Finance 320 Exam 1

Sarbanes-Oxley Act (SOX)

-2002 -Improve accuracy of information given to both boards and to shareholders -Overhauling incentives and independence in the auditing process -Stiffening penalties for providing false information -Forcing companies to validate their internal financial control processes

Double Taxation Problem

-A corporation's profits are subject to taxation separate from its owners' tax obligations -Shareholders of a corporation pay taxes twice 1) The corporation pays tax on its profits 2) When the remaining profits are distributed to the shareholders, the shareholders pay their own personal income tax on this income

Perpetuity

-A stream of identical cash flows occurring forever

Limited Partnerships (LP)

-Allow partners to have limited liability as well as limited input with management decisions. There must be at least one general partner who makes business decisions and is personally liable for business debts Advantages: -Limited partners have limited liability protections -Shared financial commitment -Complementary Skills -Partnership incentives -Limited partners' ownership share is transferable Disadvantages: -More complex than general partnerships -Shared profits -Limited partners have no management authority -Disagreements among partners -Limited Life

Balance Sheet

-Also known as the "Statement of Financial Position" -Lists the firm's assets and liabilities -Provides a snapshot of the firm's financial position at a given point in time

Balance Sheet Identity

-Assets represent the resources owned by the firm -Liabilities and Stockholders' Equity show how assets are financed -The two sides of the balance sheet must balance Assets = Liabilities + Stockholder's Equity

General Partnerships (GP)

-Assume that profits, liability, and management duties are divided equally among partners Advantages: -Easy and inexpensive to start -Shared financial commitment -Complementary Skills -Partnership Incentives Disadvantages: -No limited liability protection -Shared profits -Disagreements among partners -Limited Life -Difficult to transfer ownership

Foreign Exchange Market

-Be cautious about these -High level of leverage but extremely dangerous to try to trade without knowing what you are doing with that much leverage -Basically tracks the movement in exchange rates and you try to profit out of it

Time Value of Money is Important

-Because when you look at finance, you can see the benefits and costs -Costs come at the beginning and benefits might come in the future -Have to express everything in terms of the same unit in order to compare benefit and cost -Exponential growth is better than linear growth

Derivative Securities

-Derivative means it drives its value from some underlying asset -Lose sight of things at some point and cannot assess the risk that you are taking properly -Derivatives are financial weapons of mass destruction but it is a big part of the financial market

Bid-Ask Spread

-Difference between bid price and ask price (considered transaction cost) -The measure of transaction cost

Time Value of Money

-Dollar today is worth more than a dollar in the future -In finance, we look at market values and cash flows, more than book values and net income

Bond Market

-Each firm might have different firms -Government might have bonds -Cities can borrow money -Bigger market and stock but does not get much exposure

Ownership of a Corporation

-Entire ownership stake of a corporation is divided into shares known as stock -Collection of all the outstanding shares of a corporation is known as the equity of the corporation -Owner of a share of stock in corporations is known as a shareholder, stockholder, or equity holder -Shareholders are entitled to dividend payments

Financial Insitutions

-Entities that provide financial services such as taking deposits, managing investments, brokering financial transactions, or making loans

Annuity

-Fixed cash flows that occur for a fixed number of periods

Discounting

-How much less your money today is worth in the future

Asset Turnover

-If the number is too low, the firm has a lot of assets and not producing enough sales

Positive NWC

-If you have positive nwc, your funds are tied up in receivables, inventories, and prepaid items -the goal is to keep just enough NWC to ensure the smooth operation of business

Growing Perpetuity

-Infinite stream of fixed payments growing at a constant rate of "g"

Compounding

-Invest today and find out how much it is worth in the future

Long Term Liabilities

-Long-term debt -a loan or a debt maturing in more than a year

Commodities Market

-Market for commodities ex: Life stock pork bellies, sugar, oil, metals

Market Value of Equity (MVE)

-Market price per share x number of shares -Does not depend on historical cost of assets -Also called market capitalization

C Corporations

-Most corporations are C Corporations Must pay corporate taxes on its profits -Since individuals must pay personal income taxes on these dividends, shareholders in a C corporation effectively must pay taxes twice

Book Value of Equity (BVE)

-Net worth from an accounting perspective -True value of assets may be different from book value -Assets - Liabilities = Equity

NASDAQ

-Network of security dealers connected; over the counter stock market -Has more new or high technology firms

Negative NWC

-Networking capital: the capital available in the short term to run the business -NWC < 0 means trouble generally -In some cases NWC<0 may mean the firm is running efficiently

Listing Standards

-Outlines of the requirements a company must meet to be traded on the exchange -The NYSE's listing standards are more strict than those of NASDAQ

