CHapter 9: FINANCE - PowerPoint Presentation

CHapter 9: FINANCE Using Funds To Maximize Value Chapter 10: SECURITIES MARKETS Trading Financial Resources

Finance Worksheet

WHAT MOTIVATES FINANCIAL DECISIONS

% EVALUATING PERFORMANCE: WHERE DO WE STAND? Financial ratios provide insight into financial strengths and weaknesses Use financial data from balance sheet and income statement Companies can compare their ratios with other businesses

KEY FINANCIAL RATIOS RATIO TYPE HOW IT IS COMPUTED Current Liquidity: ability to pay short-term liabilities. Current Assets / Current Liabilities Inventory Turnover Asset Management: how firm is using assets to generate revenue. Cost of Good Sold / Average Inventory Debt-to-equity Leverage: extent to which a firm relies on debt. Total Debt / Total Owner’s Equity Debt-to-assets Leverage: measures the extent to which a firm relies on debt Total Debt / Total Assets Return on equity Profitability: compares the amount of profit compared to resources invested (Net Income – Preferred Div) / Avg Common Stock Equity Return on assets Profitability: compares the amount of profit compared to resources invested Net Income / Average Total Assets Earnings per share Profitability: compares the amount of profit compared to resources invested (Net Income – Pref Dividends) / Avg # of Shares Out

KEY FINANCIAL RATIOS Burn Rate: Decline in Cash Position / time period over which cash decline occurs Higher the Burn Rate, the more quickly a firm is using up its cash Options to conserve cash include: Conserve existing cash Seek new funds

BASIC PLANNING TOOLS Pro Forma Income Statement – forecasts the sales, expenses and net income Pro Forma Balance Sheet – forecasts the types and amounts of assets a firm will need to carry out plans. Cash Budget – detailed projection of cash flows to determine when cash shortages and surpluses will occur.

CASH BUDGET

MANAGING WORKING CAPITAL: CURRENT EVENTS Net Working Capital:Difference between current assets and current liabilities Working capital must be managedAppropriate level of current assetsCurrent liabilities needed to finance activities

MANAGING CASH Need cash to pay bills Cash does not earn returns Report cash equivalents as cash Commercial Paper T-Bills Money Market Mutual Funds

MANAGING ACCOUNTS RECEIVABLE Set Credit TermsEstablish Credit Standards Design Appropriate Collection Policy Accounts Receivable - Money which is owed to a company by a customer for products and services provided on credit.

SHORT-TERM FINANCING Spontaneous Financing Trade CreditShort-Term Bank LoansLine of Credit Revolving Credit Factoring Commercial Paper

BORROWING MONEY “ “ “If you want to know the value of money, go and try to borrow some.” - Benjamin Franklin

CAPITAL BUDGETING: IN IT FOR THE LONG HAUL Replace machines and equipment New machines and equipmentBuild a new factory, warehouse or officeIntroduce a new product line Capital Budgeting – a systematic evaluation of a firm’s major long-run capital investment opportunities.

COMPARING CASH FLOWS THAT OCCUR AT DIFFERENT TIMES Managers must evaluate costs and benefits of investments that occur over a period of many years. Time Value of Money – a dollar received today is worth more than a dollar received in the future. Compounding – earning interest in the current period on interest from previous periods.

Present Value – How much a given amount of cash received in a future period is worth today, given the time value of money. USING NET PRESENT VALUE TO EVALUATE CAPITAL BUDGETING PROPOSALS Managers must compare the amount of cash an investment generates and when it generates the cash Time value of money – a dollar received today is worth more than a dollar received in the future

NPV CALCULATION Net present value is the present value of all cash flows associated with an investment, including the initial (negative) cash flow of the investment.

