CHAPTER 9: FINANCE

Using Funds To Maximize Value

CHAPTER 10: SECURITIES MARKETS

Trading Financial Resources

Finance Worksheet

WHAT MOTIVATES FINANCIAL DECISIONS

1.

2.

What types of assets do we need to achieve goals?

How do we get the funds we need?

• Evaluate financial performance • Plan financial resources • Manage working capital • Evaluate investment opportunities • Determine appropriate strategy

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

KEY FINANCIAL RATIOS

RATIO Current Inventory Turnover Debt-to-equity Debt-to-assets Return on equity Return on assets Earnings per share TYPE HOW IT IS COMPUTED

Liquidity: ability to pay short-term liabilities.

Current Assets / Current Liabilities Asset Management: how firm is using assets to generate revenue.

Cost of Good Sold / Average Inventory Leverage: extent to which a firm relies on debt.

Leverage: measures the extent to which a relies on debt Total Debt / Total Owner’s Equity Total Debt / Total Assets (Net Income – Preferred Div) / Avg Common Stock Equity Profitability: compares the amount of profit compared to resources invested Profitability: compares the amount of profit compared to resources invested Profitability: compares the amount of profit compared to resources invested Net Income / Average Total Assets (Net Income – Pref Dividends) / Avg # of Shares Out

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

FINANCIAL PLANNING: PROVIDING A ROAD MAP FOR THE FUTURE     What assets must be obtained?

How much additional financing is needed?

How much can the firm generate Internally? Externally?

When will external financing be required?

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.

CASH BUDGET

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

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

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

SHORT-TERM FINANCING

 Spontaneous Financing  Trade Credit  Short-Term Bank Loans  Line of Credit  Revolving Credit  Factoring  Commercial Paper

BORROWING MONEY

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

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.

COMPARING CASH FLOWS THAT OCCUR AT DIFFERENT TIMES

Managers must evaluate costs and benefits of investment 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.

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

SOURCES OF LONG-TERM CAPITAL: LOANERS VS. OWNERS

Equity Financing

– owners.

Debt Financing –

creditors.

Capital Structure – the mix of equity and debt financing a firm uses for financing needs.

SOURCES OF DEBT FINANCING

 Long-term loans  Private placements  Issuing notes or bonds Pros Cons Debt is a legally binding agreement to repay the money plus interest Debt requires fixed payments Many lenders require collateral which lenders can use to recover balance Interest payments are tax-deductible Avoids additional investment of stockholders Some lenders impose covenants on the borrower

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

FINANCIAL LEVERAGE: USING DEBT TO MAGNIFY GAINS

   Heavy debt in capital structure Potential high returns to owners Increased risk

CHAPTER 10: SECURITIES MARKETS

Trading Financial Resources Trading Financial Resources

BASIC TYPES OF FINANCIAL SECURITIES

Three major types of securities that are traded in markets:

 Common Stock  Preferred Stock  Bonds

SECURITIES MARKETS

 Primary Market - where corporations raise additional capital by issuing and selling

newly issued

securities

Investors Funds Stocks & Bonds

Primary Securities Market

Debt & Equity Securities Corporations Returns to Investors: Dividends, Interest, Capital Gains

Additional Funds Support:  Expansion of facilities  Research and Product Development  Adoption of New Technologies  Other strategic initiatives

Long term financing

 Secondary Market – involves trades of

previously issued

securities

COMMON STOCK: A SHARE OF CORPORATE OWNERSHIP The basic form of ownership in a corporation  Voting Rights  Right to Dividends  Capital Gains  Preemptive Rights  Right to Residual Claim on Assets

PREFERRED STOCK

 Stock that gives its holder preference over common stockholders.

 No Voting Rights  Claim on Assets  Payment of Dividends  Cumulative Feature

Foundations Stock Market Summary

Company

Andrews Baldwin Chester Digby Erie Ferris

Close

$8.89

$2.54

$3.47

$0.61

$9.10

$9.09

Change

$4.20

($0.94) ($6.24) ($2.00) $0.44

($2.71)

Shares

2,879,847 2,624,052 2,814,010 2,879,847 2,399,873 2,760,252

MarketCap ($M)

$26 $7 $10 $2 $22 $25

Book Value

$7.72

$5.09

$6.93

$1.22

$8.20

$8.83

EPS

$0.59

($0.15) ($0.97) ($3.56) $1.19

$0.34

Dividend

$0.00

$0.00

$0.00

$0.00

$0.25

$0.00

Yield

0.0% 0.0% 0.0% 0.0% 2.7% 0.0%

P/E

15.1

-17.2

-3.6

-0.2

7.7

27.0

      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

BONDS: A FORMAL IOU

 Long-term debt issued by a corporation or government  Maturity Date  Par Value  Coupon Rate

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.

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

Bond Credit Quality Ratings -Rating Agencies

Credit Risk Moody’s Investment grade

   Highest quality High quality (very strong) Upper medium grade (strong) Aaa Aa A Baa  Medium grade

Not investment grade

      Lower medium grade (speculative) Low grade (speculative) Poor quality (may default) Most speculative No interest paid or bankruptcy petition C In default C Ba B Caa Ca

Standard & Poor’s

AAA AA A BBB BB B CCC CC D D

Fitch Ratings

AAA AA A BBB BB B CCC CC C D

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.

 The Wall Street Journal tactfully refers to these securities as “high yield bonds.”

Foundations Bond Market Summary

Company

Andrews Baldwin     

Series#

11.0S2004

12.0S2006

13.0S2008

11.0S2004

12.0S2006

13.0S2008

BOND MARKET SUMMARY Face Yield

$866,667 $1,733,333 $2,600,000 11.0% 11.6% 11.9% $866,667 $1,733,333 $2,600,000 11.0% 11.6% 11.9%

Close

$100.34

$103.74

$109.36

$100.34

$103.74

$109.36

Bond series# interest rate S year you pay back Face cash you received and how much you will have to pay back at maturity Yield bond interest / trading price Close what it is trading for today- and what you would pay to retire early S&P = risk rating AAA – AA- A- BBB-….D

S&P

BB BB BB BB BB BB

TRADING SECURITIES: THE PRIMARY MARKET  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

INVESTMENT BANKS

 Financial Intermediary  Assists firm with IPO  Planning  Marketing  Assessment 

Determining how to structure the IPO is key role of Investment Banks

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

PERSONAL INVESTING

 What are your short-term and long-term goals?

 Given your budget, how much are you able to invest?

 How long can you leave your money invested?

 How concerned are you about the tax implications of your investments?

 How much tolerance do you have for risk?

 DIVERSIFICATION

DIRECT STOCK PURCHASE PLANS

 Many Corporations offer Direct Stock Purchase Plans  Purchase stock direct from company  Dividend Reinvestment Plans (DRIPS) allow current stockholders to reinvest dividends to purchase additional stock

STRATEGIES FOR INVESTING IN SECURITIES  Investing for Income  Market Timing  Value Investing  Investing for Growth  Buying and Holding

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.