Goal of the Financial Manager

-Overriding goal is to maximize the wealth of the stockholders

Stockholder's Equity

-Represents the shareholder's investment 1) Preferred stock 2) Common Stock 3) Treasury stock: stock that was once outstanding and has been re-purchased by the company 4) Retained earnings: cumulative total of all the net income over the life of the firm, less common stock dividends that have been paid out over the year

Enterprise value (EV)

-Represents the value of underlying business assets, unburdened by debt and separate from cash and marketable securities 0Enterprise value of a firm shows how much it would cost to acquire that firm -Cost-to-buy = You pay an amount equal to MVE to purchase the equity plus you assume that firm's net debt

Secondary Markets

-Shares sold after the first time

Limited Liability Partnership (LLP)

-Similar to Limited Partnership (LP) but it has no general partners. All of the owners of an LLP have limited personal liability for business debts

Sole Proprietorships

-Simplest and most commonly chosen to start a business -Unincorporated business owned and run by one individual with no distinction between the business and you, the owner -Entitled to all profits and responsible for all business's debts, losses, and liabilities Limitations: -One owner -Unlimited liability -Limited Life -Difficult to transfer owneship -Jim Horror Story

Partnerships

-Single business where two or more people share ownership

The Financial Manager's Place in the Coporation

-Stockholders own the corporation but rely on the financial managers to actively manage the corporation -Board of directors and the management team headed by the CEO posses direct control of the corporation

Liquidity and Efficiency Ratios

-Want these to be slightly >1 and not too big -Measures if the firm has enough assets to current liabilities

Market-to-Book Ratio

-Want this ratio to be high

Accounts Receivable Days (Accounts Receivable Turnover Ratio)

-Want this ratio to be low; if it is too low the investor may not like it (customer); if it is too high, you are not getting your money fast now

Inventory Days

-Want this to be high; it means you are building and selling rapidly

Agency Problem

-When managers put their own self-interest ahead of the interests of those shareholders

Private Corporation

-has a limited number of owners and there is no organized market for its shares

Public Coporation

-has many owners and its shares trade on an organized market called a stock market

Four Financial Statements are required by the SEC:

1) Balance Sheet 2) Income Statement 3) Statement of Cash Flows 4) The Statement of Stockholder's Equity -These must be prepared in accordance with US GAAP

Types of Financial institutions

1) Banks and Credit Unions 2) Insurance Companies 3) Pension Funds 4) Hedge Funds 5) Venture Capital Funds 6) Private Equity Funds

Role of Financial Insitutions

1) Move funds from savers to borrowers 2) Move funds through time 3) Help spread out risk-bearing

Financial Cycle

1) People invest and save their money 2) Through loans and stock, that money flows to companies who use it to fund growth through new products, generating profits and wages 3) The money then flows back to the savers and investors

Current Liabilities

Accounts Payable -the amounts owed to suppliers purchases made on credit Notes Payable -Loans that must be repaid in the next year -Repayment of long-term debt that will occur within the next year Accrual Items -Items such as salary or taxes that are owed but have not yet been paid and deferred or unearned revenue *Increase = Source of Cash *Decrease = Use of Cash

Long term assets

Assets that produce benefits for more than one year Reduced through a yearly deduction called depreciation according to a schedule that depends on an asset's life -Depreciation is not an actual expense, but a way of recognizing that fixed assets wear out and become less valuable as they get older -Book value of an asset is its acquisition cost - accumulated depreciation -Others include property not used in business operations, start-up costs in connection with a new business, trademarks and patents, and property held for sale

The Financial Functions within a Coporation

Board of directors CEO - CFO - COO Controller Treasurer Accounting Capital Budgeting Tax Department Risk Management Credit Management

Current Assets

Cash and other marketable securities -short term, low risk investments -easily sold and converted to cash Accounts Receivable -amounts owed to the firm by customers who have purchased on credit Inventories -raw materials, work-in-progress, and finished goods Other current assets -include items such as prepaid expenses *Increase in current assets = use of cash *Decrease in current assets = source of cash

Chapter 1

Corporate Finance and the Financial Manager

When figuring out present value

Excel and Calculator put (-) sign if it is a cash outflow (+) sign if it is a cash inflow -When you raise something to a power, you are introducing it to exponential growth

Limited Liability Companies

Hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership -No general partner -All owners have limited liability, but they can also run the business -LLCs are not taxed as a separate business entity. Instead, all profits and losses are "passed through" the business to each member of the LLC. -LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would

