FINC 301 FINAL
Funds than cannot be remitted are called __________
"Blocked"
All are often used interchangeably:
"The Riskless Rate" "The Pure Time Value of Money" "The US Treasury Bill Rate"
To convert the pre-tax cost to an after-tax basis, we multiply the pre-tax cost by...
(1 - Tax Rate)
Ethical and Legal Constraints around Float:
- "Controlled" vs "Remote" Disbursement - Check "Kiting" - Writing NSF checks - Some banks charge for uncollected funds
Letter of Credit
- ("LC" or "LoC") is a written commitment by a bank that it will make payment, on behalf of its customer ("applicant"), to a third party ("beneficiary"), provided that the terms and conditions stated in the letter of credit have been met, as evidenced by the presentation of specified documents. - Letters of credit are governed by The Uniform Customs and Practice for Documentary Credits (UCP), which is a set of rules issued by the International Chamber of Commerce.
Secured Overnight Financing Rate (SOFR)
- A benchmark base interest rate for loans and derivatives which are denominated in US dollars - Federal Reserve Market
Sole Proprietorship
- A business owned by one person Adv. / Disadv. + Uncomplicated + Retain all profits + Earnings taxed once as personal income + Direct decision- making -- Unlimited liability -- Limited lifespan equal to owner's -- Relatively difficult to raise capital -- Ownership difficult to transfer
Partnership
- A business owned by two or more persons - General partnership vs limited partnership - Importance of having a written partnership agreement - Importance of limited partners not becoming active in the business Adv. / Disadv. + Relatively uncomplicated + Share profits with partners + Earnings taxed once as a personal income -- Unlimited liability for general partners -- Limited lifespan equal to owners' -- Relatively difficult to raise capital -- Ownership difficult to transfer
Basel III
- A global. Voluntary regulatory framework on bank capital adequacy, stress testing, and market liquidity risk - Intended to increase bank liquidity and decrease bank leverage - Implementation became effective Jan 1, 2023
Sarbanes- Oxley Act of 2002 (or Sarbox)...
- A government legislative response to greed, abuses, and bad practices by corporate management - Was passed to improve corporate governance - Compliance with Sarbox is very costly, and, ironically, as led some companies to convert to private, from public, ownership.
Corporation
- A legal person, separate and distinct from its owners, with many of the rights, duties, and privileges of a human person - Articles of incorporation and by- laws - Corporations are established under State Law Adv. / Disadv. + Limited liability for owners + Unlimited lifespan of the corporation + Ease of transferring ownership + Ease of raising capital -- Relatively complicated to set up and maintain -- Earnings are taxed twice: when earned by corporation, and when received by owners
Beta Coefficient
- A number which indicates the systematic risk of a specific asset compared to the systematic risk of an average asset in an asset class - Asset with a Beta of 1.00 has exactly as much systematic risk as an average asset in that class - Asset with a Beta of 0.50 has half as much systematic risk as an average asset in that class - Asset with a Beta of 2.00 has twice as much systematic risk as an average asset in that class - Specific asset with a Beta > 1 will have more highly variable returns- both positive and negative- than an average assets with a Beta equal to one - Specific asset with a Beta < 1 will have less highly variable returns- both positive and negative- than an average assets with a Beta equal to one - Negative Betas are possible, and indicate that the investment moves in a direction opposite to the particular asset class - An asset with a Beta of zero has the same expected return as the risk-free rate
Fixed Principal Amount Loans
- A pre-set amount of principal is paid each period, along with varying amounts of interest - Ex. Corporate
Fixed Payment Amount Loans
- A pre-set total amount, consisting of varying amounts of principal and of interest, is paid each period - Ex. Retail: Mortgages, car loans, student loans, general consumer loans
Covenant
- A required action placed on the company by the bondholders, in order to protect their interests - Positive Covenants: -- Minimum working capital -- Financial reporting - Negative Covenants: -- Limitation on dividends -- Non-pledge of assets -- Limitation on mergers/ acquisition -- Limitation on other debt
Accounts Payable Turnover and Days' Cost of Goods Sold In Accounts Payable
- APT = Cost of Goods Sold/ Accounts Payable - DCGS- AP = 365/ Accounts Payable Turnover
Two basic investing approaches are:
- Active Investing: A strategy where decisions are made on buying/ selling specific assets in order to out-perform the market - Passive Investing: A strategy that seeks to replicate a market index or portfolio
Stakeholders
- Are non-stockholders who have an interest in the success of the firm, including customers, employees, suppliers, local communities, and government at all levels
Debentures
- Are unsecured bonds, with maturities of 10 years or more - Notes are unsecured bonds with maturities of 10 years or less
Balance Sheet Identity and Balance Sheet Analysis
- Assets = Liabilities + Stockholders' Equity - Three areas of focus in balance sheet analysis: 1. Liquidity 2. Long-term Debt vs. Equity 3. Market Value vs. Book Value
General Observations
- Assets are listed in increasing order by time it would normally take to convert them into cash - Current Assets: Have lives of less than one year - Current Liabilities: Have lives of less than one year - Net Working Capital: The difference between current assets and current liabilities -- NWC = Current Assets - Current Liabilities -- Change in NWC = Ending NWC - Beginning NWC - Long-term Debt: Consists of borrowed funds with a repayment period of greater than one year - Shareholders' Equity: The residual value of the firm to stockholders, after all liabilities have been paid - The Capital Structure: Consists of long-term debt and shareholders' equity
Calculating Breakeven EBIT and EPS:
- At the Breakeven Point, EPS and EBIT for the no-debt case equal EPS and EBIT for the debt case. We can find the break-even point by setting up the following equation: - EPS with no debt = EPS with debt - EBIT/ Shares no debt = (EBIT - Amount)/ Shares with Debt
The annual cost of this float can be calculated by applying the incremental borrowing/ investing rate for the firm:
- Average Daily Float * Annual Rate = Annual Cost - The higher the interest rates are, the more important cash management is to the firm
Average Tax Rate and Marginal Tax Rate
- Average Tax Rate is total taxes paid divided by total taxable income - Marginal Tax Rate is the amount of taxes payable on the next incremental dollar earned
"The Relationship"
- Because credit, priced by itself, does not give banks an adequate return on capital, banks are eager to obtain large amounts of non-credit business from corporations. This business could be cash management, investments, employee benefit programs, foreign exchange, etc. - Each credit renewal involves a frank discussion around what non-credit business the bank might obtain in order to "round out" the relationship, i.e., to attain its ROE and RAROC goals.
