Financing the Enterprise

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Financing the Enterprise McGraw-Hill/Irwin Copyright

2 CHAPTER 14 Accounting and Financial Statements CHAPTER 15 Money and the Financial System CHAPTER 16 APPENDIX D Financial Management and Securities Markets Personal Financial Planning 16-2

3 Enter the World of Business Is Bank of America too Big to Fail? Too-big-to-fail firms are linked to so many organizations that if they fail, the repercussions would destroy the economy BofA is in a precarious situation due to a series of high-risk decisions and investment in mortgage-related securities BofA has cut costs by eliminating jobs and Berkshire Hathaway purchased $5 billion in BofA s preferred stock? What are some of the economic repercussions that might occur if Bank of America fails?? Why has Bank of America s acquisition of Countrywide been criticized?? How might Berkshire Hathaway s preferred stock purchase help Bank of America? 16-3

4 Managing Current Assets and Liabilities Working Capital Management The managing of short-term assets and liabilities Since short-term assets and liabilities continually flow through an organization, they are said to be working The terms current and short-term are used interchangeably Current assets: cash, investments, accounts receivable and inventory goal is maximize return on these assets Current liabilities: accounts payable, accrued salaries, accrued taxes and short-term bank loans 16-4

5 Going Green Finance Executives Recognize the Benefits of Green Efficiencies Method is a green company selling green products, and raking in more than $100 million in annual sales Method aligns its green objectives with its cost-saving goals Method s long-term perspective, efficient operations and popularity with customers is catching on with competitors? If greener operations cut company costs, how will this affect current assets and liabilities?? Why might Method decide to pursue greener business activities that are costly in the short run?? Do you think Method s competitors are beginning to realize how green products can improve their financial conditions? 16-5

6 Managing Current Assets Idle cash does not make money and managers try to keep just enough to pay bills as they fall due Transaction Balances Cash kept on hand by a firm to pay normal daily expenses, such as employee wages and bills for supplies and utilities Lockbox An address, usually a commercial bank, at which a company receives payments in order to speed collections from customers 16-6

7 Managing Current Assets Sometimes cash comes in faster than needed to pay bills Marketable Securities Temporary investment of extra cash by organizations for up to one year in U.S. Treasury bills, certificates of deposit, commercial paper, or Eurodollar loans Treasury Bills (T-Bills) Short-term debt obligations the U.S. government sells to raise money T-bills are considered risk free 16-7

8 Managing Current Assets 16-8

9 Managing Current Assets Commercial Certificates of Deposit (CDs) Certificates of deposit issued by commercial banks and brokerage companies, available in minimum amounts of $100,000 which may be traded prior to maturity Commercial Paper A written promise from one company to another to pay a specific amount of money Eurodollar Market A market centered in London for trading U.S. dollars in foreign countries 16-9

10 Managing Current Assets Many businesses make a majority of sales on credit, so managing receivables is important Discounts for early payment and extending credit comes at the cost of lowered profits Credit ratings can be provided by credit bureaus, credit-rating agencies such as Dun and Bradstreet and industry trade groups 16-10

Managing Current Assets Financial managers have to coordinate inventory purchases to manage cash flows Optimal inventory levels are determined

11 Managing Current Assets Financial managers have to coordinate inventory purchases to manage cash flows Optimal inventory levels are determined mainly by method of production Excess inventory ties up money unnecessarily but inventory shortages could drive a customer to a competitor forever 16-11

Accounts Payable Trade Credit is extended

12 Managing Current Liabilities Averting a cash shortfall with short-term funds Accounts Payable Trade Credit is extended by suppliers for the purchase of their goods and services Most suppliers offer discounts for early payment, offered as 1/10 net 30, meaning a 1% discount is given if paid in 10 days and the full amount is due in 30 days 16-12

13 Managing Current Liabilities Most organizations obtain short-term funds from banks Line of Credit An arrangement by which a bank agrees to lend a specified amount of money to an organization upon request Secured Loans Unsecured Loans Loans backed by collateral the bank can claim if the borrowers do not repay them Loans backed only by the borrowers good reputation and previous credit rating Prime Rate The interest rate commercial banks charge their best customers (usually large corporations) for short-term loans 16-13

14 o o Managing Current Liabilities Banks are not the only source of short-term funds Factor A finance company to which businesses sell their accounts receivable usually for a percentage of the total face value Other nonbank liabilities include: taxes owed to the government and wages owed to employees Taxes and employees wages represent debt obligations and the financial manager must plan to meet them as they come due 16-14

Managing Fixed Assets Long-Term (Fixed) Assets Production facilities (plants), offices, and equipment all of which are expected to last for many years Modern facilities and

15 Managing Fixed Assets Long-Term (Fixed) Assets Production facilities (plants), offices, and equipment all of which are expected to last for many years Modern facilities and equipment are expensive, requiring long-term financing Options include capital leases and operating leases, where a company pays a fee for usage rather than owning an asset 16-15

Managing Fixed Assets Capital Budgeting The process of analyzing the needs of the business and selecting the assets that will maximize its value This process continues

16 Managing Fixed Assets Capital Budgeting The process of analyzing the needs of the business and selecting the assets that will maximize its value This process continues after purchase as all assets and projects must be continually reevaluated against the company s needs Budgeting is not an exact process and managers must be flexible 16-16

17 Assessing Risk Highest Risk Introduce a New Product in Foreign Markets Expand into a New Market Introduce a New Product in a Familiar Market Lowest Risk Repair Old Machinery Buy New Equipment for Established Market Add to a Product Line 16-17

