CHAPTER 9: FINANCEUsing Funds To Maximize ValueCHAPTER 10: SECURITIES

MARKETSTrading Financial Resources

Finance Worksheet

WHAT MOTIVATES FINANCIAL DECISIONS

1. What types of assets do we need to achieve goals?

2. How do we get the funds we need?• Evaluate financial

performance• Plan financial resources• Manage working capital• Evaluate investment

opportunities• Determine appropriate

strategy

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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 RATIOSRATIORATIO TYPETYPE HOW IT IS COMPUTEDHOW IT IS COMPUTED

Current Liquidity: ability to pay short-term liabilities.

Current Assets / Current Liabilities

InventoryTurnover

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 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

FINANCIAL PLANNING: PROVIDING A ROAD MAP FOR THE FUTURE

What assets must be obtained?

How much additional financing is needed?

How much can the firm generate Internally? Externally?

When will external financing be required?

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

liabilities Working capital must be managed

Appropriate level of current assets Current 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 Terms

Establish 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 Credit

Short-Term Bank Loans Line 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 equipment Build a new factory, warehouse

or office Introduce 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 investment 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

SOURCES OF LONG-TERM CAPITAL: LOANERS VS. OWNERS

SOURCES OF DEBT FINANCING

Long-term loans Private 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

Interest payments are tax-deductible

Avoids additional investment of stockholders

Some lenders impose covenants on the borrower

Pros

Cons

SOURCES OF EQUITY FINANCING

Direct contributions by owners Owners directly contribute resources to

unincorporated businesses Corporations raise equity capital by

issuing stock Retained earnings Equity financing provides more

flexibility than debt financing

FINANCIAL LEVERAGE: USING DEBT TO MAGNIFY GAINS

Heavy debt in capital structure Potential high returns to owners Increased 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 Dividends

Capital Gains

Preemptive Rights

Right 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 Rights Claim on Assets Payment of Dividends Cumulative Feature

Foundations Stock Market Summary

Close value of a share at the end of a trading day Change how much higher /lower price today than yesterday (in

Foundation- last year) Shares outstanding Dividend cash payment to owners Yield dividend/ stock price EPS 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 government Maturity Date Par Value Coupon Rate

How Bonds Work

Suppose 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 years Year 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 assets

Methods of retiring bonds: Serial bonds have unique maturity dates and help spread out

repayments

Companies may establish sinking fund to assist in repayment

Callable 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’sRatings

Investment 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

JUNK BONDS

Junk bonds are bonds that are rated Ba or lower in Moody’s classification

Junk 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 back

Facecash you received and how much you will have to pay back at maturity

Yieldbond interest / trading price

Closewhat it is trading for today- and what you would pay to retire early

S&P = risk rating AAA – AA- A- BBB-….D

BOND MARKET SUMMARYCompany Series# Face Yield Close S&PAndrews 11.0S2004 $866,667 11.0% $100.34 BB 12.0S2006 $1,733,333 11.6% $103.74 BB 13.0S2008 $2,600,000 11.9% $109.36 BB Baldwin 11.0S2004 $866,667 11.0% $100.34 BB 12.0S2006 $1,733,333 11.6% $103.74 BB 13.0S2008 $2,600,000 11.9% $109.36 BB

TRADING SECURITIES: THE PRIMARY MARKET

Public Offering Initial Public Offering

(IPO) Select an

Investment bank Prepare paperwork Arrange for financing Carry out the offer

Private Placement Quicker, simpler,

less expensive Investment bank

assistance No SEC registration Only available to

accredited investors

INVESTMENT BANKS

Financial Intermediary Assists firm with IPO

Planning Marketing Assessment

Determining how to structure the IPO is key role of Investment Banks

TRADING SECURITIES: THE SECONDARY MARKET

Security Exchanges New York Stock Exchange

The largest securities exchange in the United States.

Traditionally an “auction market” NASDAQ

Electronic exchange Over the Counter Market Electronic Communication Networks

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 Plans

Purchase 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.