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Semester 1 2008 CORPORATE FINANCE 2201 AFE WELCOME STUDENTS!!

Semester 1 2008 CORPORATE FINANCE 2201 AFE WELCOME STUDENTS!!. About Your Convenor Mirela Malin B Bus (Acct) BIntFin (Hons) PhD Candidate. My research interests include : Asset Pricing Multifactor Models Behavioural Finance Behavioural Models Continuation and Reversal Strategies

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Semester 1 2008 CORPORATE FINANCE 2201 AFE WELCOME STUDENTS!!

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  1. Semester 1 2008CORPORATE FINANCE2201 AFEWELCOME STUDENTS!!

  2. About Your ConvenorMirela MalinB Bus (Acct) BIntFin (Hons) PhD Candidate My research interests include: • Asset Pricing • Multifactor Models • Behavioural Finance • Behavioural Models • Continuation and Reversal Strategies • Combined Return Predictability Strategies

  3. Teaching Team Course Convenor: Mirela Malin Office: G06 Room 2.22 Phone: 5552 7719 Email: m.malin@griffith.edu.au Consult: Thursday 2 - 4 pm Tutors: Michael Howard Michael.Howard@student.griffith.edu.au Eliot Sanft e.sanft@griffith.edu.au Office: AFE tutors room in G06 1.34 and 1.35 Telephone: TBA, Consultation Time: TBA

  4. Course Comments • Most important ingredients of success in Corporate Finance course is: • Attend lectures • Consistent tutorial effort • NOTE: Tutorials start in Week 2!!! • Each week there will be tutorial homework • Be aware of the Homework rules in the course outline • Mid Semester Exam – Saturday 26th April - Week 7 • Final Exam – End of Semester Exam Period • Text: Ross, Westerfield and Jordan 7th Edition

  5. Week 1Lecture 1 Ross, Westerfield & Jordan 7e Chapter 1 Chapter 2

  6. Fundamental Concepts for Today’s Lecture • What is Corporate Finance? • The role of a financial manager • Understand the goals of financial management • Explain the Agency problem • The role of financial markets • Financial statements issues

  7. What is Corporate Finance? • Corporate Finance is the study of ways to answer three important questions: • What long-term investments should the firm take on? • Where will we get the long-term financing to pay for the investment? • How will we manage the everyday financial activities of the firm?

  8. Financial Management Decisions • Capital budgeting • What long-term investments or projects should the business take on? • Capital structure • How should we pay for our assets? • Should we use debt or equity? • Working capital management • How do we manage the day-to-day finances of the firm?

  9. Forms of Business Organization • Three major forms: • Sole proprietorship • Partnership • General • Limited • Corporation • S-Corp • Limited liability company

  10. Advantages Easiest to start Least regulated Single owner keeps all the profits Taxed once as personal income Disadvantages Limited to life of owner Equity capital limited to owner’s personal wealth Unlimited liability Difficult to sell ownership interest Sole Proprietorship

  11. Advantages Two or more owners More capital available Relatively easy to start Income taxed once as personal income Disadvantages Unlimited liability General partnership Limited partnership Partnership dissolves when one partner dies or wishes to sell Difficult to transfer ownership Partnership

  12. Advantages Limited liability Unlimited life Separation of ownership and management Transfer of ownership is easy Easier to raise capital Disadvantages Separation of ownership and management Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate) www.nolo.com Corporation

  13. Goal Of Financial Management • What should be the goal of a corporation? • Maximize profit? • Minimize costs? • Maximize market share? • Maximize the current value of the company’s stock?

  14. Goal Of Financial Management • The financial manager of a company makes decisions on behalf of the shareholders. • Thus the correct goal is to maximise shareholder’s wealth. • That is, to maximise the value of the existing shares. • Does this mean we should do anything and everything to maximize owner wealth?

