MMUGM

Meeting 1
Sources: Ch 1-3
 Chapter 1
Overview of FM
 Corporate finance provides the skills
managers need to:
◦ Identify and select the corporate strategies and
individual projects that add value to their firm.
◦ Forecast the funding requirements of their
company, and devise strategies for acquiring those
funds.

3
 Initial Public Offering (IPO) of Stock
◦ Raises cash
◦ Allows founders and pre-IPO investors to “harvest”
some of their wealth
 Subsequent issues of debt and equity

4
 Agency problem: managers may act in their
own interests and not on behalf of owners
(stockholders)
 Corporate governance is the set of rules
that control a company’s behavior towards
its directors, managers, employees,
shareholders, creditors, customers,
competitors, and community.
 Corporate governance can help control
agency problems.

5
 The primary objective should be shareholder
wealth maximization, which translates to
maximizing the fundamental stock price.
◦ Should firms behave ethically? YES!
◦ Do firms have any responsibilities to society at
large? YES! Shareholders are also members of
society.

6
 A market is a method of exchanging one
asset (usually cash) for another asset.
 Physical assets vs. financial assets
 Spot versus future markets
 Money versus capital markets
 Primary versus secondary markets

7
 Chapter 2
Financial Statements
 Balance Sheets
 Income Statements
 Cash Flow Statements

 What are they?

 Who are interested to know?
 Why are they important?
 FCF is the amount of cash available from
operations for distribution to all investors
(including stockholders and debtholders)
after making the necessary investments to
support operations.
 A company’s value depends on the amount of
FCF it can generate.

10
 Pay back principal on debt.
 Pay dividends.
 Buy back stock.
 Buy nonoperating assets (e.g., marketable
securities, investments in other companies,
etc.)

11
 Calculating Free Cash Flow in 5 Easy Steps
Step 1 Step 2

Earning before interest and taxes Operating current assets

X (1 − Tax rate) − Operating current liabilities

Net operating profit after taxes Net operating working capital

Step 3

Net operating working capital

+ Operating long-term assets

Total net operating capital

Step 5
Step 4

Net operating profit after taxes

Total net operating capital this year
− Net investment in operating capital − Total net operating capital last year

Net investment in operating capital

Free cash flow
12
 Operating current assets are the CA needed
to support operations.
◦ Op CA include: cash, inventory, receivables.
◦ Op CA exclude: short-term investments, because
these are not a part of operations.

13
 Operating current liabilities are the CL
resulting as a normal part of operations.
◦ Op CL include: accounts payable and accruals.
◦ Op CL exclude: notes payable, because this is a
source of financing, not a part of operations.

14
 Chapter 3
Analysis of
Financial Statements
 Ratios facilitate comparison of:
◦ One company over time
◦ One company versus other companies
 Ratios are used by:
◦ Lenders to determine creditworthiness
◦ Stockholders to estimate future cash flows and
risk
◦ Managers to identify areas of weakness and
strength

16
 Can the company meet its short-term
obligations using the resources it currently
has on hand?

 Current and Quick Ratios:

◦ CR = CA/CL
◦ QR = (CA-Inv)/CL

17
 How efficiently does the firm use its assets?

Sales
ITO = Inventories
Receivables
DSO = Average sales per day

FAT = Sales
Net fixed assets
TAT = Sales
Total assets
18
 Does the company have too much debt?
 Can the company’s earnings meet its debt
servicing requirements?

19
 Total liabilities
Debt ratio = Total assets

EBIT
TIE =
Int. expense

20
EBIT + Depr. & Amort. + Lease payments
Interest Lease
expense + pmt. + Loan pmt.

21
Net profit margin (PM):

PM = NI
Sales
Operating profit margin (OM):
EBIT
OM = Sales

22
Gross profit margin (GPM):
Sales − COGS
GPM = Sales

23
 EBIT
BEP =
Total assets

24
 NI
ROA =
Total assets

25
 NI
ROE =
Common Equity

26
EPS = NI
Shares out.

P/E = Price per share

EPS

27
 Com. equity
BVPS = Shares out.

Mkt. price per share

M/B = Book value per share

28
 Comparison with industry averages is difficult
if the firm operates many different divisions.
 Seasonal factors can distort ratios.
 Window dressing techniques can make
statements and ratios look better.
 Different accounting and operating practices
can distort comparisons.

29