FIN 3110 Chapter 1, FIN 3110 Chapter 2, FIN 3110 Chapter 3, FIN 3110 Chapter 4

Distributions

interest on debt or the dividends on stock

Securities

investors are issued these in return for use of their funds

LIBOR

-London InterBank Offered Rate -Interest rate at which banks in the Eurocurrency market lend to each other

Tax deduction

an amount subtracted from taxable income

Strategic planning

-Long range in nature -Overall direction of the firm -Anticipating significant new developments and changes

Capital markets

-Long-term securities (greater than one year) -Corporations enter to obtain long-term funds (debt or equity)

EBITDA margin

-(Earnings before interest, taxes, depreciation, and amortization)/Sales -NOT influenced by noncash expenses (depr. and amort.) which vary from firm to firm -Highly correlated with cash flow

Dividends tax

-70% exclusion from federal income taxes -Eliminates triple levels of taxation

Holding period return

-AKA holding period yield or realized/ex post rate of return = [(Ending price - Beginning price + Distributions received) / Beginning price] x 100% -To be useful, must be compared to other returns computed using equal time periods

EV-EBITDA multiple

-AKA just EBITDA multiple = Enterprise value/EBITDA -Takes into account entire capital structure of firm (debt and equity, earnings (cash flow)) -Overall worth of company per dollar of earnings (cash flow) available to all capital holders -Useful for when a firm is considering buying another and wants to determine how much to pay for it

Commercial banks

-Accept demand deposits and time deposits -Loan to individuals, businesses, and governments -Short-term loans (significant amounts quickly) -Term loans

What are financial managers supposed to do?

-Acquire funds => direct investment of funds into value-maximizing projects -Balance risk and timing of expected cash flow against magnitude of expected returns

Indirect method

-Adjusts NI to reconcile it to net cash flow from operating activities (from accrual to cash basis) -Converting NI requires adding back noncash expenses -Much more common -Only need I/S and B/S

3. Determine desired cash balance

-Amount company wants to have left on hand for upcoming month -May need to take out short-term financing to cover short-term cash falls

What are the three uses of pro forma financial statements?

-Amount of external financing needed -See impact that changes in operating plan will have -Set appropriate targets for compensation plans

Free cash flow

-Amount of money a company has that is not tied up in keeping it afloat -How much you can take out without messing up company

Graduated tax schedule

-As income increases, so does marginal tax rate -Add base tax -Be careful when calculating marginal and moving between tax brackets

Corporate governance

-Board of directors are mostly independent directors -Nomination committee must be independent too -Chairman should be split from CEO -All audit committee members should be independent -Must disclose code of ethics

Why is focusing on accounting-based measures of performance bad?

-Detracts from long-term performance of company because performance measures that are not based on cash flows are subject to short-term manipulation by managers -More likely to maximize shareholder wealth

Corporate finance sections

-Capital budgeting -Capital structuring -Working capital management

Treasurer responsibilities

-Cash and marketable securities management -Capital budgeting analysis -Financial planning -Credit analysis -Investor relations -Pension fund management

1. Estimate cash receipts

-Cash or credit? -How long to receive?

Financial planning models

-Computerized representations of some aspect of a firm's financial planning process -Classifications: deterministic or probabilistic and optimize

Advantages of objective of maximizing shareholder wealth?

-Considers timing and risk of benefits expected to be received from owning stock -Conceptually possible to determine whether a financial decision is consistent with the objective -Impersonal objective (can sell shares at best price for shareholder)

Stakeholders

-Constituent groups in a firm -Stockholder, bondholders, suppliers, customers, employees, community, creditors

Forward contract

-Contract between two individuals who are known to each other -Established for any future time period for any quantity -Transaction MUST occur -Contract filled by delivery of currency at expiration of contract

Options

-Contracts that give the option buyer the right, but not obligation, to either buy or sell a fixed amount of foreign currency at a fixed price in a fixed time window -Must pay to buy option -American vs. European

What factors affect the way PPE is shown on the balance sheet?