SOURCES OF LONG-TERM CAPITAL: LOANERS VS. OWNERS

SOURCES OF DEBT FINANCING Long-term loansPrivate placements Issuing notes or bonds Debt is a legally binding agreement to repay the money plus interest Debt requires fixed payments Many lenders require collateral which lenders can use to recover balance Some lenders impose covenants on the borrower Avoids additional investment of stockholders Interest payments are tax-deductible Pros Cons

SOURCES OF EQUITY FINANCING Direct contributions by ownersOwners directly contribute resources to unincorporated businessesCorporations raise equity capital by issuing stock Retained earningsEquity financing provides more flexibility than debt financing

FINANCIAL LEVERAGE: USING DEBT TO MAGNIFY GAINS Heavy debt in capital structure Potential high returns to ownersIncreased risk

Trading Financial Resources Chapter 10: SECURITIES MARKETS Trading Financial Resources

BASIC TYPES OF FINANCIAL SECURITIES Three major types of securities that are traded in markets: Common Stock Preferred Stock Bonds

SECURITIES MARKETS Stocks & Bonds Primary Securities Market Investors Corporations Funds Securities Debt & Equity Long term financing Additional Funds Support: Expansion of facilities Research and Product Development Adoption of New Technologies Other strategic initiatives Returns to Investors: Dividends, Interest, Capital Gains Primary Market - where corporations raise additional capital by issuing and selling newly issued securities Secondary Market – involves trades of previously issued securities

COMMON STOCK: A SHARE OF CORPORATE OWNERSHIP Voting Rights Right to DividendsCapital GainsPreemptive RightsRight to Residual Claim on Assets The basic form of ownership in a corporation

PREFERRED STOCK Stock that gives its holder preference over common stockholders. No Voting RightsClaim on AssetsPayment of Dividends Cumulative Feature

Foundations Stock Market Summary Close value of a share at the end of a trading dayChange how much higher /lower price today than yesterday (in Foundation- last year) Shares outstandingDividend cash payment to ownersYield dividend/ stock priceEPS earnings per share= net income / shares Company Close Change Shares MarketCap ($M) Book Value EPS Dividend Yield P/E Andrews $8.89 $4.20 2,879,847 $26 $7.72 $0.59 $0.00 0.0% 15.1 Baldwin $2.54 ($0.94) 2,624,052 $7 $5.09 ($0.15) $0.00 0.0% -17.2 Chester $3.47 ($6.24) 2,814,010 $10 $6.93 ($0.97) $0.00 0.0% -3.6 Digby $0.61 ($2.00) 2,879,847 $2 $1.22 ($3.56) $0.00 0.0% -0.2 Erie $9.10 $0.44 2,399,873 $22 $8.20 $1.19 $0.25 2.7% 7.7 Ferris $9.09 ($2.71) 2,760,252 $25 $8.83 $0.34 $0.00 0.0% 27.0

BONDS: A FORMAL IOU Long-term debt issued by a corporation or governmentMaturity DatePar Value Coupon Rate

How Bonds WorkSuppose ABC offers bonds with a Par Value of $1000 at a Coupon (interest) rate of 10% with a Maturity of 5 years. You give ABC $1000 which they promise to pay back over the next 5 yearsYear 1, ABC gives you $100 (10% of $1000) in interest.Year 2, ABC gives you $100 in interest. Years 3 and 4, same as Year 2.Year 5, ABC gives you $100 in interest and also pays back the entire face value of the bond, $1000.

CHARACTERISTICS OF BONDS Most bonds are secured with a pledge of specific assetsMethods of retiring bonds: Serial bonds have unique maturity dates and help spread out repaymentsCompanies may establish sinking fund to assist in repaymentCallable bonds have provisions for early redemption Convertible bonds allow bonds to be transferred into shares of common stock

Bond Credit Quality Ratings -Rating Agencies Credit Risk Moody’s Standard Fitch & Poor’s RatingsInvestment grade Highest quality Aaa AAA AAA High quality (very strong) Aa AA AA Upper medium grade (strong) A A A Medium grade Baa BBB BBB Not investment grade Lower medium grade (speculative) Ba BB BB Low grade (speculative) B B B Poor quality (may default) Caa CCC CCC Most speculative Ca CC CC No interest paid or bankruptcy petition C D C In default C D D

