- Not actually realized (run through income statement) unless subsidiary
sold or closed down.

CHAPTER 3: PRESENT VALUE


Time Value of Money

Time value of money- It is the concept that the value of money changes
over time (time * interest rate)
Dollar today vs. dollar tomorrow? Why?
- Dollar received today is more valuable than a dollar received tomorrow
Why? Interest (Discount) Rate
- Discount rate finds future value
Simple Vs. Compound Interest

Simple Vs. Compound Interest


Example:
- Principal - $100
- Interest Rate 5%
- Frequency of interest payments annually
Simple interest paid only on the initial principal
- Year 1: 100 + 100*.05 = $105
- Year 2: 100 + 5 + 100*.05 = $110
Compound interest paid on both the principal and on the interest earned
in previous periods
- Principal- the amount of money on which interest is paid
- Year 1: 100 + 100*.05 = $105

Year 2: 100 + 5 + 105*.05 = $110.25, which can also be expressed as


100*(1+.05)^2

Future Value
Future value: the value of a lump sum or stream or cash payments at a
future point in time
Future value depends on interest rate, number of periods, and
compounding interval
Rule of 72 how long does it take money to double- quick way to find how
long it takes money to double
Future value has to be greater than present value for any positive integer

Compounding: the process of earning interest on interest in each successive


year
- The higher the interest rate, the higher the future value, the higher the
compounding values (the higher the interest rate, the lower the present
value)

The interest rate went up 8% causing there to be a higher future value


Important observations:
- The higher the interest rate, the higher the future value
- The longer the period of time, the higher the future value (upward slope)
- Future value grows faster at higher interest rates
Power of compound interest

Present Value

Present value: the value today of a cash flow to be received at a specific


date in the future, assuming an opportunity to earn interest at a specified
rate

Works in reverse of future value and focuses on the discount

Discounting- the process of calculating present values


If interest rates go up, the present value goes down

Important observations:
- The higher the discount rate, the lower the present value
- The longer the period of time, the lower the present value (downward
slope)
- Present value declines faster at higher discount rates
Higher discount rates penalize future cash flow

Annuities

Future value of cash flow streams


- Mixed stream: a series of unequal cash flows reflecting no particular
pattern
- Annuities: a stream of equal periodic cash flows

Future values & present value of cash flow streams


- There are two types of annuities:
1) Ordinary annuity- payments occur at the end of each period
2) Annuity due- payments occur at the beginning of each period
- For any positive interest rate, FV of annuity due is higher than FV of an
ordinary annuity (PV will always be lower) unless otherwise
specified, if I use the term annuity Im referring to an ordinary
annuity

Future Value of Ordinary Annuity:

Calculator: N = 5, I/Y = 5.5, PMT = -1000, PV = 0 FV =


5,581.09
Present Value of Ordinary Annuity:
o

Where: PMT = Annuitys Annual Payment; n = No. of Payment Periods,


r = interest rate
Present Value of an Ordinary Annuity (Example)- suppose that you
offered an annuity investment that will pay you $1000 at the end of
each year for the next five years. If the current interest rate is 5.5%,
how much would you be willing to pay for this annuity In this case,
we need to solve for the present value of the annuity, since that is the
price you would be willing to pay today.

Calculator: N = 5, I/Y = 5.5, PMT = 1000, FV = 0 PV = -4,270.28


(so you would be willing to pay $4,270.28 for the annuity investment

A Simple Annuity Example: your friend wants to save $2000 at the end of
each year for the next three years (hoping to end up with $6000) so that

she/he can buy a car. Since you are a finance expert, you know the amount
will be different from $6000 in three years time. Assuming an annual interest
rate of 5.5%, how much does your friend end up after three years?
- Solution: PMT = $2,000, N = 3 years, r = 5.5%

- What other approach could we have taken to calculate the PV?


Future value of a mixed stream example
- You won $10,000 in a lottery, but the only condition is that you cannot use
this money for the next five years. You have two options
1) Deposit in a savings account
2) Invest in an investment account that pays $3000; $3000; $4000;
$3000 and $2000 at the end of each year for the next five years.
- What would you do? The interest rate is 4%.

Present value of a Mixed Stream (Example)

Trickstar Inc., now comes up with a new plan! Now they announce that
they will pay $3000; $3000; $40000; $3000; and $2000 at the end of each
year for the next five years of you pay $12,000 up front
Again, you are suspicious of their offer and want to check that out
Assuming the interest rate to be a constant 4%, determine if their offer is
profitable for an investor.

Present Value of a Perpetuity


- For a constant stream of cash flows that continues forever

Present Value of a Growing Perpetuity

Compounding more Frequently than Annually


- M compounding periods

Continuous compounding

- The more frequent the compound period, the larger the FV!
Compounding more Frequently than Annually

Stated Versus Effective Annual Interest Rates


- Stated annual rate- the contractual amount rate of interest charged by
a lender or promised by a borrower
- Effective annual rate- the annual rate of interest actually paid or
earned, reflecting impact of compounding frequency

Annual percentage rate (APR)- the stated annual rate calculated by


multiplying the periodic rate by the number of periods in one year
Annual percentage yield (APY)- the annual rate of interest actually
paid or earned, reflecting the impact of compounding frequency. The same
as the effective annual rate.

Special Applications
Additional applications of Time Value
- Deposits needed to accumulate a future sum
o Often need to find annual deposit needed to accumulate a fixed
sum of money in n years
o Closely related to the process of finding the future value of an
ordinary annuity
o Find annual deposit
- Loan amortization
- Implied interest or growth rates
- Number of compounding periods
Deposits needed to accumulate a future sum
- Often need to find annual deposit needed to accumulate a fixed sum of
money in n years
- Closely related to the process of finding the future value of an ordinary
annuity
- Find annual deposit needed to accumulate FVn dollars, at interest rate, r,
over n years, by solving this equations for PMT:

Calculating Deposits Needed to Accumulate a Future Sum


- You wish to accumulate $35,000 in five years to make a home down
payment. Can invest at 4% annual interest.
- Find annual deposit required to accumulate FVn ($35,000), at r = 4%, and
n = 5 years

Calculating Amortized Loan Payments Amounts


- Very common TV application: finding loan payment amounts
- Amortized loans are loans repaid in equal periodic (annual, monthly)
payments
- Borrow $6000 for 4 years at 10%. Find annual payment. Divide PV by
PVFA4.10% = 3.17
A loan amortization table

The Time Value of Money


- Much of finance involves finding future and present values
- The time value of money is central to all financial valuation techniques

Das könnte Ihnen auch gefallen