# Equity

```Strategic Capital Group
Workshop #1: Investment
Fundamentals
Agenda
Introduction to USIT &amp; SCG
Creating a Company
Financial Statements
Raising Capital
Exercise and Closing
Meet the USIT Shirt Company
Currently run out of Parker’s
low cost, awful quality t-shirts
to any suckers who will buy
them.
We sell t-shirts for \$20 each, and on sell 100 per year
The \$2,000 of sales we make each year is
referred to as revenue
Price x Volume = Revenue
We pay Parker’s little brother \$2 per shirt to
assemble and \$3 per shirt for the input
materials.
This \$5 per shirt of costs are referred to as
cost of goods sold, or the direct costs of the
inputs and labor that goes into the product
Cost per unit x Volume = Cost of Goods Sold
Benedikt, the CEO, who does not actually
make the products, gets paid a fixed \$500
salary per year.
The \$500 paid to him is referred to as an
operating expense
Operating expenses are not the same as
cost of goods sold because they reflect
costs uninvolved in production
Now how to we represent the state of
The Income Statement
Revenue
-COGS
Gross Profit
-Operating Expenses
Net Income
\$2,000
500
\$1,500
500
\$1,000
• Tells us how much the
cost to sell the products,
all the way down to the
leftover profit.
• Typically shows the state
of the business for a year
or a quarter of a year
• Important to know how
The Income Statement
Key terms:
Gross Profit
\$1,500
= 75%
Gross Profit Margin =
Revenue
\$2,000
Net Income
\$1,000
= 50%
Net Margin =
Revenue
\$2,000
After paying off all expenses and costs, 50% of every dollar of
sales will be left over as profit.
As this percentage increases, the amount of costs per dollar of sales
are declining and the business is becoming more cost efficient
Parker contributed \$500 of cash
dollars
\$200 was used to buy a t-shirt
making machine.
The Balance Sheet
Assets
=
What you own
Cash
Machinery
\$1,000
\$500
\$800
\$200
Liabilities
What you owe
Loan from Ben \$500
+
Equity
What’s
contributed
and left over
Contributed Capital
\$500
Sanity Check #1
• We’ve had an introduction to two financial
statements (forms that describe a business’s
condition)
– Balance Sheet – tells us about the resources of the
business and how they were funded
– Income Statement – tells us how much we sold
and how much we spent during a period
Expanding
for cheap shirts has
developed, meaning demand
for USIT Co.’s shirts has
skyrocketed.
Making t-shirts out of Parker’s
enough, and we need to
expand.
In order to expand, we need
machines, and more
inventory.
To get more assets, we need
more capital!
Options for Raising Capital –
“Financing”
Debt (liabilities)
Equity
Types of debt:
Key Terms:Types of Equity:
Equity
• Loans –Debt
offers of money now
• Common stock
in order for a promise of a
orPublic
sharesOffering
of a company
that time
• stock,
Initial
– the first
• Face Value – the amount of money
return of capital and interest
onputs
stockitsexchanges.
company
stock for sale to
returned to the lender at the end of
later on
These
represent
fractional
any investor through a stock
the loan/bond
• Bonds – a loan that can trade
ownership
exchangeof a company and claims
• Maturity – the amount of time
ownership on public
voting rights
and profits
• onSecondary
Market
– the market
before the loan is due back
exchanges
• Preferred
Stock – stock
that has no
where investors
can publicly
• Interest/Coupon – the required
voting
right,stock
but has guaranteed
exchange
payments to investors
payments from a pool of profits
So which do we choose?
Debt
Equity
no control over the company
• Easy to raise
• Good tax implications
• You have no obligation to pay
anyone. Investors are not
guaranteed distributions
• You are legally required to pay
interest and principal or risk
bankruptcy
• You are essentially selling
you sell more than 51%, your
decisions can be vetoed
• Potential for hostile investors
…and how do we do it?
Step 1: Find an investment banker
Step 2: Have your investment banker
overwork his junior bankers to figure
out what your company is worth,
then find people to invest in your
newly issued securities
Step 3: Figure out how much money
you need to raise, then sell that
equity)
Sanity Check #2
• We’ve talked about the two ways to raise
capital:
– Debt – loans with obligatory interest payments
– Equity – stock with no obligation to pay, but gives
away voting rights
USIT Co.’s Capital Decision
Debt
Equity
• \$10M of “senior” bonds at a
5% interest rate
• \$10M of “junior” bonds at a
10% interest rate
• \$50M of proceeds from
issuing 1M shares of stock
related to a 25% stake in the
company
How much money in total did we receive?
