* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Download What is Finance?
Survey
Document related concepts
Private equity secondary market wikipedia , lookup
Investment management wikipedia , lookup
Investment fund wikipedia , lookup
Individual Savings Account wikipedia , lookup
Present value wikipedia , lookup
Conditional budgeting wikipedia , lookup
International asset recovery wikipedia , lookup
Mark-to-market accounting wikipedia , lookup
Business valuation wikipedia , lookup
Stock valuation wikipedia , lookup
Stock selection criterion wikipedia , lookup
Internal rate of return wikipedia , lookup
Modified Dietz method wikipedia , lookup
Securitization wikipedia , lookup
Transcript
1-1 What is Finance? The study of how people allocate scarce resources over time Costs and benefits of financial decisions are: spread out over time not known with certainty at time of decision Central concept: valuation Valuation deals with looking forward A Simplified Organizational Chart (Figure 1.1) Board of Directors Chairman of the Board and Chief Executive Officer (CEO) President and Chief Operations Officer (COO) Vice President Marketing Vice President Production Vice President Finance (CFO) Controller Treasurer Cash Manager Credit Manager Tax Manager Cost Accounting Manager Capital Expenditures Financial Planning Financial Accounting Manager Data Processing Manager 1-2 1-3 The Corporation Advantages unlimited life easy transfer of ownership limited liability ease of raising capital Disadvantages double taxation set-up and reporting costs agency costs 1-4 Sole Proprietorship Partnership Corporation Who owns the business? The Manager Partners Stockholders Are managers and owners separate? What is the owner’s liability? Are owners & the business taxed separately? No No Usually Unlimited Unlimited (exceptions) Limited No No Yes 1-5 Goal of Financial Management What are firm decision-makers hired to do? “General Motors is not in the business of making automobiles. General Motors is in the business of making money.” Alfred P. Sloan Possible goals Three equivalent goals of financial management: maximize shareholder wealth maximize share price maximize firm value 1-6 Agency Relationships An agency relationship exists whenever a principal hires an agent to act on their behalf Within a corporation, agency relationships exist between: shareholders and managers shareholders and creditors 1-7 Shareholders versus Managers Managers are naturally inclined to act in their own best interests But the following factors affect managerial behavior: compensation plans direct intervention by shareholders threat of firing threat of takeover Board of Directors 1-8 Shareholders versus Creditors Shareholders could take actions to maximize stock price that are detrimental to creditors In the long run, such actions will raise the cost of debt and ultimately lower stock price 1-9 Factors that Affect Stock Price Projected cash flows to stockholders Timing of the cash flow stream Risk of the cash flows VALUE (price) = the discounted value of all relevant future cash flows P = t CFt × (1 + r )–t 1-10 Computing Cash Flows Why Do We Care About This Topic? Financial managers need accurate forecasts of cash flows to make accurate investment and financing decisions Investment bankers and deal makers need to know how much to bid for a company in an acquisition and/or merger Managers need to know how much cash flow is generated by assets to get feedback on their strategic decisions Investors and creditors need to know how much cash is generated from assets and operations to determine the financial solvency of a company The Balance Sheet (Figure 2.1) Total Value of Liabilities and Shareholders’ Equity Total Value of Assets Current Assets Net Working Capital Current Liabilities Long-Term Debt Fixed Assets 1. Tangible fixed assets 2. Intangible fixed assets Shareholders’ Equity 1-11 Quincy Corporation Balance Sheet Statement: Asset Account 1-12 Years ended December 31, 1997 and December 31, 1996 ($ in Millions) Item 1997 1996 Cash 150.00 100.00 Accounts Receivable 250.00 200.00 Inventories 300.00 300.00 700.00 600.00 Buildings 200.00 175.00 Mach. & Equip. 