Transcript Introduction to Financial Management FIN 102

Introduction to Financial
Management
FIN 102
Dr. Andrew L. H. Parkes
“A practical and hands on course on the valuation and
financial management of corporations”
Syllabus and Our Course

The syllabus provides an
outline of what we will do this
semester: Chapters 1 - 4 as
well as Chapters 12, 13 and
14 of the textbook.
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This week we will talk about
Chapter 1 and some of 2;
The role of financial
management and the
business environment
The required textbook
Lectures and Practice Problems
Lectures: 2 hours per week I will introduce
the new material to you
 Practice Problems: 2 hours we will do
assignments (@)from my slides and from
the textbook
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You will have to prepare assignments
for every class; there is NO class
without homework…(Hwk).

You will work on a group project
during the course and select a
S&P500 company that you would like
to work on with your team.
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You will simulate your own
investments and learn about financial
markets (e.g. investopedia.com Forbes).
Keep up to date with
Finance related issues
Grading
Mid-term test - 20%
 Final Exam
- 40%
 Homework
- 30%
 Quizzes
- 10%
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Total
- 100%
Financial Management (ch.1)
http://money.cnn.com/galleries/2007/fortune/0704/gallery.f100_employers.fortune/2.html
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What are the most admired
companies in the world?
(see www.fortune.com)
 Innovative companies
 High management quality
companies
 High employee talent
companies
 High product quality companies
 High return on investment
value companies
 Financial sound companies
 Social responsible (ethical)
companies
 Efficient use of assets
companies
Career Opportunities in Finance
1.
2.
3.
Money and capital
markets
Investments
Financial
management
Warren Buffett – The Oracle of Omaha - #2 Forbes
World’s Billionaires - $52 Billion
Responsibility of the Financial Staff
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Maximize stock value by:
– Forecasting and planning
– Investment and financing decisions
– Coordination and control
– Transactions in the financial
markets
– Managing risk
Who owns GEICO?
Role of Finance in a Typical
Business Organization
Board of Directors
President
VP: Sales
VP: Finance
Treasurer
VP: Operations
Controller
Credit Manager
Cost Accounting
Inventory Manager
Financial Accounting
Capital Budgeting Director
Tax Department
Sole proprietorships & Partnerships

Advantages
– Ease of formation
(to start-up the company)
– Subject to few regulations
– No corporate income taxes
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Disadvantages
– Difficult to raise capital
– Unlimited liability
– Limited life
Stores along the Street
Corporation
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Advantages
–
–
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Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages
– Double taxation
– Cost of set-up and report filing
(difficult)
Setting up a Corporation…
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The incorporators of the
corporation have to:
 Create a charter of the company
–
–
–
–
Name of the company
Types of activities of the company
Amount of capital stock
Number and names/addresses of
directors
 Define a set of so called bylaws for the
company
– How directors are elected
– Will shareholders have the first right
on newly issued shares (right of first
refusal)
– The conditions for changing the
bylaws of the company
3 Main decisions of Financial
Management

Investment decision: what assets
does the firm need to hold and in
what quantities?
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Financing decision: how should
these assets be financed? (debt or
equity/ short or long?)
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Asset management decision: how
should assets develop over time
with the growth/change of the
business?
Financial Goals of the Corporation
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The primary financial goal is
shareholder wealth
maximization, which translates
to maximizing stock price.
– Do firms have any responsibilities
to society at large?
– Is stock price maximization good
or bad for society?
– Should firms behave ethically?
Is stock price maximization the
same as profit maximization?
No, despite a generally high correlation
amongst stock price, EPS, and cash flow.
 Current stock price relies upon current
earnings, as well as future earnings and
cash flow.
 Some actions may cause an increase in
earnings, yet cause the stock price to
decrease (and vice versa).
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Creating Value…
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For stakeholders of the company
like:
– Customers (sustainable flow of
products and services)
– Suppliers (sustainable flow of raw
material orders)
– Employees (sustainable jobs with
career perspectives)
– Shareholders (growing share value
and dividends)
– Banks and Financial Institutions
(sustainable pay back of loans and
interest)
– The Government … (more profit is
more tax income)
The Textbook approach…
In reality companies create value
by…
 Increasing
Free
Cash flow (FCF)
 Reducing The
Weighted Average
Cost of Capital
(WACC%)

