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Introduction to Financial Management FIN 102 – Week 2

Introduction to Financial Management FIN 102 – Week 2. Dr. Andrew L. H. Parkes “A practical and hands on course on the valuation and financial management of corporations”. Financial Management in the 21 st century. Further Globalization Trends The world is one big market

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Introduction to Financial Management FIN 102 – Week 2

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  1. Introduction to Financial ManagementFIN 102 – Week 2 Dr. Andrew L. H. Parkes “A practical and hands on course on the valuation and financial management of corporations”

  2. Financial Management in the 21st century • Further Globalization Trends • The world is one big market • Products will be made in lowest cost countries • Raw materials will be sourced in lowest cost countries • Increasing role of IT and the Internet • The world is one big information network • Technology will allow for faster and better decisions • Information will be real time on line available • Video conferencing will replace time consuming travel • Electronic Commerce will increase fast • Increasing impact of Business Ethics • Companies conduct towards stakeholders is getting more attention • The social responsibility of the company is in high focus Wind Power – Sustainable Energy Intro. to Financial Managment - Week 2

  3. The Agency Problem • Stockholders versus Management: • Owners want managers to increase shareholder wealth… • Managers can be encouraged to do the things that shareholders want them to do through bonuses and option plans related to performance. • Shareholders versus Creditors: • Creditors desire to preserve their principal and interest, if possible. • Restrictive covenants in debt agreements • Creditors will take the company into bankruptcy! Shareholders – lose everything! For Example: Enron Creditors Recovery Corp. is in the midst of liquidating its remaining operations and distributing its assets to its creditors. Intro. to Financial Managment - Week 2

  4. According to Fortune: The world’s richest man (8, Aug. 2007 • Mexican tycoon Slim is world's richest man, 'Fortune' says • MEXICO CITY (Reuters) — Mexican telecom billionaire Carlos Slim has overtaken Microsoft founder Bill Gates as the world's wealthiest man with riches of $59 billion, Fortune magazine said Monday. • Fortune, which tracks the performance of the world's top companies, said Slim has increased his net worth by $12 billion so far this year based on the market value of his companies listed on stock exchanges. • Thanks to Bobby for keeping up on the financial news! Intro. to Financial Managment - Week 2

  5. Nominal Corporate tax rates (US) • Corporate Tax Rates* • Tax Rate Taxable Income • 15% $                    1 - 50,000 • 25% 50,001 - 75,000 • 34% 75,001 - 100,000 • 39% 100,001 - 335,000 • 34% 335,001 - 10,000,000 • 35% 10,000,001 - 15,000,000 • 38% 15,000,001 - 18,333,333 • 35% over 18,333,333 • * Personal service corporations pay a flat 35%. n * Internal Revenue Service Intro. to Financial Managment - Week 2

  6. Corporate Income Taxes Example calculation provided in class.

  7. Tax Havens • Companies have the goal of creating value for their shareholders • Paying taxes is in conflict with the financial goal • Many companies raise “off shore” subsidiary's to avoid taxes • Famous tax havens are: • The Bahama’s • Grand Cayman islands • Monaco • The Netherlands Antilles • Ireland (only 12% corporate tax) Intro. to Financial Managment - Week 2

  8. Assignment #2a: Taxes • Your company has made provisions in its Income Statement over the past 5 years to pay taxes on its taxable income. • Calculate tax (t) as a % of Operating Profit (EBIT) over the years 2002-2006. • Has your company paid the full amount of taxes or does it use “off shore” tax havens? • Calculate the tax rates for each year as well as the average tax rate (%) over the period 2002-2006 also calculate the variance ? Calculating Taxes … Intro. to Financial Managment - Week 2

  9. The Financial Environment • The Financial Markets • Financial Intermediaries • Financial Brokers • Secondary Markets • Allocation of Funds and Interest Rates Intro. to Financial Managment - Week 2