Long-term plans usually are run with three cases:
- Best case- optimistic - Normal case- most likely - Worst case- pessimistic
Capital Asset Pricing Model (CAPM)
- CAPM states that the expected return for a specific asset is dependent on three factors: 1. The pure time value of money (riskless rate) 2. The market risk premium for bearing the systematic risk of that asset class 3. The amount of risk in a specific asset which risk, as measured by Beta, is greater or less than that of its asset class - Expressed as an expected return: -- ER = Riskless Rate + [(Beta) * (Market Risk Premium)]
Calculation of Accounts Payable Period
- Calculate Accounts Payable Turnover -- Turnover = Cost of Goods Sold/ Accounts Payable -Calculate Accounts Payable- days- CGS -- AP-D-CGS = 365/ Turnover -Cash Cycle = Inventory Period + Accounts Receivable Period - Accounts Payable Period
Calculation of Accounts Receivable Period
- Calculate Accounts Receivable Turnovers -- Turnover = Net Sales/ Accounts Receivable - Calculate Accounts Receivable- days- sales -- AR-D-S = 365/ Turnover - Operating Cycle = Inventory Period + Accounts Receivable Period
Calculation of Inventory Period
- Calculate Inventory Turnover: -- Turnover = CGS/ Inventory - Calculate Inventory- days- CGS: -- I-D-CGS = 365/ Turnover
Break-even Points
- Calculation of break-even points is important for: -- Evaluation of projects and investments -- Management of product lines -- Overall enterprise management - Central to calculating the break-even point are costs, which fall into these categories: -- Fixed Costs: Costs which do not change when the quantity of output changes in a specified period of time -- Variable Costs: Costs which change when the quantity of output changes -- Total Costs: The sum of Fixed Costs and of Variable Costs
Sources of credit information:
- Company financial statements, usually with an NDA - Third- party credit providers, e.g., Dun & Bradstreet - Banks, although limited by confidentiality concerns - The customer's previous payment history
Common Stock Valuation
- Compared to the valuation of bonds, the valuation of common stock is more difficult because: -- The future cash flows are not known in advance -- There is no maturity; common stock has an infinite life -- There is no easy way to determine the rate of return that the market requires - Nevertheless, common stock can be valued by treating the stream of future dividends as a perpetuity, under a zero growth and a constant growth case
Basic Terms Bonds and Bond Valuation
- Coupon: The dollar amount of regular interest payments - Face Value or Par Value: The principal amount that will be repaid at the end of the term of the bond - Coupon Rate: The annual coupon divided by face value - Maturity: The date on which the principal will be repaid
Dividend Growth Model
- D1 is the dividend at the end of the first year, not the current dividend - The dividend growth model will not work: -- If g > R, there would be a negative number in the denominator and the price cannot be negative -- If g = R, there would be a zero in the denominator, which would make the result indeterminate
Debt vs Equity
- Debt carries no ownership interest or voting rights - Interest on debt is tax-deductible; dividends on equity are not - Debt is liability, and holders of the debt have claims against company assets, which claims could result in liquidation or reorganization
Total Return for stocks is calculated:
- Dividend Yield + Capital Gains Yield - (Dividend/ Initial Price) + (End Price - Initial Price)/ Initial Price - Calculated on an annualized basis
Dividend and Types of Dividends
- Dividend: Is a payment- either in cash or stock- by a corporation to its owners. - The payment of a dividend must be authorized by the Board of Directors - The types of dividends are: 1. Regular Cash Dividends: Paid quarterly in the normal course of business 2. Extra/ Special Dividends: One-time events 3. Liquidating Dividends: Sale of part or all the business
What We Know and Do Not Know About Dividend and Payout Policies:
- Dividends tend to be paid by smaller number of large mature companies - Corporate payout ratios seem to be relatively stable over time, with the proportion of cash dividends decreasing, and wit the proportion of share repurchases rising - Pros and Cons of Paying Dividends: Pros: 1. Cash dividends can underscore good results and provide support to stock price 2. Dividends may attract institutional investors 3. Stock price usually increases with announcement of new or increased dividend 4. Dividends absorb excess cash flows and reduce agency costs Cons: 1. Dividends are taxed to recipients 2. Dividends can reduce internal sources of financing 3. Once established, dividend cuts are hard to make w/o affecting stock price of firm
Market Value Ratios: Earnings per Share (EPS), Price-Earnings (PE) Ratio, and Market-to-Book Ratio
- Earnings per Share (EPS) = Net Income after Tax/ Total Shares Outstanding - Price- Earnings (PE) Ratio = Market Price per Share/ Book Value per Share - MtBR = Market Price per Share/ Book Value per Share
How does the market react to new information?
- Efficient Market Reaction: The price instantly adjusts to, and fully reflects, the new information - Delayed Reaction: The price partially adjusts to new information upon its release; it takes additional time for the price to fully reflect the new information - Over-reaction: The price over-adjusts to the new information, and subsequently corrects
Examples of sub-classes include:
- Equities -- International stocks -- Small-cap stocks - Debt -- International debt -- Municipal debt -- Syndicated bank loans -- Distressed debt
Indenture
- Every bond issue has an indenture, which is written agreement between the corporate issuer and the bondholders. - The bondholders are represented by a trustee (usually a bank), which is a party to the indenture, which spells out all the terms of the bond, including: 1. Par Value, coupon, etc. 2. Repayment arrangements 3. Security 4. Call Provisions 5. Covenants
The DuPont Identity
- Expresses Return on Equity (ROE) as the product of three components: 1. Profit Margin, or NIAT/ Sales 2. Asset Turnover, or Sales/ Total Assets 3. Leverage, or Total Assets/ Equity - The identity formalizes the common sense understanding that return on equity depends on the combination of operating efficiency, asset use efficiency, and financial leverage. - ROE= Profit Margin * Asset Turnover * Leverage - ROE= (NIAT/ Sales)(Sales/ Total Assets)(Total Assets/ Equity) - ROE= NIAT/ Total Shareholders Equity
Future Value of Annuity
- FV of Annuity can be calculated in two ways: 1. Compounding forward on period at a time 2. Compounding each cash flows separately - FV = C * Annuity Future Value Factor
Factors driving such purchases include:
- Faced with excess cash, and a shortage of attractive investment opportunities whose NPV is positive, the best "investment" that management can make may be the company's own stock, assuming good future growth prospects - Stock repurchases cause EPS to rise, increasing the stock price- and, in many cases, management bonuses tied to stock price appreciation
Two Types of Underwritings
- Firm Commitment: Underwriter(s) buy(s) the entire issue and bear(s) the risk of resale. Fees for "firm commitments" are higher than fees for "best efforts." - Best Efforts: Underwriter(s) does not guarantee any amount of money to the issuer, but promises to use its "best efforts" to sell as much as it can.
Stages of Venture Capital
- First Stage: Build proto-type, do marketing plan. etc. - Second Stage or Mezzanine: Begin operations, hire staff, etc.
Constant Growth Case
- For many companies, steady dividend growth is a stated goal - This is effectively a growing perpetuity, which can be calculated as follows, where P0 is the current price per share, D0 is the most recent dividend, R is the required return, and g is the dividend growth rate - P0 = (D0 (1+g)) / (R-g) = D1/ (R-g) - This equation is called The Dividend Growth Model
To drive a higher stock price. Research has shown that, all else equal, companies which pay higher dividends have higher stock prices.