Increasing FCF or lowering WACC%
The Company Value =
Long Term FCF/ WACC%
Free Cash Flow is…
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NOPAT (Net Operating
Profit [Earnings before
Interest] After Tax)
+
Depreciation
–
The increase in Net
Working Capital (NWC)
–
Capital Expenditure
(CAPEX)
NOPAT you will find in the income statement
of your company
Depreciation you will find in the income
statement and cash flow statement of your
company
NWC = Accounts Receivables plus Inventories
minus Accounts Payables; the change from
your to year you can calculate (a decrease in
NWC from one year to another is a Cash In
Flow so this adds to FCF)
CAPEX you will find in the cash flow
statement it’s the amount spend on
investments…
Simple Valuation…
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So if Google Inc. in the Long Term can
generate a FCF of $ 3 b. And the WACC
of Google Inc. is 10% then the value of
Google Inc. is (follow the formula)
Company Value (Google Inc.) =
$ 3 b/0.10 = $ 30 billion
Of course this is an example and I just
made up the estimated FCF and WACC.
We will learn during the course how to
estimate FCF and WACC to enable us to
calculate the value of any company …
under certain assumptions
This in fact is the core capability of
finance
Once we can calculate the value of a
company periodically, we can calculate
if the company is in fact creating value
for its stakeholders or destroying value
Assignment 1: Value your S&P company

You have picked a S&P500 company to work on during
the course:
– Try to figure out what the Long Term Free Cash Flow is of your
company by reading its annual reports (1999-2005) Limit
yourself to the financial paragraph (5 years is fine).
– Assume your companies’ WACC is anywhere in between 5% and
25%; 5% if your company is extremely financially solid and
rather low risk, 25% if your company has a very volatile
performance over the last 5 years and a bumpy road ahead and
is an extremely high risk business (you may pick any WACC in
between).
– Step 1: Calculate the Company Value of your company
under these assumptions.
Step 2 in Valuing your S&P company
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Now look up the Long Term debt from the latest
available Balance Sheet (sure you will find it
under liabilities)
Subtract this figure from the Company Value you
found in 1a)
Now you have the companies’ equity value
Divide that number by the number of common
shares outstanding
Now you find the equity value per share
outstanding or the calculated share price of your
company
Compare this share price with the current share
price of your company (take the latest closing
price for comparison)
Does the market value the share of your
company higher (over priced) or lower
(under priced) then what you calculated?
Why do you think there is a difference?
Help…
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You can find your company’s
figures at www.sec.gov
– Go to Filings and Forms (EDGAR)
– Search for company filings
– Look up the ticker symbol of your
company at Yahoo Finance
(symbol lookup)
– Plug in the found ticker symbol
at EDGAR
– Try GOOG and you will find all
the filings of Google Inc.
– Now search for the latest 8 and
10-K (annual reports) filings or
10-Q (quarterly reports)
More help…
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Go to Yahoo Finance
Plug in the ticker of your company
See the left hand buttons “More
on…”
For a quick scan of your company
Click Profile, Key Statistics
For Historical Share Prices click…
Professional research on your
company…
Company events, news on your
company…
Everything is here…Use it!
So summarizing …
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Your Homework is:
– 1) form a team 4-5 members max.
– 2) pick a S&P 500 company
– 3) download FY 2006 annual report
of the company you have chosen
– 4) Try to calculate Free Cash Flow
– 5) Assume that the Cost of Capital
is 10% (WACC%)
– 6) Calculate The Value of the
company by: Value= Free Cash
Flow/Cost of Capital
Who is this man?
Did he create value
in his companies?