  10. The Financial Markets • What are some types of Markets? • A market is a method of exchanging one asset (usually cash) for another asset. • Physical assets vs. financial assets • Spot versus future markets • Money versus capital markets • Primary versus secondary markets Intro. to Financial Managment - Week 2

  11. What are some Financial Intermediaries? • Commercial banks • Savings & Loans, mutual savings banks, and credit unions • Life insurance companies • Mutual funds • Pension funds Intro. to Financial Managment - Week 2

  12. Primary vs. Secondary Security Sales • Primary • New issue (IPO or seasoned) • Key factor: issuer receives the proceeds from the sale. • Secondary • Existing owner sells to another party. • Issuing firm doesn’t receive proceeds and is not directly involved. Intro. to Financial Managment - Week 2

  13. Public Offerings • Public offerings: registered with the SEC and sale is made to the investing public. • Shelf registration (Rule 415, since 1982) allows firms to register an offering and sell parts of the offering over time. • Initial Public Offerings (IPOs) • Underpricing—Average increase is 14% on first day. • Performance– Underperforms similar stock during three years after IPO. Intro. to Financial Managment - Week 2

  14. Secondary Markets • Markets that trade ALREADY issued Stocks, Bonds or other securities. • Organized Exchanges (NYSE) • Over the Counter Exchanges (NASDAQ) • Privately traded or financial institution traded securites (Fannie Mae, Freddie Mac) Intro. to Financial Managment - Week 2

  15. Domestic Stock Indexes • Dow Jones Industrial Average • Standard & Poor’s 500 Composite • Nasdaq 100 • NYSE Composite • Wilshire 5000 Intro. to Financial Managment - Week 2

  16. International Stock Indexes • Nikkei 225 – Tokyo • FTSE 100 – London • Dax 30 – Germany • Hang Seng - Hong Kong => • Region and Country Indexes • Example: Morgan Stanley Capital International (MSCI) Euro Index Intro. to Financial Managment - Week 2

  17. Who are the providers (savers) and users (borrowers) of capital? • Households: Net savers (#1) • Non-financial corporations: Net users (borrowers) • Governments: Net borrowers (except ?) • Financial corporations: Slightly net borrowers, but almost breakeven Intro. to Financial Managment - Week 2

  18. Transfer of Capital from Savers to Borrowers • Direct transfer (e.g., corporation issues commercial paper to insurance company) • Through an investment banking house (e.g., IPO, seasoned equity offering, or debt placement) • Through a financial intermediary (e.g., individual deposits money in bank, bank makes commercial loan to a company) Intro. to Financial Managment - Week 2

  19. Cost of Capital • What do we call the price, or cost, of debt capital? • The interest rate • What do we call the price, or cost, of equity capital (stocks)? • Required return = dividend yield + capital gain Intro. to Financial Managment - Week 2

  20. Allocation of Funds and Interest Rates • Production opportunities • Time preferences for consumption • Risk • Expected inflation What four factors affect the cost of money? Intro. to Financial Managment - Week 2

  21. Risk-Expected Return Profile(Fig 2-2) Speculative Common Stocks Conservative Common Stocks Preferred Stocks Medium-grade Corporate Bonds Investment-grade Corporate Bonds EXPECTED RETURN(%) Long-term Government Bonds Prime-grade Commercial Paper U.S. Treasury Bills (risk-free securities) RISK Intro. to Financial Managment - Week 2

  22. Types of Risk • Default Risk • The inability to pay interest and/or principle payments of debt • Market/Liquidity Risk • The inability to sell at the value expected. • Maturity Risk • The longer until the security matures, the larger the risk. • Inflation Risk • The risk that inflation will be greater than originally measured. Intro. to Financial Managment - Week 2

  23. Ratings by Moody’s and Standard & Poors Key: Green text: Investment Grade Red text: High Yield (also called “Junk Bonds”)