- For some of the largest inventors- pension funds, endowment funds, etc.- who are tax-exempt. The tax factor is irrelevant. Simply, the higher the dividend, the more demand for the stock - Investors' desire for current income - Investors' desire for the certainty of a current income stream versus a future capital gains event - Corporate stockholders receive a 70% exclusion from income for preferred and common dividends
Valuing Stocks with PE Multiples
- For stocks without dividends, the most common valuation approach is the use of price/ earnings (PE) multiples - These multiples can be derived from: -- Company's historical averages -- Industry averages -- Estimated future multiples - The methodology is to apply the chosen multiple to present and/or to future earnings per share
Corporate Bonds
- Have seniority over equity, and over most other long-term debt, in liquidation - Usually have a call provision, the company has the right to repurchase the at a specified price prior to maturity - To compensate the bondholders, the company offers a call premium- an amount paid over the par value - A deferred call provision protects the bondholder from the bond being called for a set period of time, the first 10 years
In the stock market, there is the significant risk of a major change in value. Hence, the greater the potential return, the greater the risk
- High risk corresponds to high reward - Low risk corresponds to low reward
Stockholders
- Hire managers (agents) to run the corporation and to maximize the wealth of the principals
Static Theory of Capital Structure
- If a firm borrows too little, then it is not reaping the benefits of the interest tax shield. - If the firm borrows too much, then it is increasing the probability of bankruptcy costs and liquidation - So, the optimal capital structure lies between these two extremes - A firm borrows ip to the point where the tax benefit from an extra dollar of debt is exactly equal to the cost that comes from the increased probability of financial distress/failure
Rights
- If pre-emptive rights are included in an corporation's articles of incorporation, then the company must offer any new issue of common stock first to existing shareholders, before offering it to the public - Under a rights offering, each shareholder is given the right to buy a specified number of new shares from the company, at a specified price, by a specified date - An underwriter is not needed for a rights offering - Rights offerings are fairly rare in the US, but more common in other countries
What is the current value of funds rate (for borrowing of for investing) for obtaining the $980?
- If the current value of funds rate is less than 37.2%, then the buyer should take the discount. - If the current value of funds rate is more than 37.2%, then the buyer should not take the discount.
Premium Bond
- If the interest rates had decreased, the price of the bond would have increased. - It would sell for more than, or at a premium, par value
Strategies for using Beta
- In a rising market: Buy stock with a Beta > 1.00 in order to take advantage of their greater-than-average volatilities - In a falling market: Buy stocks with Betas < 1.00 in order to take advantage of their lesser-than-average volatilities
Standby Underwriting
- In a standby underwriting, an investment bank agrees to purchase any unsubscribed rights, so that the company is guaranteed to raise the needed amount - This arrangement protects the company if shareholders do not exercise the rights, or if the company's stock price falls below the subscription price
Take-aways Financial Leverage:
- In good times, financial leverage accelerate the increase in earnings per share - In bad times, financial leverage accelerates the decrease in earnings per share
Simple Interest
- Interest earned in the course of the investment is not reinvested, so that interest is earned only on the principal amount - SI = Principal * Rate * Time
Compound Interest
- Interest earned in the course of the investment is reinvested, so that interest is earned on the principal amount and on interest - The process is called compounding - Is one of the most powerful forces on earth
Pure Discount Loans
- Interest paid once, at maturity - Principal paid once, at maturity - Ex. Treasury bills, zero-coupon bonds - Treasury bills, with short-term maturities, are pure discount loans, they can be valued using the PV equation for a single payment
The Fisher Effect
- Investors want a nominal rate (the percentage change in the actual number of dollars received) that is the sum of the real rate plus to inflation rate - Nominal Rate = Real Rate + Inflation Rate
Selling Short
- Involves selling a stock that an investor does not own, but borrows from his/her broker, with the promise of returning the shares by a certain date - Until such date, all dividends, rights, etc. flow to the broker, not to the investor - Theoretically, this strategy carries unlimited risk of loss
Black Swan Events
- Is "an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences" - Are characterized by their extreme rarity, severe impact, and widespread insistence they were obvious in hindsight
Stock Dividends
- Is a dividend paid in stock -- Small stock dividend: less than 20-25% -- Large stock dividend: greater than 20-25% - Stock Dividends -- Increase the number of shares -- Decrease the price per share -- Do not change total market value, but do change equity account balances - No cash is involved in a stock dividend
Asset Classes
- Is a group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations - The three main categories are equities, debt, and cash-equivalents
Yield Curve
- Is a plot of the interest rates of bond (which have equal credit quality) against different maturity dates - An upward- sloping yield curve is considered "normal" - When the yield curve is horizontal, it is called "flat," and signals uncertainty about future rates - When the yield curve slopes downward, it is called "inverted," and indicates that lower interest rates are expected over the longer-term
Normal Distribution
- Is a symmetric, bell-shaped curve that is completely defined by its mean and its standard deviation - The following are the number of outcomes which are captured within the range of standard deviations: -- One standard deviation 68% -- Two standard deviation 95% -- Three standard deviation 99%
Perpetuities
- Is an annuity in which the cash flows continue forever - PV = C/r= Annual Cash Flow/ Rate
Average Accounting Return
- Is an investment's average net income divided by its average book value - Based on Average Accounting Return Method, a project is acceptable if its AAR exceeds an arbitrary target return - Does not factor in the time value of money - AAR = Average Net Income after Tax/ Average Book Value of Investment
Weighted Average Cost of Capital
- Is calculated in terms of an incremental, market-based financing rate, its main use is as a tool in evaluating capital investment projects - Often used as the discount rate in evaluating projects - If investments projects do not have rates of return at least equal the the WACC, then the projects should not be undertaken or else the firm would fail to satisfy its long-term debt investors and, especially its equity investors - Firms with high WACCs tend to have high Betas; firms with low WACCs tend to have low Betas - Firms with high proportions of equity in the capital structures have higher WACCs and higher Betas; firms with low proportions of equity in their capital structures have lower WACCs and lower Betas
Profitability Index
- Is computed by dividing the present value (not the net present value) of future cash flows by the initial investment - Greater than 1, then the project should be undertaken - Zero or less than 1, then the project should not be undertaken - Does consider the time value of money
Dividend Yield
- Is the annualized amount of the dividend per share, divided by the current stock price per share - Yield = Annual Dividend per Share/ Current Stock Price per Share
Prensent Value
- Is the current value of future cash flows discounted at the appropriate discount rate - PV is just the reverse of FV
Float
- Is the difference between book cash and back cash, representing the net effect of checks in the process of clearing through the banking system - The same float can have two different names, depending on one's perspective -- It is Collection Float to the recipient of the check, who is attempting to obtain available funds -- It is Disbursement Float to the issuer of the check, who creates the float in the first place
Yield to Maturity
- Is the interest rate required by the market for a similar bond
Break- even Number of Units
- Is the number of units which must be sold to attain break- even sales - Q = (Total Fixed Costs + Depreciation)/ (Selling Price per Unit - Variable Cost per Unit) - Where Q is the number of units sold at which breakeven sales will be attained
Dividend Payout Ratio
- Is the percent of total net income paid out in dividends - Payout Ratio= Total Annual Dividends Paid/ Total Annual NIAT
Market Capitalization
- Is the total market value of a company's outstanding stock. - It is calculated by multiplying he number of shares outstanding by the price per share.
Several different asset classes:
- Large company stocks - Small company stocks - Long-term corporate bonds - Long-term US Government bonds - Short-term US Treasury bills
An "average asset" is determined by using an asset class, such as....
