Financial Management BUS 310 Jon Hunter

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Financial ManagementBUS 310Jon Hunter
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Three main areas of Finance

• Financial Markets and Institutions
• Investments
• Financial Management (Managerial Finance)

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Financial Marketsand Institutions

• Money markets provide companies and governments
  with short-term liquidity (raise cash to pay
  bills).
• Capital markets provide companies and governments
  with long-term financing (capital).
• Typical financial institutions involved banks,
  investment banks, stock brokerages, mutual funds,
  pension funds, SLs, insurance companies
• Levels of interest rates and changes in interest
  rates are of great importance.

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Investments

• Sale of stocks and bonds
• Security analysis
• Advising
• Portfolio Management

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Financial Management

• Financial management is the study and practice of
  making dollar-denominated decisions within a
  single firm.
• Most people in finance work in financial
  management.

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Functions

• Acquisition of funds
• ? short-term financing bank loans, etc.
  (liabilities)
• ? long-term financing stocks (equity) bonds
  (debt)
• Allocation (uses) of funds
• ? short-term working capital management
• ? long-term capital (stocks bonds)
  management

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Responsibilities

• ? forecasting and planning
• ? investment and financing decisions
• ? coordination and control as member of
  management team
• ? interaction with financial markets

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Ten Axioms of Financial Management

• 1. The risk-return trade-off We wont take on
  additional risk unless we expect to be
  compensated with additional return. The greater
  the risk, the greater the expected return.
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• 2. The time value of money A dollar received
  today is worth more than a dollar received in the
  future. A dollar received today is worth more
  than a dollar received tomorrow because a dollar
  received today can earn a days interest by
  tomorrow.

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Ten Axioms of Financial Management

• 3. Cash- not profits- is king. Accounting
  profit or loss frequently does not coincide with
  the actual transfer of money. The first rule of
  running any business Do not run out of cash.
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• 4. Incremental cash flows Its only what
  changes that counts. Think incrementally. How
  will a decision change the cash flow of the
  company?

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Ten Axioms of Financial Management

• 5. The curse of competitive markets Why its
  hard to find exceptionally profitable projects.
  Success attracts competition. Competition lowers
  profits.
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• 6. Efficient capital markets The markets are
  quick and the prices are right. Security prices
  adjust very quickly and appropriately to new
  information.
• 7. The agency problem Managers wont work for
  owners
• unless its in their best interest. Most
  people will work harder for themselves than they
  will for someone else.

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Ten Axioms of Financial Management

• 8. Taxes bias business decisions. Decisions using
  cash flows must always use after-tax cash flows.
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• 9. All risk is not equal. Some risk can be
  diversified away
• and some cannot. Total risk is a combination
  of firm-specific risk, which can be diversified
  away, and market risk, which cannot be
  diversified away. (But see the futures markets.)
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• 10. Ethical behavior is doing the right thing,
  and ethical dilemmas are everywhere in finance.
  Businesses that are not trusted by other
  businesses or by customers will not maximize the
  wealth of stockholders. Perhaps the primary goal
  of firms should address stakeholders and not just
  stockholders.

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Regulation

• Primary market
• Secondary market

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Rates of return

• Increases with risk (standard deviation)
• In excess of inflation
• Treasury bills
• Treasury notes
• Corporate bonds
• Common stocks

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What determinesinterest rates?

• Risk-free rate (k) plus
• Premiums
• Inflation risk
• Default risk
• Maturity length
• Liquidity

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Basic financial statements

• Income statement
• Balance sheet
• Statement of cash flows
• Operations
• Financing activities
• Investing activities

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Financial ratio analysis

• Liquidity
• Current ratio
• Acid test
• Receivables turnover
• Inventory turnover

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Financial ratio analysis

• Profitability
• return on investment
• return on sales (net profit margin)

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Financial ratio analysis

• Financial structure
• debt ratio
• times interest earned
• return on equity

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Financial ratio analysis

• Economic Value Added (EVA)
• takes into account cost of capital

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Time value of money

• Future value of a lump sum
• Present value of a lump sum
• Future value of an annuity
• Present value of an annuity
• Annuity due
• Amortized loans

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Risk and rates of return

• Expected return
• Weighted return
• Risk
• Examples

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Required rate of return

• Concept
• Capital Asset Pricing Model (CAPM)
• kj krf bj(km-krf)

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Definition of value

• Book value
• Liquidation value
• Market value
• Intrinsic (economic) value

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Calculation ofintrinsic value

• Amount and timing of cash flows
• Riskiness of cash flows
• Required rate of return

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Preferences

• Prefer more cash than less cash
• Prefer cash sooner than later
• Prefer less risky cash flow

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Bonds

• What order claim?
• Par value
• Coupon interest rate
• Maturity
• Rating

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Bonds

• Par value
• Coupon interest rate
• Maturity
• Rating

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Types of bonds

• Mortgage bond (secured)
• Debenture (unsecured)
• Subordinated debenture
• Eurobond
• Junk bonds

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Coupon vs. yield

• Coupon rate is stated on the bond
• Yield is calculated
• annual interest payments/market price
• Zero coupon bonds

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Bond valuation

• Data needed
• cash flow information
• term to maturity
• investors required rate of return
• (which considers risk
• and market conditions)

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Capital budgeting

• Payback period
• Quick and easy
• Disregards time value of money
• Disregards cash flow after payback
• Discounted payback not much better

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Capital budgeting

• Net present value
• Sum of discounted cash flows
• Including negative cash flow for initial
  investment
• Positive do
• Negative dont do

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Capital budgeting

• Internal rate of return
• Solve for the discount rate
• when NPV0
• Compare to required rate

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Capital budgetingGuidelines

• IMPORTANT
• Dont consider financing costs when calculating
  cash flows
• They are considered in the discount rate

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Three sets of cash flows

• Initial outlay
• Sale of old equipment
• Installation
• Ongoing operations
• Terminal cash flows

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Capital budgeting

• Capital rationing IRR
• Mutually exclusive projects

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Breakeven analysis

• Another tool to help make good decisions
• What kinds?
• capital expenditures
• pricing
• growth plans

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Breakeven analysis

• Fixed costs
• Variable costs
• Semi-variable costs

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Breakeven analysis

• Revenue price x volume
• COS direct cost x volume
• Fixed cost doesnt change

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Breakeven analysis

• Contribution margin price cost per unit
• Breakeven point fixed cost / contribution

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Operating leverage

• Concepts
• change in EBIT / change in sales
• Examples page 479

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Operating leverage

• gt 1 sales go up, profits up faster
• lt 1 sales go up, profits risk less

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Combined leverage

• Total leverage DOL x DFL

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Dividend payout policy

• Dividends are paid in cash
• They are often compared to
• accounting earnings

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Dividend payout policy

• Dividends per share dividend payout
• Earnings per share ratio
• Dividends per share dividend yield
• Market price

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Dividend payout policy

• Do dividends matter?
• 1) No, dividend policy is irrelevant
• 2) Yes, high dividends increase stock value
• 3) Yes, low dividends increase stock value

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Dividend payout policy

• Dividend payment procedures
• Quarterly
• Holders of record
• Declaration date
• Date of record
• Ex-dividend date
• Payment date