Chapter 2

Introduction to Financial Statement Analysis

Corporations

Legally defined, artificial being, separate from its owners -It is a "Legal Person" -Can enter into contracts, acquire assets, incur obligations, and it enjoys protection under the U.S. Constitution against the seizure of its property; can even contribute to political campaigns without any limits -Owners (shareholders) dictate direction and policies of the corporation -Shareholder's liability is restricted to the amount of investment in company -Life of corporation does not depend on the status of its owners. Ownership can be easily transferred Advantages: -Limited Liability -Unlimited Life -Separation of ownership and management -Transfer of ownership is easy -Easier to raise capital -No Limit on the number of owners Disadvantages: -Double taxation _Greater regulation -Separation of ownership and management (Agency Problem) -No secrecy of information -Costlier to set up

The Income Statement

Lists the firm's revenues and expenses over a period of time -Sometimes called the profit and loss statement or "P&L" -The last or bottom line of the income statement shows net income -a measure of its profitability during the period -also referred to as the firm's earnings

Why study finance?

Make more informed personal finance 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 Make more informed business decisions: -Should your firm launch a new product? -Which supplier should your firm choose? -Should your firm produce a part or outsource production? -Should your firm issue new stock or borrow money instead? -How can you raise money for your start-up firm

Worldwide Stock Markets Ranked by Volume of Trade

NASDAQ, NSYE Euronext (US), Shanghair Stock Exchange, Tokyo STock Exchange, London Stock Exchange, etc.

Firm's Disclosure of Financial Information

Public companies must file financial results with the Securities and Exchange Commission (SEC) -On a quarterly basis (10-Q) -On an annual basis (10-K) -Annual report with financial statements must be sent to their shareholders every year

Banks and Credit Unions

Source of Money: Deposits (savings) Use of Money: Loans to people and businesses

Hedge Funds

Source of Money: Investment by wealthy individuals and endowments Use of Money: Invest in any kind of investment in an attempt to maximize returns

Private Equity Funds

Source of Money: Investment by wealthy individuals and endowments Use of Money: Purchase whole companies by using a small amount of equity and borrowing the rest

Mutual Funds

Source of Money: People's investments (savings) Use of Money: Buys stocks, bonds, and other financial instruments on behalf of its investors

Insurance Companies

Source of Money: Premiums and investment earnings Use of Money: Invests mostly in bonds and some stocks, using the investment income to pay claims

Pension Funds

Source of Money: Retirement savings contributed through the workplace Use of Money: Similar to mutual funds, except with the purpose of providing retirement income

Venture Capital Funds

Source of Money:Investments by wealthy individuals and endowments Use of Money: Invets in start-up, entrepeneurial firms

Financial Management

The financial manager plays a critical role inside any business enterprise. Potential decisions include: -What products to launch -How to pay to develop these products -What profits to keep and how to return profits to investors -The financial manager does all of this with the goal of maximizing the value of the firm

S Corporations

The firm's profits/losses are not subject to corporate taxes -Instead profits and losses are allocated directly to shareholders based on their ownership share -Shareholders must include these profits are income on their individual tax returns, even if no money is distributed to them

Primary Markets

The first time shares are sold it is sold in the primary market -When securities are sold, the transactions are set to take place in the primary market

Financial Manager

Three main tasks: 1) Make investment decisions* -Must weigh the costs and benefits of each investment or project -Must decide which investments or projects qualify as good uses of the stockholders' money -Should decline bad investments and accept investments that will create the best return for shareholders 2) Make financing decisions -Must decide whether to raise more money from new and existing owners by selling more shares of stock or to borrow the money instead -Borrowing has interest expense (makes firm fragile) -Selling more stock, you cannot go bankrupt, but you can just dilute your share price and create a huge amount of dilution with the share price by shrinking it 3) Manage cash flow from operating activities (Managing short-term cash needs) -Must ensure that the firm has enough cash on hand to meet its obligations at each point in time (managing working capital)

Chapter 3

Time Value of Money

Accounting Standards

US: General Accepted Accounting Principles (GAAP) -Set by the Financial Accounting Standards Board (FASB) to provide a common set of rules and a standard format for public companies' reports International Financial Reporting Standards (IFRS) -Since 2005, all publicly traded European Union companies are required to follow IFRS -Accepted by all major stock exchanges around the world except US and Japan *Convergence to IFRS in the US is likely in the near future

CEO's Performance

When the stock performs poorly: -The board of directors might react by replacing the CEO or -A corporate raider may initiate a hostile takeover

Statement of Cash Flows

uses the information from the income statement and balance sheet to determine: -how much cash the firm has generated -how that cash has been allocated during a set period -Cash is important because it is needed to pay bills and maintain operations and is the source of any return of investment for investors -Tells you where cash comes from and how it is spent, how you generate cash and what you do with it -Net income is not the same as cash flow *Increase in working capital = use of cash 1) Operating Activities 2) Investment Activities 3) Financing Activities