-Cost of asset when acquired -Length of time since acquisition -Depreciation policy -Extent to which fixed assets are leased rather than owned

Implications of taxes on capital structure

-Debt is tax advantages -Interest expense is deducted pre-tax -Dividends are paid after tax

Direct method

-Detailed transaction level data -Focus only on cash-based transactions -Much less common

Spread

-Difference between Ask Price and Bid Price -Dealers want Ask Price > Bid Price to make a profit

Over-the-counter security markets

-Do not have centralized places of business -Networks of security dealers connected by telephone and computer terminals that allow dealers to post prices -Small and relatively unknown companies (with exception of some large companies) -NASDAQ

Factors that affect % of sales forecasting method

-Economies of scale -Capacity added only in discrete or "lumpy" increments

Secondary claims

-Ex. bank savings account -Lends money to a corporation with a small chance that they will default on loan

Controller responsibilites

-Financial accounting -Cost accounting -Taxes -Data processing

Comparative/peer analysis

-Firm's performance based on one or more financial ratios, which are compared with financial ratios of competitive firms with an industry standard -Table form

Financial leverage management ratios

-Firms that rely on fixed charge financing (debt, preferred stock, leasing) are using leverage -Indicates risk exposure in meeting debt charges -More leverage = more risk BUT also = higher ROE -Types:debt, debt-to-equity, equity multiplier, times interest earned, fixed-charge coverage

Indirect quote

-Foreign currency price of one unit of the home currency -0.7692 euro/$ from US perspective

Why are cash flows better than net income?

-GAAP concepts of NI do not provide clear indication of performance of firm -Cash flows are unambiguous -Cash flows provide a clear measure of performance

Financial middlemen

-Get funds from saver in exchange for primary claim -Brokers (bring together buyers and sellers of securities) -Dealers (sell securities to investors out of inventory they carry) -Investment bankers (assist corporations in selling securities)

Financial intermediaries

-Get funds from saver in exchange for secondary claim and it keeps primary claim -Commercial banks, thrift institutions, investment companies, pension funds, insurance, finance -Facilitate the transfer of funds

Stock market indexes

-Give broad indication of how the stock market or a segment of it performed during a particular day -Most frequently quoted is Dow Jones Industrial Average (add prices of 30 stocks and divide by a number that reflects prior stock dividends and splits) -S&P 500 is broader

Dividend policy ratios

-Give insights regarding a firm's dividend strategies and its future growth prospects -Types: dividend payout, dividend yield

Six ratio groups

-Liquidity -Asset management -Financial leverage management -Profitability -Market-based -Dividend policy

Direct quote

-Home currency price of one unit of foreign currency -$1.30 per euro from US perspective

Profitability ratios

-How effectively a firm's management is generating profits on sales, total assets, and stockholders' investment -Types: gross profit margin, net profit margin, return on investment/asset, return on stockholders' equity

Asset management ratios

-How much a firm has invested in a particular type of asset relative to the revenue the asset is producing -Effective management of resources? -Types: A/R turnover, average collection period, inventory turnover, inventory period, fixed-asset turnover, total asset turnover

Financial analysis

-Identifies major strengths and weaknesses of a business enterprise -Used by people other than just financial managers

Implications of taxes on dividend policy

-If dividends are paid, they are taxed immediately as income to the shareholder -Some shareholders prefer retention and reinvestment and ultimately capital gains rather than immediate dividends (AKA reinvest funds)

Trend analysis

-Indicates a firm's performance OVER TIME and reveals whether its position is improving or deteriorating relative to other companies in the industry -Table or graph form

Term loans

-Initial maturities between 1 and 10 years -Repaid in installments over life of loan -Finance current assets, purchases of long term assets, repay debts, etc.

Primary financial market

-Investor purchases NEW securities -Companies receive assistance from underwriters

Secondary financial market

-Investor resells existing securities -Investors trade amongst themselves for liquidity (sell stock and cash in) -Organized exchanges like NY Stock Exchange, NASDAQ (over the counter)

Debt securities

-Investors who lend money -Expect periodic interest payments, as well as return of principal

How can a firm raise funds?