  24. Term Structure / Yield Curve • Term structure of interest rates: the relationship between interest rates (or yields) and maturities. • A graph of the term structure is called the yield curve. U.S. Treasury yield curve copied from the Wall Street Journal, September 9, 2007. Intro. to Financial Managment - Week 2

  25. Last week’s U.S. Treasury Yield Curves Intro. to Financial Managment - Week 2

  26. Hypothetical Treasury and Corporate Yield Curves Intro. to Financial Managment - Week 2

  27. Assignment #2b: Yield Curve • For Wednesday, September 12, 2007: Assignment 2: In Excel, graph the U.S. Treasury Yield Curve. (5 pts) • Bring a copy to class with a sentence explaining what you believe will happen to short term rates in the future. • Go to: • http://www.treas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml • There you will find the daily U.S. Treasury rates (use Sept. 10 or 11, 2007). Intro. to Financial Managment - Week 2

  28. Financial Statements • “Kicking the tires!” or understanding how a company is doing… • You need to know how to interpret the financials of a company when you are in business… • Only three financial statements are of importance: • The Balance Sheet of a company • The Income Statement (or P&L Profit and Loss) • The Cash Flow Statement Keeping you above water Intro. to Financial Managment - Week 2

  29. The Balance Sheet • Left hand side of the balance sheet shows the assets of the company. • Assets are fixed (buildings, machines, land) or current (cash, receivables from customers, inventories). • The right hand side tells you how the company finances its assets (liabilities). • Financing can be done with equity (shareholders pay in capital and buy shares) or debt (long term debt and loans from banks or short term debt like short term facilities with banks or through delaying the payment of bills from suppliers i.e. so called accounts payable). Intro. to Financial Managment - Week 2

  30. Let us have a look at:

  31. Comparative Balance SheetMicrosoft (in millions) Intro. to Financial Managment - Week 2

  32. The Income statement • Covers a specific period (mainly year, half year or quarter) • Reflects sales performance, cost control and profitability • Operating Income is EBITDA (Earnings Before Interest and Tax) • NOPAT is EBIT minus (provisions for) Tax (calculate Microsoft’s NOPAT in the next slide) Server & Tools Revenue +20% Y/Y Growth Intro. to Financial Managment - Week 2

  33. Income Statement Q4- 2004 Intro. to Financial Managment - Week 2

  34. Cash Flow Statement • Shows the performance of the company over a period of time in generating cash. • Shows how the company uses that cash generated to invest in assets (both fixed and current), or to reduce the debt level by paying back loans. • Shows how the company acquires cash from outside (bank loans) when the cash generated is not enough to fund all ambitious plans of the company. The real money is here… Intro. to Financial Managment - Week 2

  35. Cash Flow (1) Where the cash comes from…. Intro. to Financial Managment - Week 2

  36. Cash Flow (2) Where the cash is used…. Intro. to Financial Managment - Week 2

  37. Facts and Figures… Your Potential. Our Passion ! …Flair and Feeling

  38. Interpreting your company’s performance (Ch. 2) • To understand howyour company is doing you need to know much more than just the financials. • You need to know the strategy, the competition, the market environment, the innovation, and the risks. • For all the different segments that your company is operating in… Nokia is much more then just Mobile Phones… Intro. to Financial Managment - Week 2

  39. Segment Performance Information Worker $2.9B ▲23% Client $2.8B ▲9% Server & Tools $2.3B ▲20% Mobile and Embedded Devices $70M ▲59% Microsoft Business Solutions $196M ▲9% Home & Entertainment $499M ▲3% MSN $588M ▲5% Intro. to Financial Managment - Week 2

  40. Key Business Risks Linux and non-commercial software Difficult foreign exchange comparables for 2005 Difficult 2005 comparables on PC and Server unit demand Reduction in Upgrade Advantage revenue Execution of business plan Ongoing legal risk For further information regarding risks and uncertainties associated with Microsoft’s business, please refer to the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Issues and Uncertainties” sections of Microsoft’s SEC filings, including, but not limited to, its annual report on Form 10-K and quarterly reports on Form 10-Q. Intro. to Financial Managment - Week 2

