CH 1. Introduction
1. FINANCE
-
The study of resource allocation under conditions of uncertainty.
SUB-AREA
(1) Corporate Finance: - From the view point of the financial manager
A. Capital Budgeting
: process of analyzing, evaluating and investing in the projects.
B. Capital Structure
: decision on the specific mix of debt and equity to finance a firm's assets and operations.
C. Working Capital Management
: process of controlling firm’s operational efficiency and short-term financial health.
D. Dividend Policy
: process of deciding how to distribute the firm’s profit to the shareholders.
E. Corporate Governance
: structuring rules, practices, and processes to direct and manage a firm.
(2) Investment: From the view point of investors
A. Risk / Return
B. Portfolio Management
TYPES OF ORGANIZATION
(1) Sole Proprietorships - the business owned by one individual
A. Advantage
１) Easily and inexpensively formed
２) No corporate income tax [taxed as personal income to the owner]
B. Disadvantage
１) Limited ability to raise large capital
２) Limited Life
(2) Partnerships : two or more persons associated to conduct a noncorporate business
A. Advantage
１) Easily formed
B. Disadvantage
１) Limited ability to raise large capital
２) Unlimited liability to debt
３) Limited Life
４) Difficulty in transferring ownerships
(3) Corporations
A. Advantage:
１) Unlimited Life
２) Easy transfer of ownership
３) Limited liability
B. Disadvantage
１) State and Federal government regulation
２) Double Taxation
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GOAL OF CORPORATION
-
Maximize shareholders’ wealth
AGENCY RELATIONSHIP
A.
B.
C.
D.
Conflict of interests between two parties due to the separation of ownership and management
Occurs because managers place their own goals ahead of shareholders' goals.
Occurs due to the lack of alignment between the interests of managers and shareholders.
Principal
Master(군주)
Stockholders
Store owner
: Agent
: Slave(노예)
: Managers
: PT employee (i.e., Arba??)
AGENCY COST
-
Agency costs incur when the agent (managers) uses the firm’s resources for their own benefits
(1) Monitoring Cost
-
Costs associated with monitoring the agent’s behavior
Accounting Audit, CCTV
(2) Bonding Cost
-
Costs associated with bonding agent’s behavior to align the interests of both parties
Stock option
(3) Residual Loss
-
Remaining costs incurred from divergent interests of both parties after monitoring and bonding
BJR cost
FINANCIAL MARKETS
(1) Primary Market
-
Original sale of securities by firm or government
Initial Public Offering (IPO)
Public Offering (to general public) versus Private Placement (to a specific buyer)
(2) Secondary Markets
-
Market in which securities are traded after the original sale
Dealer Market (i.e. Car dealer) versus Auction Market
(3) Money Market versus Capital Market
-
Short-term securities versus Long-term securities
Short-term securities
CD (certificate of deposit), CP(commercial paper)
Long-term securities
Equity
Bond
Derivatives (option, futures)
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BUSINESS FLOW IN A FIRM
New Investment
INVESTING
Depreciation
Asset Disposal
- CF Estimation
Asset
Quantity
- Asset ReStructure
Price
Fixed Cost
OPERATING
- REV. Anal. (PQ)
- Oper. Lev. (FC.VC)
Varable Cost
Dividend
Earnings
Interest EXP.
Equity
Retained Earnings
Debt
FINANCING
- FIN. Leverage
- Capital Structure
- Cost of Capital
Invest. Funding
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CH 3. Working with Financial Statements
1. Key Concepts
-
Know how to compute and interpret important financial ratios
Understand the problems and pitfalls in financial statement analysis
Standardized Financial Statements
-
Common-Size Balance Sheet: Compute all accounts as a percent of TOTAL ASSETS
Common-Size Income Statement: Compute all line items as a percent of SALES
Standardized statements make it easier to compare financial information, particularly as the
company grows
They are also useful for comparing companies of different sizes, particularly within the same
industry
Ratio Analysis
-
Ratios also allow for better comparison THROUGH TIME or BETWEEN COMPANIES
Categories of Financial Ratios
-
Liquidity ratios
Financial leverage ratios
Asset management or turnover ratios
Profitability ratios
Market value ratios
Why Evaluate Financial Statements?
A. Internal uses
１) Performance evaluation: Compensation and comparison between divisions
２) Planning for the future: Guide in estimating future cash flows
B. External uses:
１) For Creditors and Stockholders
Benchmarking
-
Ratios are not very helpful by themselves; they need to be compared to something
A. Time-Trend Analysis
１) Used to see how the firm’s performance is changing through time
２) Internal and external uses
B. Peer Group Analysis
１) Compare to similar companies or within industries
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Sample Balance Sheet
Cash
100
A/P
A/R
1,000
N/P
Inventory
300
Other CL
Other CA
200
Total CL
Total CA
1,600
LT Debt
Net FA
2,400
C/S
Total Assets
4,000 Liab. & Equity
400
100
1,100
1,600
800
1,600
4,000
Common Size B /S
Cash
2.5%
A/P
A/R
25.0%
N/P
Inventory
7.5%
Other CL
Other CA
5.0%
Total CL
Total CA
40.0%
LT Debt
Net FA
60.0%
C/S
Total Assets
100.0% Liab. & Equity
10.0%
2.5%
27.5%
40.0%
20.0%
40.0%
100.0%
Sample Income Statement (Mil$)
Revenues
4,000
100%
Cost of Goods Sold
Expenses
Depreciation
EBIT
Interest Expense
Taxable Income
Taxes (40%)
Net Income
EPS ($)
DPS ($)
1,600
1,200
400
800
200
600
240
360
2.00
1.00
40.0%
30.0%
10.0%
20.0%
5.0%
15.0%
6.0%
9.0%
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Financial Ratios
(1) Liquidity Ratios
-
Current Ratio = CA / CL
Quick Ratio = (CA – Inventory) / CL
Cash Ratio = Cash / CL
(2) Financial Leverage Ratios
-
Total Debt Ratio = (TA – TE) / TA
Debt/Equity = TD / TE
Equity Multiplier = TA / TE = 1 + D/E
Times Interest Earned = EBIT / Interest
(3) Asset Management, or Turnover Ratios
-
Inventory Turnover = Cost of Goods Sold / Inventory
Days’ Sales in Inventory = 365 / Inventory Turnover
Total Asset Turnover = Sales / Total Assets
(4) Profitability Ratio
-
Profit Margin = Net Income / Sales
Return on Assets (ROA) = Net Income / Total Assets
Return on Equity (ROE) = Net Income / Total Equity
(5) Market Value Measures
-
PER = Price Earnings Ratio = PPS / EPS = MV/NI
PBR = Price-to-Book value Ratio = Market-to-book ratio = PPS / BVPS
Book Value Per Share = (Common stock + RE )/ # of shares outstanding
Du Pont Identity
-
ROE= NI / E = NI/SALES * SALES/TA * TA/E = PM * TAT * EM
40% = 10% * 2 * 2
20% = 10% * 1 * 2
I. Profit margin is a measure of the firm’s operating efficiency
– how well does it control costs
II. Total asset turnover is a measure of the firm’s asset use efficiency
– how well does it manage its assets
III. Equity multiplier is a measure of the firm’s financial leverage
Payout and Retention Ratios
A. Dividend payout ratio = Cash dividends / Net income
B. Retention ratio = Additions to retained earnings / Net income = 1 – payout ratio
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