-Issuing financial securities (debt and equity) -Borrowing from lender -Generating cash flow internally

Financial analysis users

-Management -Credit managers -Investors -Managers

Market-based ratios

-Measure the market's (investors') assessment of the risk and performance of a firm -Types: price-to-earnings (P/E), market-to-book value (P/BV), price-to-sales (P/S), EV-EBITDA multiple

Liquidity ratios

-Measures of firm's ability to provide sufficient cash to conduct business over next few months -Types: current, quick, and cash -Useful to those considering lending money

Types of agency costs

-Minimize incentives for management to take actions contrary to shareholder interests -Monitor management's actions -Bonding expenditures to protect owners from managerial dishonesty -Opportunity cost of lost profits

How are financial markets classified?

-Money or capital and -Primary or secondary

DuPont equation

-More informational look at ROE ROE = Profit Margin x Asset Turnover x Equity Multiplier

Implications of taxes on capital budgeting

-Must deduct taxes from cash flows generated by projects to determine available funds for shareholders -Interest, which comes from debt financing, is tax deductible whereas equity is not -Depreciation is tax deductible

Investment companies

-Mutual funds, real estate investments trusts (REITs), business development companies (BDCs) -Pool funds of many investors and invest these funds in various types of assets

What factors are taken into consideration when determining the desired cash balance?

-Nature of business -Tax laws -Bank requirements

Efficient capital market

-New information is quickly reflected in security prices in an unbiased manner -How much we can trust that a security price represents its true value -Stocks prices reflect a present value estimate of the firm's expected cash flows, evaluated at an appropriate required rate of return -Investors should be unable to make abnormal returns

Strong-form efficiency

-No individual should be able to consistently earn above-normal profits (including insiders) -Security price fully reflects all info: historical, public and private (cannot find any useful info)

How can ratios be misleading?

-Only as reliable as the accounting data on which they are based -Firms that compile industry norms do not report info about dispersion of individual values around mean ratio -Valid comparative analysis depends on availability of data for appropriately defined industries -Historic record of performance and financial condition -Comparison of firm's ratio with industry norms may not always be what they seem

Listed security exchanges

-Operate at designated places of business and have requirements governing types of securities they can list and trade -NYSE

Sole proprietorship

-Owned by one person -Easy and cheap to start -Unlimited liability -Difficult to raise capital -Personally taxed income -Nontransferrable ownership (dissolved when owners dies)

Limited partnership

-Partners have limited liability but cannot participate in daily management of firm -At least ONE general partner, who can participate in daily management

Proportionate equity base

-Percentage of assets financed with equity funds -Low = debt ratio is high

Percentages of sales forecasting method

-Permits a company to forecast amount of financing it will need for a given increase in sales -Assumes present asset levels are optimal and most items on B/S (operating accounts) increase in proportion to sales increases

Managerial compensation

-Properly designed compensation contracts help align shareholder-management conflicts -Ex. stock options at exercise price

Shareholder wealth

-Present value of the expected future returns to the owners of the firm -Measured by market value of shareholders' common stock holdings

Exercise price

-Price at which an option holder can purchase or sell a company's stock -Can typically only be exercised after a certain period of time has elapsed

Semistrong-form efficiency

-Price reflects all historical and publicly available info -Would need private info to get abnormal return

Weak-form efficiency

-Price reflects all historical info -Would need public or private info to get abnormal return -Managers are LESS likely to benefit from timing market cycles to generate higher returns (b/c market may not react correctly)

Cash budgeting

-Projection of a company's cash receipts and disbursements over a future period of time -Estimates amount and timing of financing needs -Identify potential cash flow problems and solve them with short-term funds -One of the most important short-range financial forecasting tools -Control and coordination purposes -Can be monthly or weekly basis

Deterministic model

-Projects single number estimates of a financial variable(s) without specifying their probability of occurrence -Ex. budget simulator -Main advantage: perform sensitivity analyses quickly and easily

Probabilistic model

-Provide financial decision makers with more useful info than other models -Yield more general prob. distributions -Ex. 25% chance sales will be x, 50% chance sales will be y, 25% chance sales will be z

Insurance companies

-Receive periodic or lump-sum premium payments from individuals or organizations in exchange for agreeing to make certain future contractual payments -Premiums are reserves to pay future claims

Financial ratio

-Relationship that indicates something about a company's activities -Compare over time or in relation to other firms

Corporate securities

-Represent claims against the assets and future earnings of firm -Types: debt and equity

Sensitivity analysis

-Rerunning the model to determine the effect on the output variables of changes in the input variables -AKA what-if analysis