- Market Portfolio: A broad stock market index such as the S&P 500. In most cases, this is the asset class that is used - Industry: All the stocks in a particular industry - Any other group
Internal Rate of Return (IRR)
- Method seeks to find the discount rate that sets all the cash flows- both the initial investment and all future incremental cash flows- from the project equal to zero - Does consider the time value of money
Short- comings of Financial Statements and Ratios
- Metrics vary by industry, and even within industry, e.g., power-generating companies - Many firms are conglomerates, with multiple different businesses - Peer firms may be scattered around world and may not use GAAP - Firms have different fiscal years - Extraordinary events
Some realities around Venture Capital:
- Most venture capital funds are organized as a limited partnership with a 10-20 year life, with the VC firm as the general partner, and with investors as limited partners - Bankers never plan to have a loan go bad; venture capitalists expect most (90%) of their investments to fail. - Venture capitalists can extract very favorable terms: -- Large percentage of the company's equity -- Representation on the board of directors -- Various restrictive covenants - Venture capitalists usually structure their investment as preferred stock: -- Senior status in bankruptcy -- Convertible into common stock before IPO -- Conversion price is set so that in liquidation all the money goes to the preferred shareholders (common equity worth zero)
Sources of Comparative Financial Statements
- NAICS: North American Industry Classification System - RMA: Risk Management Association
Two important Take-aways
- None of the systematic risk can be "diversified" away, i.e., diversification will not reduce or eliminate the systematic risk - If you build a large enough portfolio, you can diversify away virtually all the unsystematic risk, but you will be still be left with the systematic risk
Preferred Stock
- Normally, PS has no voting rights - Dividends -- Priority over common stock dividends -- May be deferred, but granting special rights may be granted if preferred dividends are not paid - Bond-like Features -- Stated Value per share -- Fixed dividend rate -- Credit ratings -- Convertible -- Callable
Reverse Stock Split
- Occurs when a company combines its existing shares into fewer shares -- A reverse stock split is stated as a ratio: 1-for-4, 2-for-3 - Reverse stock splits -- Decrease the number of shares -- Increase the price per share -- Do not change total market value or equity account balances - No cash is involved in a reverse stock split
Stock Split
- Occurs when a company divides its existing shares into a large number of shares -- A stock split is stated as a ration: 4-to-1, 5-to-4 - Stock Splits -- Increase the number of shares -- Decrease the price per share -- Do not change total market value or equity account balances - No cash is involved in a stock split
In order to return money to shareholders, companies may purchase their own stock, in one of four ways:
- Open Market Purchase: A company simply purchases its own shares in the market - Tender Offer: A company announces its offer to buy at a certain price, by a certain date, a certain number of shares tendered (offered) it by shareholders - Auction, usually a Dutch Auction - Direct negotiation, usually "greenmail"
The two greatest reasons for low dividend payouts are:
- Opportunity Cost: High growth companies generally have low or zero dividend payouts, because of the need to retain precious capital for growth. Theoretically, the firm should pay dividends only after all positive NPV projects have been undertaken - Restrictions: Dividends may be limited in dividend payments by bond covenants, bank credit agreements, etc. Some states restrict dividends if they would reduce retained earnings
Total Risk
- Or total volatility, is measured in terms of standard deviations - Total Risk = Systematic Risk + Unsystematic Risk
Present Value of Annuity
- PV of Annuity can be found in one of two ways: 1. Discounting back one period at a time 2. Discounting back each cash flow separately - PV = C * Annuity Present Value Factor
Some uses of Financial Statements and Ratios
- Performance Evaluation - Planning - Evaluation by creditors - Evaluation by investors - Evaluation of competitors - Acquisition Analysis
Financial Markets
- Primary Markets: Are for the original sale of securities by governments and corporation - Secondary Markets: Are for trading (buying and selling) already- issued securities
Profitability Ratios: Profit Margin, Return on Assets, and Return on Equity
- Profit Margin = Net Income after Tax/ Sales - Return on Assets = Net Income after Tax/ Total Assets - Return on Equity = Net Income after Tax/ Total Equity
Receivables Turnover and Days' Sales in Receivables
- RT = Sales/ Accounts Receivable - DSR = 365 days/ Receivables Turnover
Other examples of asset classes:
- Real Estate - Precious Metals - Foreign Currencies - Venture Capital - Commodities - Collectibles
Time Value of Money
- Refers to the fact that, all other things equal, a dollar today is worth more than a dollar promised at some time in the future - This is one of the key concepts of corporate finance
Income Statement Identity and Income Statement Analysis
- Revenue - Expenses = Income - Three areas of focus in income statement analysis: 1. GAAP 2. Non-cash Items 3. Time and Costs
Shelf Registration
- SEC Rule 415 permits a company to register at one time all of the issues that it expects to sell within the next two years. The company then chooses the time when it takes the issue to market - Available to investment grade companies - Offers the flexibility of being able to take an issue to market on an opportunistic basic, when conditions turn favorable
Commercial Draft
- Seller draws up a drat (much like a check) calling on the buyer to pay a certain amount on a certain date, the draft, along with shipping invoices, is sent to the buyer's bank - The optimal credit policy occurs at the point where marginal carrying costs (required return on receivables, losses from bad debts, costs of managing credit and collections) are equal to the marginal opportunity costs (lost sales and lost income)
Net Present Value
- Simply consists of calculating the present value of the expected cash flows from a project and netting the result against the initial capital outlay to find NPV - If NPV is positive, then the project should be undertaken - If NPV is negative, then the project should be rejected - NPV = Present Value of Future Inflows - Cost of the Investment - Is the only one which can always provide correct answers to two key questions: -- 1. Is a particular project a good investment? -- 2. If there are several good projects, which one should we undertake?
