Dr. Ahmed FINC 5000 Week-1 Name What is Finance? Corporate Finance Forms of Business Sole Proprietorship Partnership Corporations Limited Liability Companies Finance Money & Markets Investments Managerial Finance Five Functions of the Organization ABC Inc Marketing Finance Operations H. R. M. Info Tech Financial Manager's Responsibility: Forecasting & Planning Investment decisions Financing decisions Coordinate and control
Circular Function of Finance Stockholders, Management, and the Agency Cost Goals of Financial Manager Profit maximization Amount of expected profits Specific interval Dividend decisions Wealth maximization: Uncertainty Timing
Profit OR Wealth Maximization Year A-CELLPHONE B-CELPHONE 0 $50 $50 1 $35 $65 2 $55 $50 5 $75 $35 10 $125 $70 Shareholders Wealth: Market Price Per Share times Number of Shares of Common Stock Outstanding Management and Owners Ethics and Financial Management How to define [Ethics is doing the right thing...?] Financial Statements Income Statement Balance Sheet Statement of Cash flows
Income Statement ABC Corporation 2002 2001 Sales $3,850,000 $3,432,000 Cost of goods sold 3,250,000 2,864,000 Other expenses 430,300 340,000 Depreciation 20,000 18,900 Total operating costs 3,700,300 3,222,900 EBIT 149,700 209,100 Less interest expense 76,000 62,500 EBT 73,700 146,600 Income taxes 29,480 58,640 Net income $44,220 $87,960 DPS $0.22 $0.22 Shares outstanding 100,000 100,000 Cash Flows = NI + Depreciation = $44,220 + $20,000 = $64, 220
Balance Sheet ABC Corporation 2002 2001 Cash $52,000 57,600 Receivables 402,000 351,200 Inventories 836,000 715,200 Total current assets 1,290,000 1,124,000 Gross fixed assets 527,000 491,000 Less: Accumulated Depreciation 166,200 146,200 Net fixed assets 360,800 344,800 Total Assets $1,650,800 $1,468,800 Accounts payable $175,200 $145,600 Notes payable 225,000 200,000 Accruals 140,000 136,000 Total current Liabilities 540,200 481,600 Long-term debt 424,612 323,432 Common stock 460,000 460,000 Retained earnings 225,988 203,768 Total equity 685,988 663,768 Total liability and equity $1,650,800 1,468,800
Statement of Cash Flows ABC Corporation Operating Activities Net income $44,220 Other additions (sources of cash) Depreciation 20,000 Increase in accounts payable 29,600 Increase in accruals 4,000 Subtractions (uses of cash) Increase in receivables (50,800) Increase in inventories (120,800) Net cash flow from operations ($73, 780) Long-term Invest Activities Investment in fixed assets ($36,000) Financing Activities Increase in notes payable $25,000 Increase in long-term debt 101,180 Payment of cash dividends (22,000) Net cash flow from financing $104,180 Net Increase (Decrease) in Cash ($5,600) Cash at Beginning of the Year 57,600 Cash at the end of Year $52,000
Financial Institutions Financial Markets Physical Assets Markets Spot Market and Futures Market Money and Capital Markets Mortgage Markets Global, National, and Regional Markets Primary and Secondary Markets Organized and Unorganized Markets Cost of Money Production Opportunities Time preference for Consumption Risk Inflation Interest Rate Nominal Rate = Real Rate + Inflation Rate (approximation) Nominal Rate = Real Rate + Inflation Rate + (RR * IFR) (precise) Nominal rate, Quoted rate, or Required rate of return on debt = r r = r* + IP + DRP + LP + MRP r* = Real risk-free rate. IP = Inflation premium. DRP = Default risk premium. LP = Liquidity premium. MRP = Maturity risk premium.
Term structure It is the relationship between interest rates (or yields) and maturities. Yield Curve A graph of the term structure is called the yield curve. Value of the firm Basic valuation model: Value of an asset (tangible/intangible) is the sum of the present value of future cash flows generated by the asset. FCF = Free Cash Flows NOPAT = EBIT (1 Tax rate) FCF = NOPAT Net investment in Operating Capital FCF1 FCF2 Value = + 1 2 (1 + WACC) (1 + WACC) FCF +... (1 + WACC) Net Operating Working Capital = Operating Current assets Operating Current Liabilities Total Operating Capital = Net Working Capital + Operating Longterm Capital NOPAT = EBIT(1 - Tax rate) FCF = NOPAT - Net Investment in Operating Capital ROIC = NOPAT / Operating Capital
EVA = NOPAT- (WACC)(Capital) MVA = Market Value of the Firm - Book Value of the Firm Book Value = Total common equity + Value of debt Federal Income Tax Corporate Tax Structure Operating Income Dividend Income (70% dividend exclusionary rule) Capital Gains (taxed as operating income) Operating Loss (2 years carry-back, 20 years carry-forward)