Corporation

-Separate legal entity -Many legal documents -Limited liability -Easy access to capital -Double taxation (corporation pays, then shareholders pay) -Permanency -Easily transferable

Money markets

-Short-term securities (one year or less) -Large corporations participate when they have more cash than needed (better than just sitting in bank)

Pro forma financial statements

-Show results of some ASSUMED event, rather than an ACTUAL event -Scenario analysis -Short-term forecasts = specific and more accurate -Long-term forecasts = general

Low current asset balance

-Risk increases because difficulty meeting current financial obligations -Prevents a firm from being able to respond to customers' needs in timely and profitable way

Thrift institutions

-Savings and loan associations, mutual savings banks, credit unions -Accept demand and time deposits -Home mortgages, consumer loans -Have recently been acquired by commercial banks and therefore, decreased role

Weakness/limitation of ratio analysis?

-Seasonal factors (use month to month instead) -Window dressing

Capital losses

-Sell asset for < than bought -Deductible only against capital gains

Capital gains

-Sell asset for > than bought -Taxed at same marginal tax rate as ordinary income

2. Estimate cash disbursements

-Some amounts will remain constant -Others will vary by purchasers and suppliers' terms

What must you keep in mind when using ratios?

-Some are meaningful for only certain industries -Warning signs -No magic numbers, need reasonable benchmarks -Different accounting methods can affect

Futures contract

-Standardized amount of an item at a standardized date -Use clearinghouse, parties do not have to know each other -Can buy offsetting position instead of fulfilling contract

Why is the profit maximization model not useful as a decision-making model for a financial firm?

-Static (lacks time dimension) -Different definitions of profit (should you maximize total profit, rate of profit, or earnings per share?) -Provides no direct way for managers to consider risk associated with decisions

Discriminant analysis

-Statistical technique that helps the analyst classify observations (firms) into two or more predetermined groups based on characteristics -Characteristics are typically financial ratios -Ex. Lower values of certain ratios = greater prob. of bankruptcy

Two types of planning

-Strategic planning -Operational planning (subset)

External environment

-Strategics forces (Porters) -Financial system

Special forms of corporations

-Subchapter S corporation (limited liability, owners pay personal taxes, < 100 shareholders) -Limited liability corporation (LLC, similar to S corp but fewer restrictions) -Limited liability partnership (LLP, all partners have limited liability)

What do the debt ratio, debt-to-equity ratio, and equity multiplier all have in common?

-Tell same thing, just measured in different ways -High value = high debt = high risk

Marginal tax rate

-The tax rate on the next dollar of taxable income (if company increases income by one dollar) -More important for financial decision-making because it looks at additions

Partnership

-Two or more co-owners -Legal document to establish rights of owners -Access to capital is greater but still small -Personally taxed income -Ownership transfer requires new agreement -General vs. limited

Mechanisms to reduce agency conflicts

1. Corporate governance (performance reviews, audits) 2. Managerial compensation (incentive systems) 3. Threat of takeovers (financial market)

Operational planning

-Where the firm wants to be at some future point in time -What resources are needed to get there -Two levels of short-term (12-18 months) and long-term (5 years)

Three factors that determine the market value of stock shares

1. Amount of future cash flows 2. Timing of future cash flows 3. Risk of future cash flows

Steps in cash budget preparation

1. Estimate cash receipts 2. Estimate cash disbursements (payments the firm must make) 3. Determine desired cash balance at beginning of each month

Projected increase in assets

= (A/S)(Change in S)

In finance, what are two of the most important agency relationships?

1. Stockholders and creditors 2. Stockholders (owners) and managers

Porter's five competitive forces

1. Threat of new entrants 2. Threat of substitutes 3. Bargaining power of buyers 4. Bargaining power of suppliers 5. Rivalry among competitors

Projected increase in liabilties

= (CL/S)(Change in S)

Formula for shareholder wealth

= # of shares outstanding x market price per share

Quick ratio

= (Current assets - Inventories)/Current liabilities -Recognized that a firm's inventories are often one of its least-liquid current assets -Shorter time frame since we are not worried about inventory -Adjust downward is slow-paying is a problem by subtracting Accounts Outstanding over 90 days from numerator