18 Assessing Risk Pharmaceutical companies spend millions of dollars developing new drugs without knowing if the drug will pass FDA approval and have a significant margin of risk 16-18

Assessing Risk Every investment carries some risk»the longer a project or asset is expect to last, the greater its potential risk because it may

19 Assessing Risk Every investment carries some risk»the longer a project or asset is expect to last, the greater its potential risk because it may become obsolete or wear out prematurely»risk is also affected by the stability and competitive nature of the marketplace and the world economy 16-19

20 Pricing Long-Term Money Returns from any project must cover not only operating costs but interest expenses on the debt used to finance the project The most efficient and profitable companies attract the lowest-cost funds because they typically offer reasonable returns for low relative risk New companies have a strong motivator to use financial resources wisely because they will, over time, reduce the costs of their funds and increase profit 16-20

21 Financing with Long-Term Liabilities Two common sources for long-term funds: Attracting new owners (equity financing) Long-term liabilities (debt financing) Long-Term Liabilities Debts that will be repaid over a number of years, such as long-term loans and bond issues These take many different forms but the in the end, the key word is debt Heavily indebted companies may not make it through a recession and be forced into bankruptcy 16-21

Financing with Long-Term Liabilities Bonds Debt instruments that larger companies sell to raise long-term funds o o o Bondholders enter into a contract, or indenture, with the bond issuer Bondholders

22 Financing with Long-Term Liabilities Bonds Debt instruments that larger companies sell to raise long-term funds o o o Bondholders enter into a contract, or indenture, with the bond issuer Bondholders receive regular interest payments and the face value of the bond on or before the maturity date The annual interest rate (often called coupon rate) is the percentage of face value the company pays yearly 16-22

23 Unsecured Bonds Secured Bonds Serial Bonds Floating-Rate Bonds Junk Bonds Types of Bonds Debentures, or bonds that are not backed by specific collateral Bonds backed by specific collateral that must be forfeited in the event the issuing firm defaults A sequence of small bond issues of progressively longer maturity Bonds with interest rates that change with current interest rates otherwise available in the economy A special type of high interest-rate bond that carries higher inherent risks 16-23

24 Financing with Owners Equity Corporate owners own shares of the company and stockholders equity includes common stock, preferred stock and retained earnings Retained Earnings Earning after expenses and taxes that are reinvested in the assets of the firm and belong to the owners in the form of equity Retained earnings are the only long-term funds the company can generate internally 16-24

25 16-25

26 Financing with Owners Equity Dividend Yield The dividend per share divided by the stock price 16-26

over-thecounter markets where investors can trade their securities

27 Investment Banking Primary Market The market where firms raise financial capital Secondary Markets Stock exchanges and over-thecounter markets where investors can trade their securities with others Investment Banking The sale of stocks and bonds for corporations 16-27

28 The Securities Markets Securities Markets The mechanism for buying and selling securities» In the broadest sense, stocks and bonds markets are providers of liquidity» Without liquid securities markets, investors would not risk their savings on securities 16-28

29 Stock Markets Stock markets exist around the world; the two biggest U.S. stock markets are the New York Stock Exchange (NYSE) and the NASDAQ market Both exchanges are now publicly traded organizations, no longer not-for-profit Electronic trading is faster and less expensive than floor trading and now accounts for most of the stock trading done worldwide NASDAQ was traditionally an electronic market and the NYSE was traditionally a floor-traded market 16-29

Securities Markets Over-The-Counter (OTC) Market A network of dealers all over the country linked by computers, telephones and Teletype machines Most

30 Securities Markets Over-The-Counter (OTC) Market A network of dealers all over the country linked by computers, telephones and Teletype machines Most corporate bonds and all U.S. securities are traded over the counter Therefore, the OTC accounts for the largest total dollar value of all the secondary markets 16-30

31 Measuring Market Performance Investors and financial managers need to know how a companies securities are performing compared with competitors Performance measures averages and indexes are very important to many different people An index compares current stock prices with those in a specified base period An average is the average of certain stock prices and some are weighted averages 16-31

32 Measuring Market Performance 16-32

33 Measuring Market Performance The Dow Jones Industrial Average gained 10 times from August 1982 to the beginning of 2000 This was the Internet bubble and they are difficult to see until they burst Before the housing bubble burst in October 2007, the Dow Jones hit an all time high For investors to make sound financial decisions, it is important that they stay in touch with business news, markets and indexes 16-33

34 Responding to Business Challenges Advancing Gender Diversity in Finance More than half of accounting majors undergraduate programs are women, yet only 9% of CFOs at major companies are female Theorists say female employees do not have the same connections with higher-level financial executives as men do Some companies have mentorship programs for women? Why do you think there are so few female CFOs?? Describe some ways companies are trying to promote management positions to female finance employees? Do you feel a mentorship program will help close the gap? 16-34

35 Solve the Dilemma Surviving Rapid Growth Glasspray Corporation is a small firm making industrial fiberglass spray equipment The firm has run into trouble with its current assets and liabilities resulting from rapid and consistent sales increases President and founder, Stephen T. Rose said Our current assets aren t, and our current liabilities are!? Normally, rapidly increasing sales are a good thing. What seems to be the problem here?? What are some management techniques applied to current liabilities that Glasspray might use to improve its working capital positions? 16-35

Part 6 Financing the Enterprise

Part 6 Financing the Enterprise 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may