100.00 75.00 Land 250.00 200.00 50.00 25.00 Total Gross Fixed Assets 600.00 475.00 Less: Accumulated depreciation 100.00 75.00 Net Fixed Assets 500.00 400.00 1200.00 1000.00 Current Assets Total Current Assets Gross Fixed Assets (at cost) Construction in Progress Total Assets Quincy Corporation Balance Sheet: Liability and Shareholders' Equity Account Years ended December 31, 1997, December 31, 1996 ($ in Millions) Item 1997 1996 Accounts Payable 150.00 100.00 Notes Payable 200.00 200.00 Total Current Liabilities 350.00 300.00 Long-term Debt 420.00 400.00 Total Liabilities 770.00 700.00 60.00 50.00 Retained Earnings 370.00 250.00 Total Shareholders' Equity 430.00 300.00 1200.00 1000.00 Liabilities Current Liabilities Shareholders' Equity Common Stock + surplus Total Liabilities and Shareholders' Equity 1-13 1-14 Quincy Corporation Income Statement Years ended December 31, 1997 and December 31, 1996 (Million $) Item Net Sales 1997 2000.00 1996 1,250.00 Cost of Sales (1000.00) (650.00) Gross Profit 1,000.00 600.00 Selling Expenses 150.00 45.00 General Expenses 250.00 100.00 Depreciation Expense 100.00 45.00 Operating Profit (EBIT) 500.00 410.00 Interest Expense 100.00 55.00 Income Before Taxes 400.00 355.00 Taxes 200.00 177.50 Net Income 200.00 177.50 Operating Expenses: 1-15 GAAP Net Income vs. Cash Flows General Accepted Accounting Principles (GAAP) govern audited financial statements The objective of GAAP is to provide a consistent account of a firm's financial status based on historical cost, where revenues and expenses are matched over the appropriate time period. Cash flow does not equal GAAP net income. GAAP recognizes revenue at time of sale, and matches expenses to these revenues, but cash flow may occur at different time. Depreciation and other non-cash items are included in GAAP net income. Items are recorded on an accrual basis, not when the money actually comes into the firm. Cash Flow = difference between dollars in and dollars out 1-16 Cash Flow Summary 1. The cash flow identity Cash flow from assets 2. Cash flow from assets Cash flow from assets where: Operating cash flow Net capital spending = Change in NWC = = Cash flow to creditors (bondholders) + Cash flow to stockholders (owners) = Operating cash flow – Net capital spending – Additions to net working capital (NWC) = Earnings before interest and taxes (EBIT) + Depreciation – Taxes Ending net fixed assets – Beginning net fixed assets + Depreciation Ending NWC – Beginning NWC 3. Cash flow to creditors Cash flow to creditors = Interest paid – Net new borrowing 4. Cash flow to stockholders Cash flow to stockholders = Dividends paid – Net new equity raised 1-17 A Closer Look at Operating Cash Flow (OCF) OCF = EBIT + Depreciation - Taxes EBIT has already subtracted depreciation. Depreciation is excluded from OCF. It is a noncash item. By adding depreciation, we have a cash flow number that includes costs associated with operating activities and excludes non-cash items. Taxes are included in OCF because the taxes are paid on the revenues associated with operating activities. 1-18 A Closer Look at NWC Account Current Assets Cash Inventories Accounts receivable Current Liabilities Notes Payable Accounts Payable NWC End of Year Beginning of Year 100 100 80 100 110 100 50 180 80 70 50 100+110+100-80-70=160 •What is additions to NWC? •What does this number mean? Is it a cash inflow or a cash outflow? Cash Flow Summary for Quincy 1-19 A. Cash flow from assets 1. Operating cash flow = EBIT + Depreciation – Taxes = $500 + 100 – 200 = $400 2. Additions to Net Working Capital (-/-) = Ending NWC – Beginning NWC = $350 – $300 = $50 3. Net capital spending (-/-) = End. net fixed assets + Depreciation – Beg. net fixed assets = $500 + 100 – 400 = $200 4. Cash flow from assets = OCF – Additions to NWC – Net Capital spending = $400 – 50 – 200 = $150 1-20 Cash Flow Summary for Quincy, cont’d. B. Cash flow to creditors and stockholders 1. Cash flow to creditors = Interest paid – (Ending LTD - Beg. LTD) = $100 – ($420 - $400) = $80 2. Cash flow to stockholders = Dividends paid – (Ending Common - Beg. Common) = $80 – ($60 - $50) = $70 Check: $150 from assets = $80 to bondholders + $70 to stockholders 1-21 Statement of Cash Flows Summarizes the flow of cash receipts (inflows) and cash payments (outflows) during a given period of time summarizes sources and uses of cash reconciles change in cash balance over time Restatement of balance sheet and income statement 3 primary categories operating activities investing activities financing activities 1-22 The Statement of Cash Flows Operating activities + Net income + Depreciation + Decrease in current assets (except cash) + Increase in current liabilities (not notes payable) – Any increase in current assets (except cash) – Decrease in current liabilities (not notes payable) Investment activities – (Increase in net fixed assets + Depreciation) 1-23 Statement of Cash Flows, cont’d. Financing activities – Decrease in notes payable + Increase in notes payable – Decrease in long-term debt + Increase in long-term debt – Decrease in common stock + Increase in common stock – Dividends paid 1-24 Hermetic Inc., Balance Sheet as of December 31 ($ in thousands) Assets 1995 1996 $ $ Current assets Cash 45 50 Accounts receivable 260 310 Inventory 320 385 Total $ 625 $ 745 985 $1610 1100 $1845 Fixed assets Net plant and equipment Total assets 1-25 Hermetic Inc., Balance Sheet Liabilities and equity 1995 1996 $ 210 $ 260 110 175 $ 320 $ 435 205 225 Common stock and paid-in surplus 290 290 Retained earnings 795 895 $1085 $1185 $1610 $1845 Current liabilities Accounts payable Notes payable Total Long-term debt Stockholders’ equity Total Total liabilities and equity 1-26 Hermetic Inc., Income Statement ($ in thousands) Net sales Cost of goods sold Depreciation Earnings before interest and taxes Interest Taxable income Taxes $710.00 480.00 30.00 $200.00 20.00 180.00 53.45 Net income $126.55 Retained earnings $100.00 Dividend = $26.55 1-27 Cash Flow from Assets Cash flow from assets: Operating cash flow: EBIT + Depreciation – Taxes Net capital spending: Ending net fixed assets – Beginning net fixed assets + Depreciation $ + – $ $ 1,100.00 – 985.00 + 30.00 $ 145.00 Change in net working capital: Ending net working capital $ – Beginning net working capital – $ Cash flow from assets: 200.00 30.00 53.45 176.55 $ 310.00 305.00 5.00 26.55 1-28 Cash Flow from Assets, cont’d. Total cash flow to creditors and stockholders: Cash flow to creditors: Interest paid $ 20.00 – Net new borrowing – 20.00 $ 0.00 Dividends paid $ 26.55 – Net new equity raised - 0.00 $ 26.55 $ 26.55 Cash flow to stockholders: Cash flow to creditors and stockholders 1-29 Hermetic Inc., Statement of Cash Flows Operating activities + Net income + 126.55 + Depreciation + 30.00 + Increase in payables + 50.00 – Increase in receivables – 50.00 – Increase in inventory – 65.00 91.55 Investment activities – Increase in net fixed assets – 115.00 – Depreciation – 30.00 (145.00) 1-30 Hermetic Inc., Statement of Cash Flows Financing activities + Increase in notes payable + 65.00 + Increase in long-term debt + 20.00 + Increase in equity – Dividends 0.00 – 26.55 58.45 Putting it all together 91.55 – 145.00 + 58.45 = 5.00 Identify whether an activity is an operating activity (O), investment activity (I), financing activity (F) and if it is a source (+) or use (-) of cash. Activity Increase in Accounts Payable Type of Activity Operating Source or Use of Cash Source Increase in Inventories Operating Sale of a manufacturing plant 1-31 Use Investment Source Financing Source Issue common stock