CHapter 9: FINANCE

1. CHapter9: FINANCE Chapter 10: SECURITIES MARKETS Trading Financial Resources Using Funds To Maximize Value

2. Finance Worksheet

3. WHAT MOTIVATES FINANCIAL DECISIONS

4. 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 %

5. KEY FINANCIAL RATIOS

6. 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

7. 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.

8. MANAGING WORKING CAPITAL: CURRENT EVENTS • Net Working Capital: • Difference between current assets and current liabilities • Working capital must be managed • Appropriate level of current assets • Current liabilities needed to finance activities

9. 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

10. 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

11. SHORT-TERM FINANCING • Spontaneous Financing • Trade Credit • Short-Term Bank Loans • Line of Credit • Revolving Credit • Factoring • Commercial Paper

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

13. 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.

14. 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.

15. USING NET PRESENT VALUE TO EVALUATE CAPITAL BUDGETING PROPOSALS Present Value – How much a given amount of cash received in a future period is worth today, given the time value of money. • 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

16. SOURCES OF LONG-TERM CAPITAL: LOANERS VS. OWNERS

17. SOURCES OF DEBT FINANCING • Long-term loans • Private placements • Issuing notes or bonds Cons Pros

18. 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

19. Chapter 10: SECURITIES MARKETS Trading Financial Resources Trading Financial Resources

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

21. 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

22. PREFERRED STOCK • Stock that gives its holder preference over common stockholders. • No Voting Rights • Claim on Assets • Payment of Dividends • Cumulative Feature

23. 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 Foundations Stock Market Summary

24. BONDS: A FORMAL IOU • Long-term debt issued by a corporation or government • Maturity Date • Par Value • Coupon Rate

25. 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.

26. 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

27. Bond Credit Quality Ratings -Rating Agencies Credit Risk Moody’s Standard Fitch & Poor’s Ratings 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

28. European Sovereign Credit Ratings SOURCES: MOODY'S, STANDARD & POOR'S, FITCH July 25, 2011

29. 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. • TheWall Street Journal tactfully refers to these securities as “high yield bonds.”

30. 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 Foundations Bond Market Summary

31. 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 TRADING SECURITIES: THE PRIMARY MARKET

32. INVESTMENT BANKS • Financial Intermediary • Assists firm with IPO • Planning • Marketing • Assessment • Determining how to structure the IPO is key role of Investment Banks

33. 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

34. State Regulations Federal Legislation Securities Act 1933 Prohibits misrepresentation, deceit or other forms of fraud 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) REGULATIONS OF SECURITIES MARKETS: ESTABLISHING CONFIDENCE

35. 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.