Cash Flow and Financial Statements
- Sources of Cash: Activities that generate cash - Uses of Cash: Activities that use cash - The Statement of Cash Flows is the third main financial statement- besides the balance sheet and the income statement- that corporation produce - Cash Flows are broker out into three areas: 1. Operating Activity 2. Investment Activity 3. Financing Activity
Some features of Common and Preferred Stocks
- Straight Voting: A shareholder may cash all of his/her votes for each member of the board of directors - Cumulative Voting: A shareholder may cast the grand total of his/her votes (above) for one member of the board of directors - Staggered terms for directors - Shareholder submission of proposals - Proxy Voting -- A proxy is a grant of authority by a shareholder, which grant allows another individual to vote his/her shares, either as directed, or as the designated individual- e.g., a brokerage firm, the secretary of the Board of Directors, a dissident shareholder or outsider- wishes -- A proxy fight occurs when dissident shareholders or outsiders try to unseat current management, via a hostile takeover, and each side solicits the votes of shareholders. -- If the shareholder did not want to vote in person, the he/she could vote their shares: - By telephone - On the internet - By mail - In the event of a proxy fight, the party attempting the hostile takeover would send its own proxy form to the shareholders, asking them to let the hostile party vote their shares
Some terms and some considerations around making a capital investment, or capital budgeting, decision:
- Sunk Costs: Costs that already have been incurred and that cannot be undone. Sunk costs should not be considered - Fixed Overhead Costs: These on-going costs should not be considered in evaluating the project - Project Costs: The actual costs of the project itself - Erosion: Existing cash flows because of the new project - Opportunity Cost: The most valuable opportunity for future cash flows that is lost because of the new project - New Working Capital: An increase in NWC can be "hidden" cost of a new project - Financing Costs: Interest, dividends, etc. should not be considered in evaluating the project
Tax Avoidance and Tax Evasion
- Tax Avoidance: The structuring of business in order to minimize legally the amount of taxes payable - Tax Evasion: The non-payment of taxes that legally are due and payable
Portfolio Beta
- The Beta of your portfolio will be the weighted average of the Betas of the securities in the portfolio
There are two main approaches to calculating the Cost of Common Stock:
- The Dividend Growth Model Approach - The Capital Asset Pricing Model Approach
Dutch Auction
- The Dutch Auction originated during The Dutch Tulip Bulb Mania of the 1630s - The underwriter does not set a price for the issue, but lets potential investors make competitive bids for the issue. The number of shares bid and the price bid by each bidder determine which bidders will receive shares, how many shares each budder will receive, and the proceeds which the company will receive. - This is the method used today by the U.S. Treasury to sell all its bills, notes, and bonds
Each of these returns consists of two components:
- The Riskless Rate: The pure time value of money - The Risk Premium: The required return, above the riskless rate, to compensate for risk
Terms of the Sale
- The Terms of Sale has three components: 1. The period for which credit is granted 2. The cash discount and the discount period 3. The type of credit instrument - Basic form of expressing terms of sale: - "2/10, net 30": This means that the customer may deduct 2% from the sales price if full payment is made within 10 days, or the customer may pay full amount in no more than 30 days
Earnings Management
- The acceleration and/or deferral of income from one period to the next. - Executives of publicly-traded corporations use earnings management to smooth out earnings, in order to avoid major fluctuations in the price of the company's stock.
What is the "agency problem"?
- The agency problem arises when there are conflict of interest between principals (shareholders) and agents (corporate management)
Payback Period
- The amount of time required for the project to generate cash flows sufficient to recover its initial cost- is less than a specified time frame - Based on the companies internal policies and guidelines, there is no one "correct" payback period - Evaluates smaller, shorter-term projects
The Capital Structure Question:
- The basic Capital Structure decision is this: How much debt, and how much equity, should a firm have in its long-term capital structure? -- The goal is to find the capital structure that maximizes the value of the firm. Stated another way, the value of the firm is maximized when the Weighted Average Cost of Capital is minimized
Long-term Transaction Risk
- The best way of dealing with long-term forex transaction risk is via a "natural hedge," where revenues and expenses, as well as assets and liabilities, are denominated in the foreign currency, so that the risks inherent in components of the income statement and the balance sheet cancel themselves out.
Cash Cycle or Cash Conversion Cycle
- The cash cycle is the period between the firm's payment for materials and its collection on its sales -- Cash Cycle = Inventory Period + Accounts Receivable Period - Accounts Payable Period
Annuity Due
- The cash flows occur at the beginning of the year - Rent payments and Leases payments - PV Annuity Due = (PV Ordinary Annuity) * (1+r)
Stated Interest Rate
- The interest rate expressed in terms of the actual interest payment made - Also known as the quoted interest rate
The Cost of Long-term Debt
- The market rate, or yield to maturity, of the debt- NOT the coupon rate - If the firm has no publicly- traded long-term debt, then the cost can be estimated as the yield to maturity on similarly- rated bonds of comparable companies - If there is no publicly- traded long-term debt, then one can use is the incremental borrowing cost
WACC should be calculating using:
- The market values of long-term debt and of equity (both preferred and common) - The after-tax cost of long-term debt
Information Content Effect
- The market's reaction to a change in dividends. - An increase in dividends generally results in an increase in the stock price - A decrease in dividends- especially an unanticipated one- generally results in a decrease in the stock price, since such a dividend cut often is viewed as a sign that the firm may be in trouble - Managers "smooth" dividends, raising them slowly and incrementally, and cutting them only when there is no other acceptable alternative
Zero Growth Case
- The present value of a perpetuity can be calculated as follows, where P is the price per share, D is the cash flow per share received every period, and R is the required return - P = D/ R
Exchange Rate Risk:
- The risk that changes in exchange rates will adversely affect the financial statements of a company - Specific Risks are: -- Short-term Transaction Risk -- Long-term Transaction Risk: -- Translation Risk 1. Enter into a forward contract for the delivery of Euro 1,000,000 in 60 days at what probably will be a premium to today's spot price. 2. Place them into an offshore Euro account
International Financial Reporting Standards (IFRS)
- The set of standard accounting principles which is gaining increasing acceptance globally. - The US SEC and Financial Accounting Standards Board (FASB) are working towards a convergence between IFRS and GAAP
Conclusions and Take-aways:
- The shorter the cash cycle, the less financing that a company requires - The goal of financial management is to minimize the cash cycle
Operating Cycle
- The time between the acquisition of inventory and the collection of cash from accounts receivable - Operating Cycle = Inventory Period + Accounts Receivable Period
Foreign Exchange (Forex)
- The trading of one current for another - An exchange rate is the value of one country's currency expressed in units of another country's currency
Rule of 72s
- There is a shortcut (sometimes) to quickly finding the discount rate or also called the Rate of Return - Dividing the time to double into the number 72 gives the approximate rate of return - Dividing 72 by the rate of return of 9% gives you the time to double of eight years - This rule is generally accurate for discount rates of from 5% to 20%
Promissory Note
- This is used mainly when the seller believes that there may be a problem with collection - The note is signed after delivery of the goods
The Credit Period
- This period is almost always between 30 and 120 days - The shorter the buyer's inventory period and operating cycle, the shorter the credit period should be
Interest Rate Risk
- This risk to bondholders from fluctuating interest rates - All other things equal, interest rate risk is greater: -- The longer the time to maturity -- The lower the coupon rate
Commercial Paper
- This vehicle allows companies to "dis-intermediate" by borrowing directly from investors - Characteristics: 1. Available generally to investment grade companies 2. Short-term, usually 30 days, but up to 270 days; longer than 27 days must be registered with SEC 3. Unsecured, but with backup lines of credit 4. Issued at a discount, reflecting current market rates 5. Minimum denominations of $100,000 6. May be used only for working capital purposes
Reasons for a reverse stock split include the following:
- To lower transaction costs to shareholders - To enhance marketability - To attain "respectability" - To list on a stock exchange, or avoid de-listing - To buy out small shareholders - To arrange for a different regulator
The reasons for a stock split include the following:
- To provide a larger "float," i.e., number of shares available for investors to purchase - To reduce the price per share to a level where it is more attractive for inventors to buy
Note that the ____________ in all four cases. However, the ____________ in all four cases
- Total market value does not change - Number of shares and the price per share do change
Ratio Analysis
- Turns financial data into financial information, and provides the basis for understanding and for decision-making - There are five main categories of financial ratios: 1. Liquidity, or short-term solvency 2. Turnover, or utilization 3. Leverage, or long-term solvency 4. Profitability 5. Market Value