  41. Assignment #2c: Annual report • Your company is a S&P500 company and you will be able to find its latest annual reports on its website (investor relations) or at www.sec.gov. • Download the annual reports 2002-2006 and keep them in your files for quick reference. • Copy the Balance sheet, Income statement and Cash flow statement of each year to an EXCEL spreadsheet such that you can generate a 5 year overview (2002-2006) for each statement. • Perform a segment analysis and Business Risk assessment; what segments are the money makers which ones are the value destructors. • Now look at your figures and draw conclusions: • How have the assets developed in the balance sheet? • How has the company financed its assets over the years (mainly debt or equity)? • How has the sales growth been over the years? • And how has the profitability performed? • Is the company generating enough cash to fund its growth? • For what purposes is the company using the cash generated (pay back loans or invest in future expansion)? Intro. to Financial Managment - Week 2

  42. Assignment #2d: Annual report UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934 • Companies that follow the calendar year for reporting, there is 2 quarters (first half of 2007) more recent financial data available; download these data (10-Q form in sec.gov). • These companies may also have Q3 almost or just now available; check investor relations and the release of Q3 financials for your company and download them when available. • Now review your conclusions of #2a based on the latest financials and management reports. Intro. to Financial Managment - Week 2

  43. Other Performance measures • ROIC (Return on invested Capital) relating NOPAT (operating result after tax) with Capital invested (Fixed assets plus Net Working Capital). • EVA (Economic Value Added) calculating NOPAT after deduction of the Cost of Capital over the Capital invested. • MVA (Market Value Added) calculating the Market Value (common shares outstanding times share price per share) of the stock of the company minus all paid in capital (Equity Capital Supplied by Shareholders) Some websites for your information Intro. to Financial Managment - Week 2

  44. Assignment #2e: Calculate • For your company determine: • ROIC based on the latest available financials • MVA • EVA • Now compare the ROIC, MVA and EVA of the main competitor of your company. • Which company is performing better ? Recommended Reading Intro. to Financial Managment - Week 2

  45. The Federal Reserve System • The Board of Governors • The Fed Banks • The Federal Open Market Committee (FOMC) Intro. to Financial Managment - Week 2

  46. The Fed: The Board of Governors Intro. to Financial Managment - Week 2

  47. The Fed: The Fed Banks Intro. to Financial Managment - Week 2

  48. The Fed: The FOMC • The FOMC: • The Seven Governors, New York Fed President and 4 other Fed Presidents – 12 total members • Set Monetary Policy for the United States • In other words, the FOMC sets the “Federal Funds Rate” – The interest rate that banks borrow funds from each other • The “Fed Funds” rate determines the “Prime” rate or the interest rate that banks charge their “best” corporate customers • An Increase in the fed funds rate means borrowing is more “expensive.” • A decrease? Intro. to Financial Managment - Week 2

  49. The Fed: The FOMC Next Meeting: Sept. 18, 2007 • 2007 Members of the FOMC • MembersBen S. Bernanke, Board of Governors, ChairmanTimothy F. Geithner, New York, Vice ChairmanCharles L. Evans, ChicagoThomas M. Hoenig, Kansas CityDonald L. Kohn, Board of GovernorsRandall S. Kroszner, Board of GovernorsFrederic S. Mishkin, Board of GovernorsWilliam Poole, St. LouisEric S. Rosengren, BostonKevin M. Warsh, Board of Governors • Alternate MembersRichard W. Fisher, DallasSandra Pianalto, ClevelandCharles I. Plosser, PhiladelphiaGary H. Stern, MinneapolisChristine M. Cumming, First Vice President, New York Intro. to Financial Managment - Week 2

  50. The Fed: The Chairman Down .25% or ? Sept. 18, 2007 Ben Bernanke Intro. to Financial Managment - Week 2

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