Fixed-charge coverage

= (EBIT + Lease payments)/Total fixed charges -Total fixed charges: Interest + Lease payments + Preferred dividends before tax + Before-tax sinking fund -Number of times a firm is able to cover total fixed charges (interest, preferred dividends, payments on long-term leases)

Net capital spending

= (Ending net fixed assets - Beginning net fixed assets) + Depreciation

Dividend yield ratio

= (Expected) Dividend per share/Stock price -How much return investors receive from dividends -High value = low future growth -Low value = high future growth

Gross profit margin ratio

= (Sales - COGS)/(Sales) -How much each dollar of sales is around after subtracting COGS -Relative profitability of a firm's sales after the cost of sales has been deducted -Reveals how effectively management is making decisions regarding pricing and control of production costs

Average collection period

= Acct. Receivable/(Annual credit sales/365) -Average number of days an account receivable remains outstanding

Net cash increase (decrease)

= Cash from operating + Cash from financing + Cash from investing

Cash ratio

= Cash/Current Liabilities -Ability to pay in much shorter time frame (days)

Inventory turnover ratio

= Cost of sales/Average inventory -Number of cycles of selling and restocking inventory -Must calculate Average Inventory but in finance we usually use Ending Inventory

A/R turnover ratio

= Credit sales/A/R -Number of cycles of customer buying on credit and then paying

Current ratio

= Current assets/Current liabilities -Time frame must be long enough to convert all current assets to cash -How much assets cover liabilities

Cash flow to shareholders

= Dividends paid - Net new equity raised -Can pay cash to shareholders in the form of more dividends or get more stock

Dividend payout ratio

= Dividends per share/Earnings per share -Percentage of a firm's earnings that are paid out as dividends to its common shareholders -High value = low investment opportunities (to grow company)

After-tax cash flow (ATCF)

= EAT + Noncash charges (depreciation, deferred taxes) -Available from current operations to make capital expenditures, pay dividends, repay debt -Does NOT consider additional cash tied up in net working capital

Dividends paid

= EAT - Change in R/E

Return on investment (ROI)

= EAT/Total assets = EAT/Sales x Sales/Total assets -Broken down further in order to see "margin" and "turnover"

Operating CF

= EBIT + Depreciation - Taxes

Times interest earned ratio

= EBIT / Interest -AKA interest coverage -How well a firm can pay interest expenses -Considered a stronger measure of long-term solvency because numbers come from income statement rather than balance sheet -High value = EBIT could drop and still not problem paying

Operating profit margin ratio

= EBIT/Sales -Profitability of operations before considering the effects of financing decisions

Net profit margin ratio

= Earnings after taxes (EAT)/Sales -How profitable a company's sales are after all expenses (taxes, interest, COGS) have been deducted

Return on stockholders' equity

= Earnings after taxes (EAT)/Stockholders' equity -Like ROA, just equity instead

Return on investment/assets ratio

= Earnings after taxes (EAT)/Total assets -For each dollar invested in assets, how much net profit

Change in net working capital

= Ending NWC(CA-CL) - Beginning NWC(CA-CL)

Net new equity raised

= Ending common stock - Beginning common stock

Net new borrowing

= Ending long term debt - Beginning long term debt

Total financing needed

= Forecasted asset increase - Forecasted current liability increase = (A/S)(change in S) - (CL*/S)(change in S) -Amount needed to pay for new assets -Some can be covered by income reinvested

Cash flow to creditors

= Interest paid - Net new borrowing -Amount firm could pay back to creditors (pay back principal)

Inventory period

= Inventory/(COGS/365) -Number of days inventory sits on shelf before sold

Market-to-book value (P/BV) ratio

= Market price per share/Book value per share -Higher the rate of return on common equity relative to return required by investors, higher P/BV ratio -Can be affected by accounting treatments that vary

Price-to-earnings (P/E) ratio

= Market price per share/Current earnings per share *Can use next year's projected earnings per share since investors are buying FUTURE earnings stream -How much the market (investors) is willing to pay per dollar of earnings of the firm

Price-to-sales (P/S) ratio

= Market price per share/Sales per share

Cash flow from assets

= Operating cash flow - Net capital spending - Change in net working capital -What firm has generated from operations and can distribute to investors/creditors -AKA free cash flow