Venture Capital and Venture Capital Companies
- Venture Capital: Money invested to finance a new, start-up firm - Venture Capital Companies: Enterprises which pool funds from various sources- individuals, insurance companies, pension funds, endowments, etc.- and who specialize in financing new, start-up companies
Amortizing Loans
-Can be fully or partially amortizing; and there are two broad types of amortizing loans: -- Fixed Principal Amount- Corporate -- Fixed Payment Amount- Retail: Mortgages, car loans, student loans, general consumer loans - Interest paid periodically - At least some principal paid periodically
Stages in the issuance of securities:
1. Approval by the company's board of directors 2. Registration Statement filed with the SEC , which statement discloses all material information concerning the company 3. Company issues Preliminary Prospectus, called a "Red Herring" 4. On the effective date of the registration, after SEC approval, underwriters price the issue 5. The company issues formal Prospectus, a legal document describing for potential investors details of the company and proposed offering 6. Underwriters publish a "Tombstone," an advertisement announcing the public offering
The uses of Break-even Analysis are many, including:
1. Before producing a product, management can determine whether it can sell enough units of the product to make a profit 2. Before producing a product, management can use break-even analysis in setting the price of the product 3. If a product or product line is losing money, then management can do a break-even analysis to discover whether continuation of the product is warranted 4. Applying break-even analysis to the entire enterprise can help management decide whether to shut down or to continue operations, e.g., gold mining, shale oil, etc. 5. Applying break-even analysis across the entire enterprise can help management during the process of restructuring, e.g., Deutsche Bank - Break-even Analysis is an important, and often-overlooked, tool for the financial manager
Statements about Corporate Income Taxes
1. Besides being subject to federal income taxes, corporations are subject to many other taxes, e.g., state and local income taxes, etc. 2. The US federal corporate income tax rate is 21% 3. The marginal tax rate is the relevant one for financial decision- making 4. The average tax rate varies from industry to industry 5. The marginal tax rate is the rate of tax on the next incremental dollar of income
There are several types of long-term debt:
1. Bonds- covered previously 2. Bank/ Institutional Term Loans - Bank Term Loans- Term Loan A -- 3-7 year term -- Amortizing - Institutional Term Loans- Term Loan B -- 5-10 year term -- Non- amortizing or small amortization 3. Long-term Private Placements
Corporate finance is the art and science of addressing three issues:
1. Capital Budgeting 2. Capital Structure 3. Working Capital Management
The Five "Cs" of Credit
1. Character 2. Capacity: Ability to meet obligations 3. Capital: Financial reserves 4. Collateral: Assets pledged as security 5. Conditions: General economic conditions
Two types of Letters of Credit:
1. Commercial: Used to facilitate actual trade transactions - Documentation required to draw under commercial letters of credit generally includes: -- A draft -- An invoice -- A packing list -- Bills of lading, evidencing shipment -- Supplier's certificate -- Any required gov documents 2. Standby: Contingently payable, if something happens, or fails to happen.Used to secure down payments, performance guarantees, etc. - Documentation required to draw under standby letters of credit generally includes: -- A draft -- A statement by the beneficiary that it is entitled to payment under specific contract or agreement
The price of a bond at any time in the market depends on the four preceding items....
1. Coupon 2. Face value 3. Coupon rate 4. Maturity but also on current market interest rates
Observations on issuance costs:
1. Economies of scale apply on larger issues 2. Cost of issuing equity is always greater than the cost of issuing debt 3. IPOs are more expensive that Secondary Equity Offerings (SEO) 4. Cost of straight bonds < cost of convertibles
The cost of equity is (almost) invariably higher than the cost of debt. Why?
1. Equity investors have a higher risk-reward calculus than debt investors; and 2. The tax-deductibility of interest (but not dividends); and 3. The higher costs of raising equity
So, now we can evaluate the choices facing the rights' holders:
1. Exercise all of the rights 2. Sell the rights 3. Do nothing, and let the rights expire
When given rights, shareholders may:
1. Exercise, and subscribe to, some or all shares= NO DILUTION 2. Sell some or all of the rights= DILUTION 3. Do nothing, and let the right expire= DILUTION - When rights are issued, shareholders always receive one right for every share of stock that they own - The amount of funds to be raised, number of rights required to buy one new share of stock, and the subscription price are arbitrarily decided by the company. For the rights to have value, the subscription price must be below the market price
The two most prominent methods of analysis for active investing are:
1. Fundamental Analysis: Also called "value investing"- focuses on finding an asset's intrinsic value by evaluating macroeconomic factors, microeconomic factors, and company-specific factors, including financial statement analysis, new products, quality of management, etc. 2. Technical Analysis: Also called "charting"- attempts to forecast the direction of prices solely through the study of past price movements and other data including trading volumes. - Technical analysis rests on the view that: 1. History always repeats itself, predictably 2. Prices move in trends 3. The market price factors in everything; fundamental analysis is irrelevant
Three Major Types of Loans:
1. Interest-Only Loans 2. Amortizing Loans 3. Pure Discount Loans
The Net Present Value Method is the only one which can always provide correct answers to two key questions:
1. Is a particular project a good investment? 2. If there are several good projects, which one should we undertake?
Components of Float:
1. Mail Float: Checks are in the postal system 2. Processing Float: The time from receipt by the company until the check is deposited 3. Availability Float: The time to clear a check through the banking system - For the firm, collection float represents an opportunity cost, while disbursement float represents an earnings opportunity
The challenge of the financial manager here is four-fold:
1. Providing the right amount of financing; 2. Providing the right mix of debt and equity; 3. Providing the right types of financial instruments; and 4. Preserving financial flexibility for future financings
Bonds may be issued in one of two forms:
1. Registered: Form of issuance where owners are recorded by a registrar who makes payments directly to owners of record 2. Bearer: Form of issuance made payable to "Bearer," with no record of owner's name. Drawback include difficult recovery if lost or stolen, and the inability of the company to communicate with bondholders
Reasons for Holding Cash
1. Speculative Motive: Holding cash to take advantage of unforeseen opportunities 2. Precautionary Motive: Holding cash as a financial reserve to ensure a margin of safety for unforeseen adversity 3. Transaction Motive: Holding cash for payments in the normal course of business 4. Liquidity Management: Broadly, concerned with the optimal amount of liquid assets that a firm should maintain 5. Cash Management: More narrowly, concerned with the systems and procedures for the collection, concentration, investment, and disbursement of cash in the course of business
Two types of Forex Trades:
1. Spot: An immediate transaction, settling in two business days 2. Forward: An agreement to exchange currencies at some point in the future Spot rate and forward rate are not equal - Forward rate would be higher or lower than spot rates, depending on a number of factor - The forward rate is the expected spot rate at a specific future point in time
There are two kinds of risk:
1. Systematic Risk: Risk that influences all assets across an asset class 2. Unsystematic Risk: Asset- specific risk - The amount of systematic risk and the amount of unsystematic risk vary from specific asset to specific asset
The Securities and Exchange Commission (SEC) administers the two key laws regulating securities:
1. The Securities Act of 1933 2. The Securities Exchange Act of 1934 - The first issuance of stock by a company is called its Initial Public Offering, or IPO
Reasons for Underpricing:
1. The belief that shares must be underpriced to attract investors 2. Underpricing is insurance that the underwriters will not be sued for an unsuccessful issue 3. As a way of guaranteeing a quick profit to institutional investors who provide the underwriters with their honest opinions on the value of the issue
The NPV and the IRR approaches will always lead to the same decision, provided that
1. The cash flows are conventional, i.e., the first cash flow (the initial investment) is negative and all the rest are positive 2. The projects are independent, i.e., the decision to accept/ reject one project does not affect the decision to accept/ reject another project
Stock repurchases increase shareholder value only if all of the following three conditions are met:
1. The company can fund all of its investment projects that are NPV- positive 2. The company can do the repurchase from cash, without borrowing 3. The company's stock price is substantially (30% or more) below its intrinsic value
The three components of WACC are:
1. The cost of long-term debt, and 2. The cost of preferred stock, and 3. The cost of common stock
Two important observations emerge from the historical record:
1. There is a reward for bearing risk 2. The greater the reward, the greater the risk
Stock prices tend to decline following the initial announcement of a new equity issue. Some possible reasons why:
1. What does management know that we don't? 2. A signal of too much debt or too little liquidity? 3. Equity issuance costs can be substantial
Capital Structure Questions for every CFO:
1. What is the right amount of financing? 2. What is the right mix of debt and equity? 3. What are the right types of financial instruments? 3. How does the current financing preserve financial flexibility?