  15. The Agency Problem • Agency relationship • Principal hires an agent to represent his/her interest • Stockholders (principals) hire managers (agents) to run the company • Agency problem • Conflict of interest between principal and agent • Agency costs • Direct • Indirect

  16. Managing Managers • Managerial compensation • Incentives can be used to align management and stockholder interests • The incentives need to be structured carefully to make sure that they achieve their goal • Corporate control • The threat of a takeover may result in better management • Other stakeholders • Governments, suppliers, employees

  17. Financial Markets • What is a Market? A Market is the means through which the buyers and sellers are brought together. • Role of a Financial Market • To channel savings into investments • Enable sale and purchase of financial assets • Cash flows to the firm – Fig. 1.2 page 15 • Primary vs. secondary markets • Dealer vs. auction markets • Listed vs. over-the-counter securities • NYSE • NASDAQ

  18. End of Chapter 1

  19. Week 1Lecture 1 Ross, Westerfield and Jordan 7e Chapter 2 Financial Statements, Taxes and Cash Flows

  20. Key Concepts and Skills • Know the difference between book value and market value • Know the difference between accounting income and cash flow • Know the difference between average and marginal tax rates • Know how to determine a firm’s cash flow from its financial statements

  21. Balance Sheet • The balance sheet is a snapshot of the firm’s assets and liabilities at a given point in time • Balance Sheet Identity • Assets = Liabilities + Stockholders’ Equity • Assets – Liabilities = Stockholders’ Equity • Net Working Capital • Current Assets – Current Liabilities • Positive when the cash that will be received over the next 12 months exceeds the cash that will be paid out • Usually positive in a healthy firm

  22. The Balance Sheet - Figure 2.1

  23. Liquidity, MV vs BV, D vs E • Liquidity • Ability to convert to cash quickly without a significant loss in value • Liquid firms are less likely to experience financial distress • But liquid assets earn a lower return • Trade-off to find balance between liquid and illiquid assets • Market Vs. Book Value • The balance sheet provides the book value of the assets, liabilities and equity. • Market value is the price at which the assets, liabilities or equity can actually be bought or sold. • Which is more important to the decision-making process? • Debt Vs. Equity • Financial Leverage

  24. US Corporation Balance Sheet – Table 2.1

  25. Income Statement • The income statement measures the performance of a firm over a specified period of time. • Revenues – Expenses = Income • Matching principle – show revenue when it accrues and match the expenses required to generate the revenue

  26. US Corporation Income Statement – Table 2.2

  27. Taxes • The one thing we can rely on with taxes is that they are always changing • Marginal vs. average tax rates • Marginal – the percentage paid on the next dollar earned • Average – the tax bill / taxable income • For financial decision making purpose, the marginal tax is used

  28. The Concept of Cash Flow • Cash flow is one of the most important pieces of information that a financial manager can derive from financial statements • Cash Flow Identity: • Cash Flow From Assets = Cash Flow to Creditors + Cash Flow to Stockholders Cash generated from utilizing assets = Cash paid to those that finance the purchase of those assets (Creditors + Stockholders)

  29. Cash Flow From Assets • CFFA = CFC + CFS • CFFA = OCF – NCS – ΔNWC • Cash Flow From Assets (CFFA) = Operating Cash Flow (OCF) – Net Capital Spending (NCS) – Changes in Net Working Capital (ΔNWC)

  30. Cash Flow From Assets • CFFA = OCF – NCS – ΔNWC • OCF = EBIT + depreciation – taxes = $547 694 + 65 - 212 = 547 • NCS = end net fix. assets – begin net fix. assets + depr. = $130 1709 - 1644 + 65 = 130 • Changes in NWC = ending NWC – beginning NWC = $330 1014 - 684 = 330 ‘05 1403(CA) - 389(CL) - ’04 1112(CA) - 428(CL) • CFFA = 547 – 130 – 330 = $87