DuPont analysis

= Profit margin x Asset turnover x Equity multiplier -Breaks down the ROI to pinpoint potential areas for improvement to enhance firm's ROI

Profit

= Revenue - Cost

Fixed-asset turnover ratio

= Sales / Net fixed assets -Indicates the extent to which a firm is using its existing PPE to generate sales -How many dollars of sales supported by one dollar of fixed assets -Usually < 1 -Due to varying methods in identical companies, only use this for trend analysis, not peer

Total asset turnover

= Sales / Total assets -How effectively a firm uses its total resources to generate sales -Like fixed asset turnover, just total assets instead -If low, firm may be overinvested

Book value per share*

= TOTAL common SE/Number of shares outstanding

Deferred tax

= Tax amount reported - Cash amount actually paid -Occur because of temporary differences in stated amounts of A and L -Can continue to defer payment as long as it continues to purchase sufficient amount of new fixed assets

Equity multiplier

= Total Assets/Total Equity

Debt-to-equity ratio

= Total Debt / Total Equity -Relates the amount of a firm's debt financing to the amount of equity financing

Debt ratio

= Total debt/Total assets -Proportion of a firm's total assets that is financed with creditors' funds *In this context, debt includes both short and long term liabilities

Additional financing needed

= Total financing needed - Increased retained earnings = TFN - (EAT - Dividends) -Amount leftover to pay for new assets after you use retained earnings (EXTERNAL) -Firm looks at financing policy to determine how to obtain this amount

EBIT

= Total sales - Total operating costs

Average tax rate

= Total taxes/Taxable income

Annualized forward premium or discount

= [(F - S₀)/S₀][12/n][100%]

Free cash flow equation

= [EBIT(1-T) + Depreciation and Amortization] - [Cap.Ex. + Change in NOWC] = [$ generated by operation] - [$ tied up in keeping operation going] -Positive = happy investors (can pay them or reinvest) -Negative = could mean spending more money than making OR could be a large capital expense that will benefit in future

Realized/ex post returns

ACTUAL returns based on previous years

How are financial middlemen compensated?

Bid-ask spread = Ask price - Spread price

Expected/ex ante returns

ESTIMATED returns for future years

How are financial intermediaries compensated?

Interest rate spread = Loan rate - Savings rate

Forms of covenants

Limitations on dividends, limitations of type of investments, poison put, limitations of issuance of new debt

Eurodollars

US dollars deposited in banks outside the US

Why do we have to add depreciation back?

annual depreciation expense recorded for an asset is an allocation of its original cost and does not represent a cash outlay

Cash flow

actual cash generated or paid by the firm

Currency risk

amount of home currency that you receive will change as exchange rates fluctuate

Scenario analysis

budgets that reflect pessimistic, realistic, and optimistic assumptions about coming year

How does US financial system help ensure best use of resources?

channels funds from savers to borrowers

Capital budgeting

choose which projects to invest in

Equity securities

common stock or preferred stock

Eurocurrency

currency deposited in a bank outside of the country of origin

Why does CL have a * by it?

current liabilities will vary depending on financial policy so only use OPERATING CL

Multinational corporation

direct investments in more than one country

If forward exchange rates increase with time, the currency they represent is selling at a what in the forward market?

discount (ex. US dollar will be worth more than Euro in the future so you will get less money in future)

Optimization models

determine values of financial decision variables that optimize some objective function (like profits or costs)

What accounts do NOT vary in proportion to sales?

financing accounts (ex. interest)

Proxy statements

firms are required to file these prior to annual shareholder meetings, detailing matters to be discussed and voted upon

General partnership

each partner has unlimited liability for business

Primary purpose of SEC

ensure full disclosure of security info so that investors, individuals, and institutions have credible and timely info on which to base their decisions

Financial assets

financial claim on real assets (ex. stocks, bonds, mortgages, etc.)