The prices of bonds go ___ as interest rate go _____ and the prices of bonds go _____ as interest rates go ______
1. up 2. down 3. down 4. up
Financial projection models usually project required future external financing requirements as.....
A "balancing" or "plug" item.
Callable
A bond which can be repurchased by a company at a set price prior to the maturity of the bond
Multi Currency Credit Facility
A credit facility which may be drawn in various currencies, at the option of the borrower
Annuity
A stream of equal cash flows at regular intervals for a fixed period of time
Syndicated Bank Loans
A syndicated bank loan is a commercial loan provided by a group of lenders and structured, arranged, and administered by one or several commercial or investment banks known as "arrangers."
Underwriters
Are investment banks which act as intermediaries between the company and potential investors. Underwriters handle the method of issuance, preparation documents, legal requirements, pricing, and selling the securities. Several underwriters may work together in the form of a syndicate.
Blue Sky Laws
Are state regulations designed to protect investors against securities fraud by requiring sellers of new issues to register their offerings and to provide financial details. This allows investors to base their judgments on trustworthy data. The term originated in the early 1900s when Judge Kennesaw Mountain Landis, a U.S. Supreme Court justice, declared the need to protect investors from speculative ventures that had "as much value as a patch of blue sky."
Convertible Bond
At the option of the holder, the bond can be swapped for a certain number of shares of common stock
According to the 2022 Triennial Central Bank Survey by the BIS, ______________ in the global forex markets was $7,508,000,000,000
Average daily volume
Formula for the Value of a Bond
BV = PV of coupons + PV of par value BV = (C * PV Factor) + (FV * PV Factor)
The place where the interests of stockholders and of managers meet is the corporate....
Board of Directors
Current Ratio
CR = Current Assets/ Current Liabilities
Just-in-Time (JIT) Inventory Management
Called kanban in Japan, where it originated, JIT involves frequent inventory replenishments. The firm holds only enough inventory for immediate production needs. Suppliers are expected to ship inventory quickly on demand. This system is highly dependent on excellent communication and logistics; disruptions of either can have a very adverse impact on production. A major advantage of JIT is the reduction of inventory, and related working capital needs, on the balance sheet of the producer.
Debt is always....
Cheaper than equity, partly because lenders bear less risk and partly because of the tax advantage associated with debt
Calculating Collection Float:
Collection Float = Total Float in a Month/ Total Days
In a Chapter 11 proceeding, secured creditors have full recourse to their collateral. Unsecured creditors are paid according to the following waterfall:
Common Shareholders are at the bottom not the top 9. Common shareholders
Monitoring Receivables
Companies maintain an Aging Schedule which provides a summary of receivables outstanding, by their age
Identify all of the following costs which SHOULD and SHOULD NOT be considered when making a capital investment decision:
Consider: - Project costs - Erosion - Opportunity costs - Net Working Capital needs Do Not Consider: - Sunk Costs - Fixed Overhead Costs - Financing Costs
DONE WITH CHAPTERS 1-4
DONE WITH CHAPTERS 1-4
DONE WITH CHAPTERS 13 -17
DONE WITH CHAPTERS 13 -17
DONE WITH CHAPTERS 5-7
DONE WITH CHAPTERS 5-7
DONE WITH CHAPTERS 8-12, 12 SUPPLEMENTAL
DONE WITH CHAPTERS 8-12, 12 SUPPLEMENTAL
Identify all of the capital budgeting method(s) which does and does not include the time value of money:
Does: - Net Present Value - The Discounted Payback Period - The Internal Rate of Return - The Profitability Index - The Practice of Capital Budgeting Does NOT: - The Payback Period - The Average Accounting Return
The Capital Asset Pricing Model (CAPM) Approach
Expected Return = Riskless rate + [(Beta) * (Market Risk Premium)] - Expected return= Cost of common stock
TRUE or FALSE. The relevant tax rate for financial decision-making is the Average Tax Rate
FALSE
PV and FV Equation
FV: FV = PV(1+r)^t FV = PV * FACTOR PV: PV = FV/ (1+r)^t PV = FV * FACTOR - Given any three of the four elements- PV, FV, Discount Rate, and Time- we can calculate the fourth element - PV and FV are the inverse, or reciprocal, of each other
"Claw- backs"
For payments to credits or to insiders made while insolvent up to 90 days before filing bankruptcy
Financial statements are prepared using....
Generally Accepted Accounting Principles (GAAP)
Variability of Returns
How we identify and measure risk.
Lockboxes
In 1948, Continental Illinois National Bank in Chicago innovated a cash management technique called "lockbox," which is now widespread. With lockboxing, the customer mails the checks to a post office box—or boxes in multiple locations—set up by the bank. The boxes have unique ZIP codes, which further accelerate the mail times. The bank collects the mail several times each day, opens the envelopes, and deposits the checks. At the end of the day, the bank sends the company a record of the payments and remittance information. This arrangement saves significant amounts of mail, processing, and availability time.
Bond Ratings
In order to assist prospective bondholders in understanding the risk of a particular bond issue, companies ask independent rating agencies to rate the creditworthiness of the issuer, and the possibility of default. The three leading rating agencies are Standard & Poor's, Moody's, and Fitch. Bond ratings fall into two categories: Investment grade and speculative grade or "junk." A bond which devolves from investment grade to junk status is called a "fallen angel." Investment: Lowest BBB+ Investment Grade: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB- Speculative Grade: BB+, BB, BB- Lowest Credit Grade: BBB- Highest Grade Credit: BB+ Companies may be "split-rated." That is, one rating agency gives them a different rating than another rating agency. Even investment grade bonds can have volatile swings in price due to interest rate risk
Enterprise Value
Is equal to the market value of its equity plus the market value of its long-term debt, less cash. As the name states, this number is of particular interest to potential acquirers of the company.
