Comm unit 17-18

Venture capital

Venture capital: is another source of equity capital. It is most often used by small and growing firms that aren't big enough to sell securities to the public. This type of financing is especially popular among high-tech companies that need large sums of money.

Volatility

Volatility: refers to the fluctuations in a security or index over time. Why are stock returns so volatile? The value of the stock of a company changes as the expectations of the future revenues and expenses of the company change.

Equity financing

- A firm obtains equity financing by selling new ownership shares (external financing), by retaining earnings (internal financing), or for small and growing, typically high-tech, companies, through venture capital (external financing). - Common stock: is a security that represents an ownership interest in a corporation - Common stockholders have voting rights. - Equity owners have a residual claim on income (dividends are paid only after paying interest and any scheduled principal) and no obligation to pay dividends. - The company is not required to repay equity, which has no maturity date. - Dividends are not tax-deductible and are paid from after-tax income. - Preferred stock: is another form of equity. Unlike common stock, preferred stock usually has a dividend amount that is set at the time the stock is issued. These dividends must be paid before the company can pay any dividends to common stockholders.

Debt financing

- The major advantage of debt financing is the deductibility of interest expense for income tax purposes, which lowers its overall cost. In addition, there is no loss of ownership. The major drawback is financial risk: the chance that the firm will be unable to make scheduled interest and principal payments. - Creditors typically have none, unless the borrower defaults on payments. Creditors may be able to place restraints on management in event of default. - Debt holders rank ahead of equity holders. Payment of interest and principal is a contractual obligation of the firm. - Debt has a stated maturity and requires repayment of principal by a specified date. - Interest is a tax-deductible expense. - Term loan: is a business loan with a maturity of more than one year. Term loans generally have maturities of 5 to 12 years and can be unsecured or secured. - Bonds: are long-term debt obligations (liabilities) of corporations and governments. A bond certificate is issued as proof of the obligation. - Interest: The issuer of a bond must pay the buyer a fixed amount of money - Coupon rate: the amount of annual interest paid by the bond issuer; is multiplied by the face value of a bond to determine annual interest or coupon payment amounts. - Principal: The issuer must also pay the bondholder the amount borrowed— or par value—at the bond's maturity date (due date). - Mortgage loan: a long-term loan made against real estate as collateral. The lender takes a mortgage on the property, which lets the lender seize the property, sell it, and use the proceeds to pay off the loan if the borrower fails to make the scheduled payments.

Accounting vs Finance

Accounting - Communicate financial position - Prepare - Past, results - Rules, accuracy Finance - Determine how and where to add value - Analyze - Future projections - Analysis, insights

Accounts payable vs. Accounts receivable

Accounts payable: to pay money owed to others as late as possible without damaging the firm's credit reputation, and to minimize the funds tied up in inventory. Accounts receivable: represent sales for which the firm has not yet been paid. Because the product has been sold but cash has not yet been received, an account receivable amounts to a use of funds. to collect money owed to the firm as quickly as possible.

Capital budgeting and capital expenditures

Capital budgeting: analyze long-term projects and select those that offer the best returns while maximizing the firm's value. Decisions involving new products or the acquisition of another business are especially important. Capital expenditures: A firm also invests funds in physical assets such as land, buildings, machinery, equipment, and information systems.Unlike operating expenses, which produce benefits within a year, the benefits from capital expenditures extend beyond one year.

How (in what ways) does money flow into and out of a firm

Cash flows: the inflows and outflows of cash Financial management: the art and science of managing a firm's money so that it can meet its goals—is not just the responsibility of the finance department. All business decisions have financial consequences. Owners investment, Cash sales, Borrowed funds, Purchase of fixed assets, Collection of accounts receivable, Payment of dividends, Payment of expenses, Purchase of inventory

Areas of Finance

Corporate Finance, Investments, Financial Markets and Institutions

Risk and return: Types of risks

Default risk: on a financial security is the chance that the issuer will fail to make the required payment. For example, a homeowner may fail to make a monthly mortgage payment, or a corporation may default on required semiannual interest payments on a bond. Inflation risk occurs when investors have less purchasing power from the realized cash flows from an investment due to rising prices or inflation. Diversifiable risk: also known as unsystematic risk, occurs when investors hold individual securities or smallish portfolios and bear the risk that a larger, more well-rounded portfolio could eliminate. In these situations, investors carry additional risk or uncertainty without additional compensation. Non-diversifiable risk: or systematic risk, is what remains after portfolio diversification has eliminated unnecessary diversifiable risk. Political risk: associated with macroeconomic issues beyond the control of a company or its managers. This is the risk of local, state, or national governments "changing the rules" and disrupting firm cash flows. Political risk: could come about due to zoning changes, product liability decisions, taxation, or even nationalization of a firm or industry.

