Class 2 - University of Southern California
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Transcript Class 2 - University of Southern California
Overview of Finance
Week 1 – August 26 and 28, 2002
J. K. Dietrich - FBE 432 – Fall, 2002
Financial Analysis, Functions,
and Careers
August 28, 2002
J. K. Dietrich - FBE 432 – Fall, 2002
FBE 432 Objectives
Analyze
and communicate implications of
financial theory using cases
Understand finance careers and functions
Refine and expand specific financial
analytical skills
Responsibility for learning is with you
Requirements are clear: review, prepare,
and participate
J. K. Dietrich - FBE 432 – Fall, 2002
Financial Analysis
Analyze
performance of corporations (and
projects)
– What should be the objective of financial
management?
– How do we determine whether management is
good or bad?
Focus
in finance is on the future
– Who knows what will happen in the future?
– How can we deal with our uncertainty
concerning the future?
J. K. Dietrich - FBE 432 – Fall, 2002
Financial Functions
All
finance is concerned with value
Corporate decision-making
– Investments, including mergers and
acquisitions and divestitures (disinvestment)
– Growth and financing needs
– Management of working capital
Chief
financial officer is responsible for
these decisions
– Requires project analysts, treasury assistants
J. K. Dietrich - FBE 432 – Fall, 2002
Investment Banking
Investment
bankers assist corporations in
their dealings with financial markets
– Issuing securities
» Initial public offerings (IPOs) or secondary offerings
» Issuing debt or preferred stock to private investors
(private placements) or to public markets
– Mergers and acquisitions
– Advising and valuing firms
This
services are corporate finance or
investment banking services
J. K. Dietrich - FBE 432 – Fall, 2002
Investment Banking (continued)
Investment
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bankers also buy and sell securities
Brokers (retail and institutional)
Market makers
Asset management
Research
Investment
banks are classified in a variety of
ways
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Full line
Boutique
Regional
“Bulge bracket”
J. K. Dietrich - FBE 432 – Fall, 2002
Investment Banking (continued)
Investment
bankers need many types of
financial skills
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Analysts for research
Analytical support in doing deals
Traders
Marketing securities to retail and institutional
markets
Investment
banks hire junior analysts and
associates at entry level
J. K. Dietrich - FBE 432 – Fall, 2002
Investment Banking and Markets
Investment
bankers assist corporations (and
governments) in designing securities for
sale to public or private markets
Employees of investment banks are usually
called are said to work on the sell side of a
securities firm, or are called sell side
analysts or sell side traders or brokers
J. K. Dietrich - FBE 432 – Fall, 2002
Investors
Individuals
and institutions invest savings in
securities (and other investments)
Individuals are usually divided into the retail
market (small investors) and affluent investors
(private banking)
Buying and selling securities in the retail market
Advising and investing for individuals is financial
advising and asset management
Individuals often invest in mutual funds and save
in pension plans
J. K. Dietrich - FBE 432 – Fall, 2002
Institutional Investors
Pension
funds, mutual funds, insurance
companies, and specialized investment
vehicles for wealthy investors (e.g. hedge
funds) are called institutional investors
Institutional investors require analysts and
portfolio managers to invest funds
Employees of institutional investors are
usually said to be on the buy side, as for
example a buy-side analyst or a buy-side
trader
J. K. Dietrich - FBE 432 – Fall, 2002
Specialized Investment Vehicles
Venture-capital
firms provide financing to
new firms, often firms in new technologies,
requiring both technical and financial skills
Hedge funds are unregistered investment
vehicles for wealthy investors’ or
institutional funds, often using complex
investment strategies requiring sophisticated
financial analytical skills
J. K. Dietrich - FBE 432 – Fall, 2002
Developments in Finance
Financial
theory has developed to value
financial instruments like options and swaps
Technology has developed to enable
accounting and trading for complex
financial claims like collateralized
mortgage obligations (CMOs)
Trading and valuing these instruments and
advising corporations on how to use them to
manage risk demands highly developed
research departments
J. K. Dietrich - FBE 432 – Fall, 2002
Commercial Banking
Commercial
banks make loans to
corporations and individuals
Corporate commercial bankers provide a
variety of services to corporations,
including cash management and lending
Banks require financially trained
individuals to call on corporations and
analyze corporate customers
J. K. Dietrich - FBE 432 – Fall, 2002
Finance Career Paths
Many
individuals move between financial
functions in corporations and investment
banking, asset management, commercial
banking, and financial advising over the
course of their careers
Research, marketing (selling), deal-making,
and advising require varying levels of
interpersonal skills
Risk tolerance and energy requirements
vary in different finance career paths
J. K. Dietrich - FBE 432 – Fall, 2002
Next Time – August 28
Review
valuation approaches
Read for practice, The Union Carbide Deal
(Abridged)
– Outline issues at issue in the case
– What role do investment bankers play?
