Introduction to Financial Management FIN 102

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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.

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

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.

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%

Total - 100%

Financial Management (ch.1)

http://money.cnn.com/galleries/2007/fortune/0704/gallery.f100_employers.fortune/2.html

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

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

VP: Sales

Treasurer

Credit Manager

Inventory Manager

Capital Budgeting Director

President

VP: Finance

Controller

VP: Operations

Cost Accounting

Financial Accounting

Tax Department

Sole proprietorships & Partnerships

Advantages

Ease of formation

(to start-up the company)

Subject to few regulations

– No corporate income taxes

Disadvantages

Difficult to raise capital

Unlimited liability

– Limited life

Stores along the Street

Corporation

Advantages

– 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…

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?

Financing decision: how should these assets be financed? (debt or equity/ short or long?)

Asset management decision: how should assets develop over time with the growth/change of the business?

Financial Goals of the Corporation

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).

Creating Value…

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…

NOPAT ( N et O perating

P rofit [Earnings before

Interest] A fter T ax)

+

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…

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

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…

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…

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 …

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?

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