Chapter 9: FINANCE

Chapter 9: FINANCE

CHAPTER 9: FINANCE CHAPTER 10:ToSECURITIES Using Funds Maximize Value MARKETS Trading Financial Resources Finance Worksheet WHAT MOTIVATES FINANCIAL DECISIONS What types of assets do we need to achieve goals? How do we get the funds we need? Evaluate financial performance Plan financial resources

Manage working capital Evaluate investment opportunities Determine appropriate strategy 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 Current Liquidity: ability to pay short-term liabilities. Inventory Asset Management: how firm is using Turnover assets to generate revenue. Debt-to-equity Leverage: extent to which a firm relies on debt. HOW IT IS COMPUTED Current Assets Current Liabilities Cost of Good Sold Average Inventory Total Debt Total Owners Equity KEY FINANCIAL RATIOS RATIO

TYPE Debt-to- Leverage: measures the extent to assets which a relies on debt HOW IT IS COMPUTED Total Debt Total Assets Return on Profitability: compares the amount of equity profit compared to resources invested Net Income Preferred Div Avg Common Stock Equity Return on Profitability: compares the amount of assets profit compared to resources invested Net Income Average Total Assets Earnings per Profitability: compares the amount of

share profit compared to resources invested Net Income Pref Dividends Avg # of Shares Out 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 Cash Budget forecasts the sales, detailed projection of expenses and net income cash flows to determine when cash shortages Pro Forma Balance Sheet and surpluses will occur. forecasts the types and amounts of assets a firm will need to carry out plans. 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 Accounts Receivable - Money which is owed to a company by a customer for products and services provided on credit. Set Credit Terms Establish Credit Standards

Design Appropriate Collection Policy SHORT-TERM FINANCING Spontaneous Financing Short-Term Bank Loans Trade Credit 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 firms major longrun 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. USING NET PRESENT VALUE TO EVALUATE CAPITAL BUDGETING PROPOSALS Managers use the process of discounting to calculate the present value. Present value depends on the interest rate the invested money will earn. Net present value is the present value of all cash flows associated with an investment, including the initialPresent Value (negative) cash flow of the investment. How much a given amount of cash received in a future period is worth today, given the NPV CALCULATION

SOURCES OF LONG-TERM CAPITAL: LOANERS VS. OWNERS Capital Structure the mix of equity and debt financing a firm uses for financing needs. Debt Financing creditors. Equity Financing owners. SOURCES OF DEBT FINANCING Long-term loans Private placements Issuing notes or bonds 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 SECURITIES MARKETS Funds Investors Stocks & Bonds Returns to Investors: Dividends, Interest, Capital Gains Primary Securitie s Market Debt & Equity Additional Funds

Support: Expansion of facilities Research and Product Development Adoption of New Technologies Other strategic initiatives Securities Corporation s Long term financing COMMON STOCK: A SHARE OF CORPORATE OWNERSHIP The basic form of ownership is a corporation Voting Rights

Right to Dividends Capital Gains Preemptive Rights Right to Residual Claim on Assets PREFERRED STOCK Stock that gives its holder preference over common stockholders.

No Voting Rights Claim on Assets Payment of Dividends Cumulative Feature Stock Market Summary 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 Company 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 BONDS: A FORMAL IOU Long-term debt issued by a corporation or government Maturity Date Par Value Coupon Rate 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 Investment grade Highest quality High quality (very strong) Upper medium grade (strong)A Medium grade Not investment grade Lower medium grade (speculative) Low grade (speculative) Poor quality (may default) Most speculative No interest paid or bankruptcy petition In default

Moodys Standard & Poors Fitch Ratings Aaa Aa AAA AA AAA AA A A Baa

BBB BBB Ba B Caa Ca C C BB B CCC CC D D BB B CCC CC C D

JUNK BONDS Junk bonds are bonds that are rated Ba or lower in Moodys classification Junk bonds offer a higher rate of interest. In December, 2006, Delta Airlines, Ford Motor Company, and General Motors all had bond issues that were in the junk bond category. The Wall Street Journal tactfully refers to these securities as high yield bonds. Bond Market Summary Company

Andrews Series# 11.0S2004 12.0S2006 13.0S2008 Baldwin 11.0S2004 12.0S2006 13.0S2008 BOND MARKET SUMMARY

Face Yield $866,667 11.0% $1,733,333 11.6% $2,600,000 11.9% $866,667 $1,733,333 $2,600,000 11.0% 11.6% 11.9% Close $100.34 $103.74 $109.36 S&P BB BB

BB $100.34 $103.74 $109.36 BB BB BB Bond series#interest rate S year you pay back Face cash you received and how much you will have to pay back at maturity Yield 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 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 Traditionally NASDAQ Electronic an auction market exchange Over the Counter Market Electronic Communication Networks NEW YORK STOCK EXCHANGE The largest securities exchange in the United States. It is typically referred to

as NYSE. REGULATIONS OF SECURITIES MARKETS: ESTABLISHING CONFIDENCE State Regulations Federal Legislation Securities Act 1933 Require firms to file registration when issuing stock Securities Exchange Act of 1934 Securities and Exchange Commission

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? How much are you able to invest? How concerned are you about the tax

implications? How much tolerance do you have for risk? FULL SERVICE VS DISCOUNT BROKERS Individuals must use a broker to trade stocks on the organized exchanges and OTC market Full Service Brokers Provide a range of services like research, advice and tax planning Discount Brokers Basic buy/sell capabilities

The competition between brokers is intense and both attempt to offer more services. 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 Poors 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. STOCK QUOTES ONLINE

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