  31. Cash Flow from Assets • Operating cash flow: • EBIT 694.00 • + Depreciation + 65.00 • – Taxes – 212.00 $547 Less • Net capital spending: • Ending net fixed assets 1,709.00 • – Beginning net fixed assets – 1,644.00 • + Depreciation + 65.00 $130 Less • Change in net working capital: • Ending net working capital 1,014.00 • – Beginning net working capital 684.00 $330.00 • Cash flow from assets: $87.00

  32. Cash Flow to Creditors and Shareholders • CFFA = CFC + CFS • CFC = Interest Paid – Net New Borrowings • CFFA = CFC + CFS • CFS = Dividends Paid – Net New Equity

  33. Cash Flow to Creditors and Shareholders • CFC = interest paid – net new borrowing = $24 70 - 46 = 24 ’05 LTdebt 454 – ’04 LTdebt 408 • CFS = dividends paid – net new equity = $63 103 - 40 = 63 ’05 CS. 640 – ’04 CS 600 • CFC + CFS = 24 + 63 = $87

  34. Cash Flow to Creditors and Shareholders • Cash flow to creditors: • Interest paid 70.00 • – Net new borrowing – 46.00 $24.00 Plus • Cash flow to shareholders: • Dividends paid 103.00 • – Net new equity raised 40.00$63.00 • Cash flow to creditors and shareholders = $87

  35. Cash Flow Identity • CF Identity: CFFA = CFC + CFS • CFFA = 547 – 130 – 330 = $87 • CFC + CFS = 24 + 63 = $87

  36. Cash Flow Summary Table 2.5

  37. Lecture 1 Key Points • Three main areas in Corporate Finance • Capital Budgeting • Capital Structure • Working Capital Management • Goal of financial management = maximise shareholders value • Book value differs from Market value • It is the market value we want to maximise • Cash flows are important in valuation • Cash flow identity: CFFA = CFC + CFS

  38. Basic Algebra Reminders.. Order of Operations: BODMAS • Brackets first then • Other grouping symbols (eg: LN(x), xa, x-1) • Division and • Multiplication next • Addition and • Subtraction last

  39. Example • 10+5[(3/10)7-1] = 5.001 • First we have to remove the square bracket • But before that we remove the round bracket by performing the division • Then the power and subtraction in the square bracket • Multiplication by 5 • Addition of 10

  40. Basic Algebraic Identities and Laws (1) • a(b + c) = ab + ac • 3(2+5) = 3*2 + 3*5 • (a + b) / c = a/c + b/c • (9+7)/5 = 9/5 + 7/5 • (a / b) / (d / c) = (a / b) * (c / d) = ac / bd • (3/2)/(5/7) = (3/2)*(7/5) = (3*7)/(2*5)

  41. Basic Algebraic Identities and Laws (2) • x-1 = 1/x , x-a = 1/xa , bx-1 = b/x , bx-a = b/xa • 5-1 = 1/5 , 5-2 = 1/52 3*5-1 = 3/5 , 3*5-2 = 3/52 • x1/2 = √x , x1/a = a√x , xb/a = a√(xb) • 91/2 = √9 , 91/3 = 3√9 , 93/2 = 2 √(93) • am * an = am+n , (am)n = am*n , am * bm = (a*b)m • 23 * 24 = 23+4 = 27 , (23)4 = 23*4 , 24 * 34 = (2*3)4 • am/an = am-n , am/bm = (a/b)m • 25/22 = 25-2 , 23/53 = (2/5)3

  42. Basic Algebraic Identities and Laws (3) • LN means logarithm with the base of e • e is a constant (2nd function on some calculators) • There is a button on the calculator for LN and e • LN(a*b) = LN(a) + LN(b) • LN(3*2) = LN(3) + LN(2) • LN(a/b) = LN(a) – LN(b) • LN(3/2) = LN(3) – LN(2) • LN(xa) = a*LN(x) • LN(32) = 2*LN(3) • If ℮x = y then LN(y) = x • e2 = 7.389056099 then LN(7.389056099) = 2

  43. End of Chapter 2

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