– How are they compensated?
J. K. Dietrich - FBE 432 – Fall, 2002
Introduction to Valuation and
Review
August 28, 2002
J. K. Dietrich - FBE 432 – Fall, 2002
Value and Valuation
Finance
objective function is to maximize
owners’ value
Value is the present value of future cash
flows at the risk-adjusted discount rate
Valuation principles are the same whether
we are valuing stocks, bonds, real estate, or
corporations
The challenge is to estimate the cash flows
and choose a discount rate
J. K. Dietrich - FBE 432 – Fall, 2002
Corporate Cash Flows
Corporate
cash flows are similar to all firms’ cash
flows, that is, they come from cash revenues
minus cash costs
Because of tax laws and standard reporting
conventions, corporate cash flows are more
standardized
Value of claims on corporations can be calculated
separately (e.g. stock and bond valuation) or in the
aggregate (so-called entity approach)
J. K. Dietrich - FBE 432 – Fall, 2002
Future Corporate Cash Flows
Since
value comes from future cash flows
and the future is unknown, future cash
flows must be estimated
The future is usually divided into two or
more parts
– Forecast period and continuing value period
– Rapid growth period and normal growth period
Choice
of division depends on case and data
available
J. K. Dietrich - FBE 432 – Fall, 2002
Cash Flow Determination
Items From the Income Statement
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Revenues (R)
Cash Expenses (W)
Non-Cash Expenses (Dep)
Capital Expenditures (Capex)
Cost of Goods Sold (CGS):
» Excludes depreciation
– Interest Expense (Int)
– Taxes (T)
J. K. Dietrich - FBE 432 – Fall, 2002
Cash Flow Determination
Other
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Items
Tax Rate (t)
Repayment of Principal (P)
Changes in Net Working Capital (DNWC)
Permanent Debt (D)
J. K. Dietrich - FBE 432 – Fall, 2002
Definition of Earnings Components
Earnings
Before Interest & Taxes [EBIT]
R-(W+Dep+CGS)
Earnings
Before Interest, Taxes,
Depreciation (and Amortization) EBITD(A)
EBIT+Dep+(Amort)
J. K. Dietrich - FBE 432 – Fall, 2002
Definitions of Earnings Components
Pre-Tax
Income
– [EBIT-Int]
Tax
Bill [T]
– t(EBIT-Int)
Net
Income
– NI =Pre-Tax Income - T
J. K. Dietrich - FBE 432 – Fall, 2002
Cash Flow Definitions
Levered
Cash Flow [to equity] {LCF or FTE}
Money that goes to stockholders account
[R-(W+Dep+CGS+Int)](1-t)+Dep-Capex-P-DNWC
Unlevered
Cash Flow {UCF}
Cash flow that would occur if there was no debt
(1-t)EBIT+Dep-Capex -DNWC
J. K. Dietrich - FBE 432 – Fall, 2002
Next Week – September 4
Review
valuation techniques and relate to
case materials
Prepare Eskimo Pie Case
Form groups for group case analyses
following Eskimo Pie
J. K. Dietrich - FBE 432 – Fall, 2002