Diversification

Diversification: Holding a variety of assets in a portfolio, in order to manage risk. It is akin to the saying "Don't put all of your eggs in one basket"

Dividends/retained earnings

Dividends: are payments to stockholders from a corporation's profits. Dividends can be paid in cash or in stock. Stock dividends: are payments in the form of more stock. Stock dividends may replace or supplement cash dividends. After a stock dividend has been paid, more shares have a claim on the same company, so the value of each share often declines. Retained earnings: profits that have been reinvested in the firm, have a big advantage over other sources of equity capital: They do not incur underwriting costs. Financial managers strive to balance dividends and retained earnings to maximize the value of the firm.

Key activities of finance: planning, investment, financing

Financial planning: Preparing the financial plan, which projects revenues, expenditures, and financing needs over a given period. Investment (spending money): Investing the firm's funds in projects and securities that provide high returns in relation to their risks. Financing (raising money): Obtaining funding for the firm's operations and investments and seeking the best balance between debt (borrowed funds) and equity (funds raised through the sale of ownership in the business).

SEC and SEC requirements for companies

Founded during GreatDepression Mission: Protect investors Maintain fair, orderly, efficient markets Facilitate access to the markets for entrepreneurs and companies Public companies are required to file with the SEC: Annual reports (Form 10-K) Quarterly reports (Form 10-Q) Current reports (Form 8-K):"major events that shareholders should know about

Class example: Funko

Funko Pop toys were once a sought after collectible in the U.S., but a sharp plunge in their value has the company sending the figurines to the trash heap. Demand for the toys has tumbled so much that parent company Funko said it plans to "eliminate" between $30 million and $36 million worth of the vinyl figurines. Funko said it will trash its overstock of collectibles during the first half of this year. "We're not a toy company, we're a pop culture company"

Time value of money

Future Value: How much will an amount today be worth in the future? FV= PV( 1+r )^n Present Value: How much is a future amount worth today? PV= FV[ 1/( 1+r )^n]

Time value of money

Future value (FV): we can invest our money in interest-bearing accounts and investments, its value can grow over time as interest income accrues or returns are realized on our investments. refers to how a specific amount of money today can have greater value tomorrow. Present value (PV): The current value of a future amount, calculated by discounting the future value back at a known discount or interest rate for a specified period of time. Compound interest: is the term we use to refer to interest income earned in subsequent periods that is based on interest income earned in prior periods. To put it simply, compound interest refers to interest that is earned on interest. Year 1: $1,000 × 0.04 = $40 Year 2: $1,040 × 0.04 = $41.60 FV = PV × (1 + r)n FV = Future value PV = Present value r = Interest rate n = number of periods *An important concept to remember is that compounding is the process that takes a present valuation of money to some point in the future, while discounting takes a future value of money and equates it to present dollar value terms.*

IPO (Initial Public Offering)

IPO (Initial Public Offering): A company's first sale of stock to the public

Diversification

Reduce risk through allocation of assets Equity, debt, cash Size/industry of companies Domestic vs. foreign companies Can buy index funds that match or track popular indices Both mutual funds and ETFs

Risk

Risk: "the degree of uncertainty and/or potential financial loss inherent in an investment decision. In general, as investment risks rise, investors seek higher returns to compensate themselves for taking such risks"

S&P 500

S&P 500 Index 500 large companies Market-capitalization weighted(total value of outstanding shares)

Managing inventory

Inventory: In a typical manufacturing firm, inventory is nearly 20 percent of total assets. The cost of inventory includes not only its purchase price, but also ordering, handling, storage, interest, and insurance costs.