Current Yield
Is its annual coupon divided by its current price
Future Value
Is the amount that an investment is worth after on or more periods
Ex-rights Date
Is the beginning of the period when a stock is sold without its recently- declared rights
Credit Scoring:
Is the process of quantifying the probability of default, based on statistical models with a wide variety of inputs. A credit "score" is assigned to the (prospective) customer.
Dilution
Is the relative loss of shareholders' value in terms of percentage of ownership, percentage of market value, percentage of book value, or percentage of EPS
Break- even Sales
Is the sales level that results in zero project net income
Non- Diversifiable Risk
Is the systematic risk and the remainder of the unsystematic risk
The only thing that can be said with certainty about any long-term financial forecast is that.....
It will be wrong
Long-term Debt-to-Capital Ratio
LTD to CR = Long-term Debt/ (Long-term Debt + Equity)
Major US Exchanges for stocks and bond are....
New York Stock Exchange and NASDAQ
Insolvency
Occurs when a company is unable to meet its financial obligations. At this point, a company has three options: Find a financial "angel," liquidate, or reorganize.
Pre-packaged Bankruptcy
Occurs when a company obtain approval in advance from a majority of its creditors of a plan of reorganization, and the files
Underpricing
Occurs when underwriter(s) set the offering price below fair market value. The proof of underpricing is outsized first-day-issue price jumps
Netting Systems
One technique that very large multinationals use is a complex intra-corporate "netting system." Once a month, and sometimes more often, all intra-company payables/receivables—many of which are in multiple currencies—are netted against each other, and only the net amounts are actually paid. From an accounting viewpoint, the invoices are settled, but, from a cash viewpoint, the company is able to save on foreign exchange transaction costs by paying only net amounts
Corporate Finance contributes to this goal by...
Optimizing decisions in the areas of capital budgeting, capital structure, and working capital management
Optimal Capital Structure
Or the Target Capital Structure, is that mix of long-term debt and of equity which results in the lowest possible Weighted Average Cost of Capital
The Cost of Preferred Stock
P = D/ R P= Price D= Dividend R= Rate - Solving this equation for Rate, or R, gives the cost of preferred stock
The Dividend Growth Model Approach
P0 = (D0*(1+g))/ (R-g) P0 = D1/ (R-g) P0= Current price per share D0= Current dividend D1= Value of next year dividend g= Growth rate R= Required return or cost of common stock
Most financial models project asset items, liability items, and income statement items as.....
Percentages of sales
Companies generally use___________ from one year (budgeting) to three-five years (long-term)
Planning Horizons
Forecasted numbers are referred to as....
Pro forma, Pro forma financial statements are projections
Subordinated Bond
Refers to a bond which has been placed in a lower level of the repayment cascade, junior to other debt which is senior
Bonds may be _____ by collateral, including pledge of assets (railroad cars, investments, etc.), mortgages on specific properties, blanket mortgages, etc. Most bonds are unsecured.
Secured
One important forecasting tool is _________, which.....
Sensitivity Analysis, consists of changing one variable to determine its impact on the outcome of the forecast
Discount Bond
So one year later, our bond is selling in the market less than, or at a discount to, par value
Principle of Diversification
Spreading investment funds across a number of individual assets will eliminate most of the unsystematic risk
The US Treasury Bill rate is viewed as a ________ for the riskless rate
Surrogate
Times Interest Earned Ratio
TIER = EBIT/ Interest
TRUE or FALSE. Due to various industry-specific deductions, allowances, and loopholes, the average tax rate varies widely by industry.
TRUE
TRUE or FALSE. Limited partners and corporate stockholders both have limited personal liability.
TRUE
TRUE or FALSE. Sole proprietors and general partners both have unlimited personal liability.
TRUE
TRUE or FALSE. The goal of a limited liability corporation (LLC) is to be taxed like a partnership, but to retain limited liability (like a corporation) for its owners.
TRUE
TRUE or FALSE. The key in financial forecasting is to be directionally correct.
TRUE
The two major venues for trading stock are....
The New York Stock Exchange, NASDAQ, and OTC Markets Group
The Cash Discount and Discount Period
The cash discount and the discount period should be set in incent the buyer to pay quickly, so as to reduce the amount that the seller must maintain in accounts receivable, and, hence, net working capital
The Goal of Financial Management
The goal of financial management is to maximize the current value per share of the existing stock of the corporation
Practical Implications
The higher the tax rate, the greater is the incentive to borrow The greater the volatility of its EBIT, the less that a firm should borrow Taking on debt increases the risk (and the cost) both of debt (by increasing the probability of bankruptcy) and of equity (by making earnings to equity investors more volatile) As to bankruptcy, firms heavy in tangible assets that can be sold without great loss will have an incentive to borrow more. Firms heavy with tangible assets that cannot be sold without great loss will gave a dis-incentie to borrow more Financial Flexibility- Maximizing the options open for the next financing- is extremely important
Annual Percentage Rate (APR)
The interest rate changed per period multiplied by the number of periods in a year
Common-sized Financial Statements
The line items are expressed as percentages of a total- total assets or total sales
Weighted Average Cost of Capital (WACC)
The minimum return that a company must earn in order to satisfy its long-term debt investors and its equity investors
Capital Structure
The mix of long-term debt and of equity (both preferred stock and common stock) financing
Discounted Cash Flow Valuation
The process of calculating the PV of a future cash flow to determine its value today
Diversification
The process of spreading investment funds across individual assets, thereby forming a portfolio
Discount Rate
The rate used to calculate the PV of future cash flows
Reorganization
The restructuring of a failing firm in order to attempt to continue operations as a going concern. It is covered under Chapter 11 of the U.S. Bankruptcy Code.
Arbitrage
The simultaneous purchase and sale of different currencies in order to profit from a market price disparity among their cross-rates
Liquidation
The termination of the firm as a going concern. It is covered under Chapter 7 of the U.S. Bankruptcy Code. It can be voluntary or involuntary.
Translation Exposure
There is no good mitigant for long-term translation exposure. Diversification across many countries would reduce the translation risk from any one of them.
Credit Instruments
These are various ways of evidencing trade credit
Open Account
This is the most common method, and has only the invoice as evidence
Discounted Payback
To overcome the payback period method's failure to account for the time value of money, one variation is used to discount cash flows to calculate the payback period
In the corporate finance organizational chart, what are the two main parts?
Treasury and Accounting
The two most important ways to evaluate financial ratios are.....
Trends over time and Comparison to the industry
In planning the optimal mix of debt and equity to meet future required financing needs, the financial manager should always think _____ financings ahead. This is so that the immediate financing does not in any way limit alternatives for subsequent financings. This "keeping your options open" is called _______________________
Two, Maintaining Financial Flexibility
How Venture Capitalists make money?
Venture Capitalists make their money when one of their portfolio companies goes public or is acquired by another firm
Only incremental _______ cash flows should be considered when evaluating a project
after- tax