Why are cash flows important?

financial health of a firm depends on its ability to generate sufficient amounts of cash to pay its credits, employees, suppliers, and owners

Working capital management

funding day-to-day operations

American option

gives holder the right to buy or sell at any time prior to expiration

European option

gives holder the right to buy or sell only at expiration

What do market-to-book ratio, P/E, and P/S have in common?

high value = high expected growth OR = low risk (combo of both)

Book value

historic cost of company's assets

Capital structuring

how to fund the company

When will the current portion of long-term debt change?

if and only if it is part of financing policy

How do taxes affect leasing?

if the asset user is losing money or not subject to taxation, leasing is advantageous because the asset owner can reflect the tax benefits of ownership

Agency costs

incurred by shareholders to minimize agency problems

Agency problems

inefficiencies that arise because of agency relationships

Financial plan

lays out financial resources that are needed to achieve the operational (and financial) objectives of the firm

Strategic plan is determined by _____________ goals of firm but it also affects the ____________________ objectives of firm

long-term, operational

What is the limitation of traditional financial ratio analysis in predicting bankruptcy?

looks at only one ratio at a time and then relies on analyst's judgement

What does an operational plan consist of?

marketing plan, production plan, HR plan, and financial plan

Corporate finance objective

maximize shareholder wealth

The operational plan is not only a planning device but also a ___________________ device

monitoring

Loss carryback

net operating loss applied against taxable income in previous year (back 2 years)

Loss carryforward

net operating loss applied against taxable income in succeeding year (forward 20 years)

Finance companies

obtain funds by issuing their own debt securities through loans from commercial banks

Agency relationships

occur when one or more individuals (principals) hire another individual (agent) to perform a service on behalf of principals

Discrete/"lumpy" increments

once output reaches the capacity of an existing production facility, expansion requires building another one (increases in stepwise manner instead of proportionally)

What things do you need to construct an indirect statement of CF?

one I/S and two B/S

What does an operational plan begin with?

operational objectives (where the firm wants to be at the end of the period)

Call option

option to buy something

Put option

option to sell something

Forecasting methods

percentage of sales method*, cash budgets*, pro forma statement of cash flows*, computerized models, financial ratios

Real assets

physical or intellectual property

Pension funds

pools contributions of employees and invests the funds in various types of financial assets

Hybrid securities

preferred stock, convertible bonds, long-term leases

Bid price

price at which dealer is willing to buy a given security

Ask price

price at which dealer is willing to sell a given security

Market value

price at which the stock trades in the marketplace (ex. NY Stock Exchange)

Efficient market

quick to react

Forward rates

rate of exchange between two currencies being bought and sold for delivery at a FUTURE date

Economies of scale

relationships may not be strictly proportional

Spot rates

represent the rate of exchange for currencies being bought and sold for IMMEDIATE delivery

Alternative incentive compensation policies

restricted stock or performance stock

Primary claim

securities sold directly by the borrower and bought by the saver (lender)

Short-selling

selling a security you do not own ("borrowing" from another investor) and then replacing it by buying the security at a later date, hopefully at a lower price

High current asset balance

shareholder wealth sacrificed due the opportunity cost of funds

Common-size balance sheet

shows firm's assets, liabilities and SE as percentage of total assets

Common-size income statement

shows firm's income and expense items are percentage of net sales

Inefficient market

slow to react

Forms of business

sole proprietorship, partnership, corporation

Window dressing

something a firm does at critical times to temporarily enhance its image

With what type of earnings are companies more likely to pay out more dividends?

stable rather than volatile

Performance stock

stock grants based on company meeting specific performance targets

Restricted stock

stock that cannot be sold unless the manager is with the company for a stated period of time

Why add back deferred taxes?

subtracted as an expense in determining earnings but did not constitute cash payment

Enterprise value

sum of market value of common stock plus market value of debt

Discount rate

takes into account the returns available from alternative investment opportunities during a specific (future) time period

Financial forecasting

techniques that can determine the amount of additional financing that a firm will need in the future

Why are accounting earnings often misleading?

they do not reflect actual cash inflows and outflows of firm

How can you use common-size statements?

to compare companies of different sizes

Present value

value today of some future payment or stream of payments, evaluated at appropriate discount rate

Risk

variability of returns

Risk of future cash flows

want certainty *Greater the perceived risk, greater rate of return required by investors and managers

Amount of future cash flows

want higher amount of cash

Timing of future cash flows

want same amount of cash now

Degrees of market efficiency

weak-form, semistrong-form, strong-form