Mutual Funds and ETFs

Mutual Funds: Purchased at end of trading based on calculated price ETFs: Trade like a stock (can be purchased anytime during trading hours)

Class example's: Sam's

Sam's Sporting Goods sells sporting equipment and uniforms to players on local recreational and school teams. Customers have been inquiring about customizing items such as baseball caps and equipment bags with logos and other designs. Sam's is considering purchasing an embroidery machine so that it can provide these customized items in-house. The machine will cost $16,000. Purchasing the embroidery machine would be an investment in a fixed asset. If it purchases the machine, Sam's will be able to charge customers for customization. Imagine that another, more expensive embroidery machine maybe available that is able to make more stitches per minute.Although the initial cost of this heavy-duty machine is higher, it would allow Sam's to embroider and sell more items each year, generating more revenue. The two embroidery machines are mutually exclusive projects. Mutually exclusive projects compete with one another; purchasing one embroidery machine excludes Sam's from purchasing the other embroidery machine. The heavy-duty machine costs $25,000, but it will generate more cash inflows in years 3 through 6

Short-term expenses vs long-term expenses

Short term: are outlays used to support current production and selling activities. They typically result in current assets, which include cash and any other assets (accounts receivable and inventory) that can be converted to cash within a year. Cash management: making sure that enough cash is on hand to pay bills as they come due and to meet unexpected expenses.

Capital budgeting and net present value

Should a firm make a certain investment? Aggregate the cash flows to determine whether the cash inflows are greater than the cash outflows (positive return) Future cash flows that occur at different times or over a period of time have different present values These cash flows have to be "discounted" to the present time Aggregating these discounted cash flows tells us the NET PRESENT VALUE Process requires assumptions (e.g., returns, interest rates) Net Present Value: NPV > 0: The PV of the inflows is greater than the PV of the outflows. The money earned on the investment is worth more today than the costs, therefore, it is a good investment. NPV = 0: The PV of the inflows is equal to the PV of the outflows.There is no difference in value between the value of the money earned and the money invested. NPV < 0: The PV of the inflows is less than the PV of the outflows. The money earned on the investment is worth less today than the costs, therefore, it is a bad investment. Net present value: considering the expected inflows AND outflows, how much is an investment worth today?Allows firms to compare investments with different costs, expected returns, and time frames NPV=PV(Cash Inflows) − PV(Cash Outflows)

Warren Buffets bet

The bet was this: Over a 10-year period commencing January 1, 2008, and endingDecember 31, 2017, the S&P 500 would out perform a portfolio of five hedge funds of funds, when performance was measured on a basis net of fees, costs and expenses. Buffett, who chose the Vanguard IndexFund as a proxy for the S&P 500, won by a landslide. The five fund of funds had an average return of only 36.3% net of fees over that ten-year period, while the S&P index fund had a return of 125.8%. Standard & Poor's has been tracking the record of active managers for more than 20 years. Their mid-year 2022 report indicates that when adjusted for fees and for funds dropping out due to poor performance, after five years 84% of large cap actively managed fund managers underperform their benchmark, and after 10 years 90% underperform. But it's very likely you don't have Buffett's expertise -- or billions in cash to back you up. In that case, diversification is a must. If you can't absorb catastrophic losses, take steps to prevent them.

Key sections of annual report

The primary method of communication with external users is the annual report Some of the key components: Management discussion and analysis (MD&A) External auditor's report Financial statements Footnotes to the financial statements

Liquidity and managing cash flows

To grow and prosper, a firm must keep investing money in its operations. The financial manager decides how best to use the firm's money. Short-term expenses support the firm's day-to-day activities. For instance, athletic-apparel maker Nike regularly spends money to buy such raw materials as leather and fabric and to pay employee salaries. Long-term expenses, also referred to as capital expenditures, are typically for fixed assets. For Nike, these would include outlays to build a new factory, buy automated manufacturing equipment, or acquire a small manufacturer of sports apparel.

GAAP (Generally Accepted Accounting Principles)

US-based public companies must report information using GAAP (Generally Accepted Accounting Principles)

Risk-Return trade off

return: the opportunity for profit risk: the potential for loss, or the chance that an investment will not achieve the expected level of return. risk-return trade off: A basic principle in finance is that the higher the risk, the greater the return that is required