Moody's Fitch S&P Austria Aaa AAA AAA Belgium Aa1 AA+ AA+ Bulgaria Baa3 BBB- BBB Cyprus A2 A- A- Czech Republic A1 A+ A Denmark Aaa AAA AAA Estonia A1 A A Finland Aaa AAA AAA France Aaa AAA AAA Germany Aaa AAA AAA Greece Ca CCC CCC Hungary Baa3 BBB- BBB- Ireland Ba1 BBB+ BBB+ Italy Aa2 AA- A+ Latvia Baa3 BBB- BB+ Lithuania Baa1 BBB BBB Luxembourg Aaa AAA AAA Malta A1 A+ A Netherlands Aaa AAA AAA Poland A2 A- A- Portugal Ba2 BBB- BBB- Romania Baa3 BB+ BB+ Slovakia A1 A+ A+ Slovenia Aa2 AA AA Spain Aa2 AA+ AA Sweden Aaa AAA AAA United Kingdom Aaa AAA AAA SOURCES: MOODY'S, STANDARD & POOR'S, FITCH July 25, 2011 European Sovereign Credit Ratings

JUNK BONDS Junk bonds are bonds that are rated Ba or lower in Moody’s classificationJunk bonds offer a higher rate of interest (and risk).In 2007, only 22 companies in the world defaulted on their bonds.During the recession in 2008, the number soared to 126. The Wall Street Journal tactfully refers to these securities as “high yield bonds.”

Foundations Bond Market Summary Bond series#- interest rate S year you pay backFacecash you received and how much you will have to pay back at maturityYield bond interest / trading price Close what it is trading for today- and what you would pay to retire early S&P = risk rating AAA – AA- A- BBB-….D Company Series# Face Yield Close S&P Andrews 11.0S2021 $866,667 11.00% $100.34 BB   12.0S2023 $1,733,333 11.60% $103.74 BB   13.0S2025 $2,600,000 11.90% $109.36 BB     Baldwin 11.0S2021 $866,667 11.00% $100.34 BB   12.0S2023 $1,733,333 11.60% $103.74 BB   13.0S2025 $2,600,000 11.90% $109.36 BB

TRADING SECURITIES: THE PRIMARY MARKET Public OfferingInitial Public Offering (IPO) Select an Investment bankPrepare paperworkArrange for financingCarry out the offer Private Placement Quicker, simpler, less expensive Investment bank assistance No SEC registration Only available to accredited investors

INVESTMENT BANKS Financial IntermediaryAssists firm with IPOPlanning MarketingAssessmentDetermining how to structure the IPO is key role of Investment Banks

TRADING SECURITIES: THE SECONDARY MARKET Security ExchangesNew York Stock Exchange The largest securities exchange in the United States.Traditionally an “auction market”NASDAQElectronic exchangeOver the Counter MarketElectronic Communication Networks

REGULATIONS OF SECURITIES MARKETS: ESTABLISHING CONFIDENCE State Regulations Federal LegislationSecurities Act 1933Prohibits misrepresentation, deceit or other forms of fraudRequire firms to file registration when issuing stock Securities Exchange Act of 1934 S ecurities and E xchange C ommission Established report filing Registration of brokers and dealers Prosecution power Individual and Company Fraudulent Activity (i.e. insider trading)

PERSONAL INVESTING What are your short-term and long-term goals? Given your budget, how much are you able to invest?How long can you leave your money invested?How concerned are you about the tax implications of your investments? How much tolerance do you have for risk? DIVERSIFICATION

DIRECT STOCK PURCHASE PLANS Many Corporations offer Direct Stock Purchase PlansPurchase stock direct from company Dividend Reinvestment Plans (DRIPS) allow current stockholders to reinvest dividends to purchase additional stock

STRATEGIES FOR INVESTING IN SECURITIES Investing for Income Market Timing Value Investing Investing for Growth Buying and Holding

KEEPING TABS ON THE MARKET: STOCK INDICES Stock Index – tracks how the prices of a specific set of stocks have changed. Standard and Poor’s 500 – tracks 500 stocks and weighs the total market value of each stock. Dow Jones Industrial Average (DJIA) – most widely followed index. Tracks 30 stocks picked by the Wall Street Journal editors.