Welcome to Finance 410

1
Welcome to Finance 410

• Clay M. Moffett

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Fi 410

• Overview of the course
• Text Corporate Finance by Ross, Westerfield and
  Jaffe
• Syllabus, methodology
• Intros

3
Chapter 1 The Corporation

• Corporate Finance addresses the following three
  questions
• What long-term investments should the firm
  choose?
• How should the firm raise funds for the selected
  investments?
• How should short-term assets be managed and
  financed?

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B.S. of the Firm

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Chapter 1 The Corporation

• Investment - Capital Budgeting.
• True or False If a projects value is greater
  than its required investment, then the project is
  attractive and should be invested in.
• Financing/Capital Structure

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Capital Budgeting

Current Liabilities
Current Assets
Long-Term Debt
Fixed Assets 1 Tangible 2 Intangible
Shareholders Equity
What long-term investments should the firm choose?
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Short Term Asset Mangement

Current Liabilities
Current Assets
Net Working Capital
Long-Term Debt

• How should short-term assets be managed and
  financed?

Fixed Assets 1 Tangible 2 Intangible
Shareholders Equity
8
Chapter 1 The Corporation

• Corporation vs. Sole Proprietorship
• Duration
• Limited Liability
• Management vs Ownership

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A Comparision

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Chapter 1 The Corporation

• Profits and Principle
• Mantra Maximize shareholder value.
• Actuality Provide customers with value.
• Trust - Important or not?

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Agency Problem

• Agency relationship
• Principal hires an agent to represent his/her
  interest
• Stockholders (principals) hire managers (agents)
  to run the company
• Agency problem
• Conflict of interest between principal and agent
• Management decides to benefit management.
• Compensation Structure - Tie mgmts interest into
  shareholders.

12
Financial Markets

• Primary Market
• Issuance of a security for the first time
• Secondary Markets
• Buying and selling of previously issued
  securities
• Securities may be traded in either a dealer or
  auction market
• NYSE
• NASDAQ

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Quick Quiz

• What are the three basic questions Financial
  Managers must answer?
• What are the three major forms of business
  organization?
• What is the goal of financial management?
• What are agency problems, and why do they exist
  within a corporation?
• What is the difference between a primary market
  and a secondary market?

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Chapter 2 Financial Statements

• Sources of Information
• Annual reports
• Wall Street Journal
• Internet
• NYSE (www.nyse.com)
• NASDAQ (www.nasdaq.com)
• Textbook (www.mhhe.com)
• SEC
• EDGAR
• 10K 10Q reports

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Financial Stmts

• Balance Sheet Basics
• CA FA
• CL LDT SE
• Book Value vs. Market Value

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Balance Sheet Analysis

• When analyzing a balance sheet, the Finance
  Manager should be aware of three concerns
• Liquidity
• Debt versus equity
• Value versus cost

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Liquidity

• Refers to the ease and quickness with which
  assets can be converted to cashwithout a
  significant loss in value
• Current assets are the most liquid.
• Some fixed assets are intangible.
• The more liquid a firms assets, the less likely
  the firm is to experience problems meeting
  short-term obligations.
• Liquid assets frequently have lower rates of
  return than fixed assets.

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Debt vs. Equity

• Creditors generally receive the first claim on
  the firms cash flow.
• Shareholders equity is the residual difference
  between assets and liabilities.

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Value vs. Cost

• Under Generally Accepted Accounting Principles
  (GAAP), audited financial statements of firms in
  the U.S. carry assets at cost.
• Market value is the price at which the assets,
  liabilities, and equity could actually be bought
  or sold, which is a completely different concept
  from historical cost.

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Income Statement

• Income Statement
• Profits Cash Flow
• Cash Flow ??
• Cash In Sales - Increase in Rcvbls.
• Cash Out COGS Inventories
• Accrual vs. Cash
• Taxes

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GAAP Income Statement

Total operating revenues
2,262
The operations section of the income statement
reports the firms revenues and expenses from
principal operations.
Cost of goods sold
1,655
Selling, general, and administrative expenses
327
Depreciation
90
Operating income
190
29
Other income
Earnings before interest and taxes
219
Interest expense
49
Pretax income
170
Taxes
84
Current 71
Deferred 13
Net income
86
Addition to retained earnings
43
Dividends
43
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GAAP Income Statement

Total operating revenues
2,262
The non-operating section of the income statement
includes all financing costs, such as interest
expense.
Cost of goods sold
1,655
Selling, general, and administrative expenses
327
Depreciation
90
Operating income
190
29
Other income
Earnings before interest and taxes
219
Interest expense
49
Pretax income
170
Taxes
84
Current 71
Deferred 13
Net income
86
Addition to retained earnings
43
Dividends
43
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GAAP Income Statement

Total operating revenues
2,262
Cost of goods sold
1,655
Selling, general, and administrative expenses
327
Depreciation
90
Operating income
190
29
Other income
Earnings before interest and taxes
219
Usually a separate section reports the amount of
taxes levied on income.
Interest expense
49
Pretax income
170
Taxes
84
Current 71
Deferred 13
Net income
86
Addition to retained earnings
43
Dividends
43
24
GAAP Income Statement

Total operating revenues
2,262
Cost of goods sold
1,655
Selling, general, and administrative expenses
327
Depreciation
90
Operating income
190
Other income
29
Earnings before interest and taxes
219
Interest expense
49
Net income is the bottom line.
Pretax income
170
Taxes
84
Current 71
Deferred 13
Net income
86
Retained earnings
43
Dividends
43
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Income Statement Analysis

• There are three things to keep in mind when
  analyzing an income statement
• Generally Accepted Accounting Principles (GAAP)
• Non-Cash Items
• Time and Costs

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Non-Cash Items

• Depreciation is the most apparent. No firm ever
  writes a check for depreciation.
• Another non-cash item is deferred taxes, which
  does not represent a cash flow.
• Thus, net income is not cash.

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Taxes

• The one thing we can rely on with taxes is that
  they are always changing
• Marginal vs. average tax rates
• Marginal the percentage paid on the next dollar
  earned
• Average the tax bill / taxable income
• Other taxes

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Statement of Cash Flows

• There is an official accounting statement called
  the statement of cash flows.
• This helps explain the change in accounting cash,
  which for U.S. Composite is 33 million in 2007.
• The three components of the statement of cash
  flows are
• Cash flow from operating activities
• Cash flow from investing activities
• Cash flow from financing activities

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Statement of Cash Flows

The statement of cash flows is the addition of
cash flows from operations, investing, and
financing.
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Quick Quiz

• What is the difference between book value and
  market value? Which should we use for decision
  making purposes?
• What is the difference between accounting income
  and cash flow? Which do we need to use when
  making decisions?
• What is the difference between average and
  marginal tax rates? Which should we use when
  making financial decisions?
• How do we determine a firms cash flows? What are
  the equations, and where do we find the
  information?

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Problems

• Know Concepts Review and Critical Thinking (All
  Chapters.)
• Chapter 2 5, 7, 11, 25, 27