What was the stock price we issued at?
How much is the total equity of the company worth?
Stock price is arbitrary!
It’s important to note that the
company chooses the stock price it
wants to issue at.
We could have issued:
10 million shares @ \$5 per share
100 million shares @ \$.50 per share
1 share @ \$50 million per share
Either way, we still
dollars in proceeds
Implications
After raising publicly-traded stock, you are considered a public
company. Every quarter and at year end, you file an annual
report with various financial statements and notes called a 10-K
or 10-Q
A quick update on what our new
balance sheet looks like, post-financing
Assets:
Cash
Machines
\$70,000,800
\$
200
\$70,001,000
Liabilities:
Loans
Bonds Payable
\$
500
\$20,000,000
Equity:
Common Stock
\$50,000,000
Contributed Capital\$
500
\$70,001,000
Let’s fast forward a year…
The Income Statement
Revenue
-COGS
Gross Profit
-Operating Expenses
Net Income
Earnings Per Share
Stock price at issuance: \$50
per share
\$100,000,000
(40,000,000)
\$60,000,000
(50,000,000)
\$10,000,000
Number of shares: 1 million
\$10.00
Net Income (earnings)
EPS =
Shares of stock outstanding
Literally…how much your company earns per each share
Valuation
Finance is the process of raising capital for a
business, but in order to know the
appropriate amount of capital to raise and
how much it will cost, we need to value a
company
Investors and bankers have several
tools to value a company, but first…
Valuation
fruit you’ve never seen for him, but to
not spend too much for him.
The fruit is only sold by one vendor and
costs \$5 per pound, but you have no idea
if that’s a good price. What do you do?
You compare it to other things that are like
it, namely, other fruit!
You can refine your search further by
comparing to other fruit that look and
taste like it.
The same concept can apply to
companies:
T-shirt
Co
Price =
\$50.00 per
share
T-shirt
Co
Price =
\$5.00 per
share
Which is the cheaper investment?
What about if we look at EPS?
T-shirt
Co
EPS =
\$10.00 per
share
T-shirt
Co
EPS =
\$3.00 per
share
USIT seems to pay out more per share…
P/E- The Price to Earnings Ratio
Share price is not enough!
P/E: how much does one dollar of
this company’s earnings cost?
Price (the amount you pay)
\$50.00
=
USIT P/E =
=
Earnings per share (how much the
firm makes)
\$10.00
Price (the amount you pay)
\$5.00
= 2.5x
=
SCG P/E =
Earnings per share (how much the
firm makes)
5x
\$2.00
Become The Investor
So now which is the cheaper investment?
5x
2.5x
Remember: P/E ratios are a measurement of how
much you pay per dollar of earnings
The answer is… there isn’t one.
• Widely varying interpretations of P/E
– High P/E – investors value the earnings more,
willing to pay more
• Could mean optimism
– Low P/E – cheaper earnings, better deal
• Note: This is all relative
– We are comparing to similar companies
– “Cheap-er”, “costli-er”
Valuation
• Relative valuation is just one of the ways we
value a company and has its advantages and
• Later during the year we will discuss different
ways to value a company and will flesh out
further how to use these tools.
Sanity Check #3
• We’ve learned about the P/E multiple
• We’ve compared two companies and decided
which to invest in
Exercise
• Which of the following companies would you
Company
Price
Shares
Assets
Revenue
Profit
Margin
P/E
P/B
P/S
USIT
\$4.00
10,000,000
\$11,000,000
\$100,000,000
\$33,300,000
33.3%
1.20
3.64
0.40
SCG
\$7.57
5,000,000
\$12,000,000
\$125,000,000
\$48,000,000
38.4%
0.79
3.15
0.30
UCF
\$82.53
1,000,000
\$19,800,000
\$228,000,000
\$49,500,000
21.7%
1.67
4.17
0.36
Nike
\$67.73
2,000,000
\$8,000,000
\$48,000,000
\$35,700,000
74.4%
3.79
16.93
2.82
Average
\$40.46
4500000
\$12,700,000
\$125,250,000
\$41,625,000
41.9%
1.86
6.97
0.97
```